You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right — and that's the only thing that makes you right. And if your facts and reasoning are right, you don't have to worry about anybody else
All investing and speculation is basically an exercise in attempting to beat time
Stock Market as a Living Organism
Unchecked animals reproduce until the food supply or illness limits them. Similarly, unfettered capitalism left to itself has a tendency to drift into either financial instability or monopoly
For example, there were important credit crunches in 1987, 1997 and 2007. There will be probably another around 2017. Periodically the big banks run into trouble and when they do it usually is a good time to invest in them
This happens because the financial market is a highly connected market, traders know what everyone else is doing. Financial markets are a robust yet fragile system. Most of the time, they are resilient to small shocks (robust), but occasionally a small one percolates across the entire system, on a near-global scale (fragile). Analysts desperately tell stories after such events to give the illusion they understand
However, physicist Doyne Farmer shows how the properties of financial markets can be explained on the assumption that traders have zero intelligence — Financial markets could be understood with a simple model, which explained how ants forage for food (Paul Ormerod)
About Financial Planning
There’s some end at last for the man who follows a path; mere rambling is interminable
Seneca, 60 AD
Archimedes suggested defining a straight line as the shortest path between two points. This is not true in the Stock Market: the middle section of the shortest path to your financial goals is not set by your final destination or your current situation. Different actions are required according to the current stage of the long-term business cycle1
We propose to follow an opportunistic approach instead — according to the indicated Action Plan
Personal Goals
Do you know the only thing that gives me pleasure? It's to see my dividends coming in
Our long-term goal is to build a portfolio with a stable, high dividend yield and — more important — a dividend growing at a high rate
For investors, the big diversified banks offer a rare combination: juicy yields plus significant earnings growth
Our goal can be achieved with a portfolio concentrated in diversified banks and other financials with large capitalization
Dividend stocks outperform the market. Wharton professor Jeremy Siegel found that, from 1872 to 2003, a full 97% of equity returns came from dividends — specifically, reinvested dividends. Only 3% came from the original principal (Stocks for the Long Run).
Dividends are also built-in protection from the corporate money-squandering endemic to this age: Maintaining a payout forces management to pick and choose only the very best projects. That's smart because it saves a ton of corporate waste.
All of that hits your bottom line as a dividend investor: Rob Arnott and Clifford Asness found that stocks paying the highest dividends actually had the highest earnings growth over the following 10 years!
The financial-services industry is made up of:
- commercial banks
- savings & loans and mortgage-financing companies
- consumer-finance firms like credit-card issuers and small-loan companies
- money managers and trust companies
- investment banks and brokerages
- insurance companies
- firms engaged in developing or owning real estate, including real-estate investment trusts
Expected Risks
The long-term goal is a very risky proposition by itself,
We would be careful about buying any financial stock. It is virtually impossible to find out what toxic brew the financial companies may hold in their balance sheets (either because they may not want you to know the truth or because even they don't know the truth themselves). Financial companies use “best estimates” for many line items on the balance sheet and when companies are in trouble, they frequently have a chance to downplay the seriousness of the problems. Most of them are honourable but there are a few who use, what I've coined, “the 'DROP' principle” on unsuspecting investors. (D is for dribbling out the bad news slowly, R is for raising money, and OP is for dishing out the most optimistic projections.) Once the money has been raised from investors, these companies will announce a few months later “the big drop” that is, to take a big write-down
Banks make money from two sources. They take interest on our current accounts and charge us for services. This is easy, safe money. But they also take risks, big risks, with the whole panoply of loans, mortgages, derivatives and any other weird scam they can dream up. “Banks have never made a penny out of this, not a penny. They do well for a while and then lose it all in a big crash.”
The consequences are a well-organized disapparition of owner's equity,
If the Federal Reserve judges that a major financial institution:
- is too big to fail in that its failure will generate systemic risk
- has followed portfolio strategies that have produced inappropriate and excessive leverage
- requires immediate action
then the Federal Reserve will intervene to structure and support a deal that leaves principals and investors in the offending systemic risk-creating institution with effectively zero equity. Counterparties will be rescued. Principals and investors will not—even if normal more lengthy legal and bargaining processes would give principals and investors a share of the equity value on the table (…I)n a crisis the lender-of-last-resort will always show up, but investors and principals in individual institutions that need to be specially rescued will discover that the lender of last resort is not their friend
Time Horizon
We must wait 5 to 10 years before we buy this portfolio over one year, and spend the rest of the time hoarding capital and researching financial businesses
Any financial enterprise's assets are mostly financial papers, which must be valued in the balance sheet at the current market value (mark to market). There are cyclical market disruptions that diminish the financial paper's market value, even though they sustain the cash flow. These disruptions remain for a while because papers decrease or stay depressed in price, since that cash-holders know that they can buy them cheaper if they wait. Cash is King when this happens
We started building this portfolio using a straight-line approach in 2004-2005. However, 2007 was particularly exhausting because we timed the market terribly wrong. We learned that this approach is not be best one to build this type of portfolios
For example, we bought a lot of USA bank shares between February and October 2007. Prices had already fallen 20% off from the cycle top, but they still have to fell another 30% — even when we knew perfectly that stock prices usually fall ~50% from the top to the bottom (ouch!)
A stock takes the stairs up, but the elevator down
If we had waited until November 2007 to do all the shopping done in the US markets since 2004 (when retail investors rushed in), we could have increased our annual dividends about 50% by now — this is called premature accumulation, one of the more common sins of value investors (Bruce Berkowitz)
Detailed Plan
We have included a check-list of conditions to be verified before submitting buy-orders in the future, to avoid the same mistakes timing the market. The intention is to obtain much better results during the next credit crunch, which probably will happen between 2011 and 2017
When an individual stock held as a dividend investment lowers its dividend, immediately sell it
