attack my high-yield investing

[Alex in Virginia]

response #3 to comments on my high-yield investing

Your principal is very at risk, especially with high-yield stocks and bonds as opposed to something more tame. Those kinds of yields I associate with nearly out of business companies.

You are not very diversified, meaning you can expect wider portfolio value swings than necessary. With so many similar investments you are more vulnerable to a single event/trend knocking your entire portfolio down.

OK, now we're going to start getting into some of the nitty gritty. IMO, my portfolio is extremely diversified. These are my guidelines there: no more than 6% of the portfolio in any one company... no more than 3% of the portfolio in any one "junk" bond... and no more than 12% of the portfolio in any one industry (stocks and bonds combined). This has allowed my portfolio to roll with the punches and keep growing the dollar dividend payout and the dividend yield percent notwithstanding the occassional dividend cut and even dividend suspension.

At this moment, I hold positions in 25 separate companies in 14 different industries. Is that not diversified? (Cash and real estate I've kept separate from this discussion.)

Regarding why these companies' dividends are so high. These are not companies "nearly out of business". Setting aside the occassional accidental high-yielder, every company I own stock in is committed to returning value to its stockholders in the form of dividends to the highest degree possible within the bounds of financial responsibility. And every capital action these companies take is intended to be accretive to that payout, either immediately or within less than a year of the action having been taken.

Notes:
[] I'm responding to comments in the order they appear, so thanks for being patient

[] Don't be put off (please) by my use of the word "attack" in the thread title; I DO want and APPRECIATE any and all devil advocate comments

[] And, no, I'm not saying my way is the best way to make money in stocks; but I am questioning why so many financial advisors have told me (without providing reasons) that my way is NOT a way to make money in stocks.

Alex in Virginia

 

[RunningBum]

I look at the stock exchange as a horse race. The first horse to the finish line wins. This horse race has a few special rules. You can start the race whenever you like. You can stop the race whenever you like. In fact, when your horse falls behind, you can stop the race, and jump onto the lead horse! It seems kind of hard to lose a race like that

Except in the stock market horse race, if you jump on the leader, you don't get any of the benefit of the leading horse's effort up to then. It's pulled back to the same position as the horse you just jumped off of. Maybe that lead horse will continue to run better than your last horse, but quite often that lead horse runs out of steam. What that analogy sounds like is a "buy high, sell low" strategy. I doubt you really meant that, or really follow that.

Good luck. I appreciate that you (or maybe it was the OP) say that for you, active investing has been better. For me, I found that my passive investments were doing better, so now I'm nearly 100% passive. But I didn't spend enough time and didn't have any real rules or guidelines for getting in or out of individual positions. And I certainly didn't have any ironclad rules for when and how to adapt. In all seriousness, you're sounding somewhat like the 5% monthly Forex system guy.

 

[bondi688]

Alex in Virginia
Good luck with your investment plans. My "pretty well diversified dividend yielding blue chips stock portfolio" made a total return of 10.4% in 2012, including both growth and dividends, which was significant less than the return I got from the mutual funds I held at either Fidelity and Vanguard.

If the trend continues, I'll probably go more with index funds or having professionals picking stocks and rebalancing the holdings in actively managed funds in the future.

 

[vxp036000]

Hopefully I can make it clear that I make nowhere near 5 % / month nor do I expect that kind of return. That sounds like a recipe for disaster. I average a little better than 10% in a year. Trying to improve on that would require more risk than I'm willing to take.

Except in the stock market horse race, if you jump on the leader, you don't get any of the benefit of the leading horse's effort up to then. It's pulled back to the same position as the horse you just jumped off of. Maybe that lead horse will continue to run better than your last horse, but quite often that lead horse runs out of steam. What that analogy sounds like is a "buy high, sell low" strategy. I doubt you really meant that, or really follow that.

Good luck. I appreciate that you (or maybe it was the OP) say that for you, active investing has been better. For me, I found that my passive investments were doing better, so now I'm nearly 100% passive. But I didn't spend enough time and didn't have any real rules or guidelines for getting in or out of individual positions. And I certainly didn't have any ironclad rules for when and how to adapt. In all seriousness, you're sounding somewhat like the 5% monthly Forex system guy.

 

[KMyer]

I'm an accountant so I'll suggest that the OP take a look at the financial statements of a sample of the entities that have bonds that are yielding 10% in the current low interest rate environment. I suspect that the financial statements will be really "ugly". The entities will probably be insolvent, under-capitalized or unprofitable. I would be hesitant to have a large percentage of my retirement savings invested in these type of entities. Good luck though.

 

[JPatrick]

As a dirty rotten market timer, I must say the OP and his sidekick have launched one of the best "sell soon" signals I have seen lately. Crap, now I've got even more homework for the weekend.

 

[mathjak107]

the biggest problem facing those who's argument is i don't really care what my principal is doing if i am not selling it is this.

if you are living off dividends and or interest the issue becomes when dividends and interest are cut and there is a a shorfall in income you will have to sell a bigger chunk of principal to make up the shortfall in income cutting future income.

total return is all that counts and those that turn a blind eye to the principal part eventually get a rude awakening.

 

[Alex in Virginia]

Response #4 to comments on my high-yield investing strategy

Keep in mind if you have a company that goes bankrupt in your portfolio, that is a permanent loss. So your portfolio won't be spitting out 8% once that happens.

your portfolio would not be growing if you are taking all the income out... so any defaults are to principal... and your buying power will be dropping over time due to inflation...

These comments I think go to the questions of diversification and of the management of the portfolio. I've already spoken to diversification, so let's see if what I say about management makes sense to you all.

This is an actively managed portfolio, with some buys and sells happening pretty much on a weekly basis. I have hopefully explained already why IMO my investing approach frees me from having to sell holdings in order to generate income from the portfolio. But I do sell holdings whenever there is a sufficient gain to be realized. That's (and some of you may have caught this) how I can have an 8% dividend-yield portfolio that has grown in actual book value by more than 20% per year over the last 3 years. (I have left out of that calculation the bumper crop gains of the 2009 recovery, the first year I used this investing strategy.)

So, my first answer to the points raised by hlfo718 and Texas Proud is that gains so realized will cushion realized losses as well as provide added capital to keep the portfolio growing. And over the last 4 years that is what has happened. Whenever I have taken an intentional realized loss, there have been realized gains to offset it. The loss has not been "permanent" -- as both commenters quoted above seem to assume.

My second answer (and I realize this will require an extended explanation in a future post) is that I vett in depth every one of the companies I invest in to ensure as much as possible that the company is not going to go bankrupt, as hlfo718 fears.

Nevertheless, and in spite of best efforts, sh*t does happen. So I'll close with 2 little war stories that I hope will give more color to what I am trying to explain.

FIRST STORY. I am still holding shares in a regional telecom (OTT) that has lost 90% of its market value since I bought the shares -- and the dividends have been "deferred." OTT unexpectedly lost its service contract with one of the major national telecoms, and that contract represented too large a share of its business. Now OTT management is scrambling to find replacement business and to rework its financing. But because OTT represents only 4% of my portfolio's book value (diversification!), I have just suffered a "ding" and not a disaster. And realized gains from other share sales have allowed me to buy more shares in other dividend-paying companies to more than make up for the (temporary?) loss of OTT dividends.

SECOND STORY. Just 2 days ago I sold off my ARR shares at a 10% loss. I sold them because in my judgment recent shifts in Federal Reserve policies are going to inexorably eat into ARR's ability to pay dividends and ARR management can't do anything about that. Was ARR a bad buy? Not hardly. Over the 2 years that I held ARR positions (bought, sold, bought, and now sold), I collected 30% of my investment in dividends and realized a net 6% loss on the stock sales. My net net is a 24% realized profit (12% per year +/-) on my original investment. My portfolio's book value and dividend generation grew as a result of the reinvestment of that 24% realized profit. Works for me.

As far as inflation goes, I believe it will be a wash. Inflation will push up company profits and dividends, right along with consumer prices.

Am I making sense?

Alex in Virginia

 

[mathjak107]

time will tell....

kind of like those who in their mind say that they will give up the 10% at the top and the 10% at the bottem and keep the 80% in the middle.

like those who followed fabian and his moving averages proclaimed.

it all sounded like a wonderful plan. how could it fail?

well under battlefield conditions nothing went as planned and things only worked until they broke rank and didn't.

needless to say it all sounded so good but failed to actually work out that way.

all i can say is good luck and hope it works for you.

 

[Animorph]

The past years have been great, but not at all representative of a variety of market conditions. Much more similar to the run-up to 2000, though hopefuly not too overvalued. Pretty much all positive and hard to do anything wrong. I would suspect a good debt ceiling fight might change things a bit.

You sound less diversified than the S&P 500. Which is not terribly diversified itself. International? Growth? Anything without a dividend? Small cap? Emerging markets?

Here:
Is High Yield Overvalued?

"Historically, high-yield bonds have been one of the riskiest fixed-income sectors. In 2008, the high-yield bond category had a drawdown of over 32%. Since 1989 there have been 12 occurrences of drawdowns of over 5%. High yield is what's known as a high-kurtosis asset class, which means that extreme market events happen more frequently than in other asset classes. As you can see from the chart below, high yield is prone to negative shocks."

 

[NW-Bound]

The thread title says "Attack my high-yield investing". Well, the OP got his wish.

The majority of posters here falls into 2 groups: people who buy broad market indices and do not believe in stock picking, and people who trust the managers of Wellesley and Wellington to do the picking for them. Only a minority including myself does true active investing, meaning choosing stocks or ETFs and doing our own AA rebalancing.

However, perhaps 99% believe in diversification, because we cannot be sure that we are always right, and simply hope that we are right more often than wrong.

There are indeed people who like a concentration in a type of asset, or a sector. For example, there was Mark Twain who said "Put all your eggs in one basket -- and watch that basket!". Well, Mark Twain had to file for bankruptcy.

But then, there was Warren Buffet who said “Wide diversification is only required when investors do not understand what they are doing.” However, we should note that Warren said wide diversification. He indeed shuns tech stocks and other new-economy equities. So, his holdings look nothing like the S&P500. Yet, he still does well.

So, I dunno. Even as an active investor, I still diversify quite a bit. I only have the audacity to increase holdings of certain sectors that I felt were the current underdogs and might have a chance to outperform in the next few years. Even when I was proven correct eventually, the timing of the execution was not easy. Yes, I would make money, but do I beat the indexers? It ain't easy.

All this is to say, I wish the OP good luck. The higher your concentration in a sector of the market, the higher your chance of outperforming (how does one outperform the market if he indexes?), but also at a higher risk of losing big. But if you are convinced that you are right, you can simply carry on your virtuous way. There's no need to ask to be attacked.

PS. Note that Wellesley's equities tend to be the dividend-paying boring types of company. They do not own the go-go tech stocks, and have only a small segment of the whole market. Yet, their performance has been pretty darn good and keep up with the S&P500 in the long run. Go figure!

 

[Htown Harry]

Alex,

1. Have you compared your returns to any sort of index?

For example (with a 12/31/12 yield 4.11%):

Morningstar U.S. | Morningstar Indexes

The Morningstar Dividend Yield Focus Index is a portfolio of high quality and high yield US stocks screened for consistent records of dividend payments and the ability to sustain them in the future. The index consists of 75 stocks that are weighted in proportion to the total pool of dividends available to investors.

Total returns:
Trailing %
1 Month -1.123
Month -2.64
YTD 10.15
1 Year 10.15
3 Year Annualized 14.99
5 Year Annualized 7.99

2. Managing the credit risks associated with a high-yield stock is a common concern in the posts. What quality tests do you apply in selecting individual stocks? In assessing and managing that risk across the portfolio?

Your OP cites what I consider a price-based or technical indicator as the first filter for your stock selections, i.e. yield exceeds x%. Your description of any "quality" screens are missing, however.

I will illustrate what I am getting at.

Construction of the index above is described in an interview here.
Morningstar

The index manager cites three fundamental analysis techniques he uses in selecting the constituent stocks:

The strategy itself is based on two pillars: business quality and financial health. In the Dividend Yield Focus Index, business quality is indicated by our economic moat ratings, and financial health is measured by distance-to-default...a company needs to earn good marks on these two tests plus a third (our analysts’ uncertainty ratings, which can capture risks not explicitly included in the first two).

Clearly a fundamentals-based approach applied as a second (and third and fourth) screen after dividend yield.

 

[target2019]

Alex,
Your strategy is high risk, and that fits your investing style. There are two items that stick out quite a bit.
1) You started this strategy in 2009.
2) You are the sole executor of the strategy.

1) There is advantage in the upside from the Great Recession. But it is a cycle, and there is more to come. See https://www.fidelity.com.hk/investo...t-economy-investing/the-investment-clock.page
2) The greatest risk IMO is your self. Something could happen to you, and you become unable to continue to carry out this strategy.

 

[Htown Harry]

Here's another way to compare the quality of a basket of dividend-paying stocks. This time, dividend quality is the first filter, followed by yield.

At this web page, 200 dividend-paying stocks belonging to the Dividend Achievers, Dividend Aristocrats and U.S. Dividend Champions are listed. These stocks are sorted by dividend yield from highest to lowest.

Nine have yields greater than 8%. Another four have a yield between 6 and 8%.

Stocks With Rising Dividends: All Dividend Achievers, Dividend Aristocrats and U.S. Dividend Champions (Sorted by Dividend Yield)

A stock-picking technique like this might be called "Dogs of the Dividend Payers", after Dogs of the Dow.

 

[veremchuka]

Hopefully I can make it clear that I make nowhere near 5 % / month nor do I expect that kind of return. That sounds like a recipe for disaster. I average a little better than 10% in a year. Trying to improve on that would require more risk than I'm willing to take.

Why go through "all that work"?

For 2012 the Vanguard Total International Stock Index Admiral shares returned 18.21% and Vanguard Total Stock Index Admiral Shares returned 16.38%.


No research, analysis, decisions, et al just buy it. As it's been said if this works for you fine but it's a lot of work, taxes if in a taxable account, trading costs.

 

[vxp036000]

Short answer: because I enoy it and, for me, it is actually less risky. Case in point; when the market plummited after the recent election, I had already sold off my shares for a substantial profit. I jumped back in the day after New Years and won another substantial profit. In the meantime, most of my passive investing peers were moaning and groaning about their massive losses during the downturn. I lost nothing.

Why go through "all that work"?

For 2012 the Vanguard Total International Stock Index Admiral shares returned 18.21% and Vanguard Total Stock Index Admiral Shares returned 16.38%.


No research, analysis, decisions, et al just buy it. As it's been said if this works for you fine but it's a lot of work, taxes if in a taxable account, trading costs.

 

[NW-Bound]

For 2012 the Vanguard Total International Stock Index Admiral shares returned 18.21%...

For the record, VTIAX went down 15% in 2011.

Just playin' devil advocate...

 

[vxp036000]

I should add that the trading costs are neglegible compared to profit when you're working with $250k + of capital.

 

[veremchuka]

For the record, VTIAX went down 15% in 2011.

Just playin' devil advocate...

Huh?

From the Vanguard website:



Total International Stock Index Admiral Shares VTIAX International 0.18% — 2.32% 18.21% — — 3.85%
(11/29/2010)

Average Annual Returns as of 12/31/2012 the red is 1 year

never mind i see this is since 2010 not for the 2012 year!

 

[vxp036000]

16.19% according to google finance. Ouch! I think I'll stick with my stocks.

For the record, VTIAX went down 15% in 2011.

Just playin' devil advocate...

 

[vxp036000]

And the Dow was up 5.5 % that year.

16.19% according to google finance. Ouch! I think I'll stick with my stocks.

 

[Htown Harry]

Here's yet another way to look at risk, specifically the sequence of returns risk to principal for a basket of dividend-paying stocks over the past few years.

Pasted below is a 6-year "stock return map" for VYM, the Vanguard High Dividend Yield Index Fund, which employs an indexing investment approach designed to track the performance of the FTSE High Dividend Yield Index.

Notably, this covers a period of declining interest rates, which all things being equal is favorable for dividend stock values.

Tool available for inputting any stock here:
Stock Return Map Maker - See Patterns of Winners and Losers
An old thread that shows historic real and nominal returns for the S&P 500 here:
http://www.early-retirement.org/forums/f28/new-chart-shows-real-return-54123.html

 

[Alex in Virginia]

response #5 to comments on my high-yield investing

Alex,

... 2. Managing the credit risks associated with a high-yield stock is a common concern in the posts. What quality tests do you apply in selecting individual stocks? In assessing and managing that risk across the portfolio?

Your OP cites what I consider a price-based or technical indicator as the first filter for your stock selections, i.e. yield exceeds x%. Your description of any "quality" screens are missing, however.

Thanks so much for asking, Harry. (I've just been waiting for someone to ask. )

Once a week, I run a dividend-yield screen to see where I might place unallocated cash that's come into my portfolio from dividends and stock sales during the week. I screen for a dividend yield of 8% or better, and then sort the companies out from highest to lowest yield. Then I vet them one at a time (starting with the highest, of course) as follows below until I've allocated all available portfolio cash except for a 5% reserve.

My primary financial vetting of potential additions to my stock portfolio include:
-- current liquid assets must exceed current liabilities
-- total assets minus goodwill must exceed long term liabilities
-- operating cash flow must exceed paid-out dividends
-- net income must exceed interest payments

In my calculations, I also factor out any unrealized gains on hedges and other derivatives.

I review these parameters for the 4 quarters prior to my possible purchase.

I strongly opt for companies with 1.5x or better ratios for any or all of the above criteria. I'll put up to 6% of my portfolio in such a company. If a company's ratios are not that strong (but still at least 1.0x), I will limit my exposure to 3% - 4.5% of my portfolio, "depending."

If I am considering a high-yield bond instead of a stock, I will also review the Moody's report on the company and the bond issue and do a qualitative assessment of positive and negative points in the report. Positives have to exceed negatives. The bond has to be rated at least B3. And its current yield must be 10% or better. If the bond passes, I will put 3% of my portfolio into it. Otherwise, bupkus.

Secondary financial criteria I look at include cash per share, book value per share and net profit margin. Acceptable numbers vary by industry.

If the company has passed that vetting, I will do an in-depth review of how its business operates and how management has presented its future expectations and plans in its most recent quarterly conference call. I will also review news headlines on and from the company for the previous 3 months to make sure there isn't some snake lurking in the grass behind the numbers.

I will repeat and update this review on a quarterly basis for each company in my portfolio. (News headlines I check daily because snakes can bite you before you know it if you're not alert.)

In general terms, that's it. There's a lot of other parameters that matter from industry to industry, but it's probably too much detail. Stuff like are a shipping company's vessels on long-term charter or offered on the spot market... is the prepayment rate on a REIT's mortgages under control... what is an energy exploration company's production ratio of oil to gas... yaddy, yaddy, yaddy. (It all matters because 2 companies in the same industry with a presently similar dividend yield can prove to be very different in how sustainable that dividend yield may be.)

Once I decide a company is "good to go", then I analyze the stock price chart to determine the buy price at which the risk/reward ratio of buying the stock is acceptable to me. But that's a whole other post.

So, how does my "quality screening" sound?

Cheers!

Alex in Virginia

 

[brewer12345]

It sounds rather simplistic and clueless. Good thing you have been doing this in a rising market.

 

[vxp036000]

To someone that doesn't understand the market, active investment through a "dogs of the DOW" approach or directly trading stocks is doomed to failure. But don't generalize it to folks that actually put the effort into coming up with a profitable strategy. I know, impossible... Just keep thinking that; it makes it easier for the rest of us

It sounds rather simplistic and clueless. Good thing you have been doing this in a rising market.