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Dividends vs. Capital Appreciation

People in retirement don’t need to invest conservatively, and young people don’t need to invest aggressively.

Dividends vs. Capital Appreciation

10 Stocks to Buy & Hold Forever

SolarCity (SCTY)

First, thanks for your feedback on last Thursday’s column about driving a rental car in Ireland without insurance. I appreciate all the responses.

Roughly a third of respondents disagreed with my conclusion. They’d buy the insurance because it brings peace of mind.

The remainder either agreed or contributed information and anecdotes.

There’s no new conclusion, but I’m happy to have been able to share an idea.

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Moving on, the following letter came in recently.

Dear Tim,

I am a new subscriber to Cabot Stock of the Month and also Cabot Benjamin Graham Value Investor. At 66, I am retired and want to have enough money coming in from my investments along with my S.S. to allow me to live a simple, but financially safe life. I am not looking to make millions, but just stay afloat without the need to be looking over my shoulder all the time.

If I could invest in the CDs that used to return 7% with a return of principal, I would be satisfied. Since that option doesn’t exist any longer, I am doing my best at choosing stocks that provide dividends/interest which provide my income. I always felt that I needed to have a stock that provided me “something” and even if the stock declined in value, my bills would get paid.

However, by doing this I miss out on the capital gains that the big successful stocks like Apple, Google, and Amazon have provided.

Every time I look at stocks that have great numbers and momentum, I fear that success has possibly reached its limit and that I would be buying “expensive” and lose to a big drop in the market. So, I have usually purchased stocks that I felt were “cheaper” and could rebound to where they once had been. At least I am receiving a dividend and feel that the company will rebound eventually. I choose lots of “commodity” stocks using that “theory.”

I can’t seem to choose stocks that will only benefit me with a capital gain. Moreover, when I see that they have done so well for the past few years, I feel as if I am late for the party and so I continue to avoid choosing the more “successful” stocks.

Today, I read that you suggested that a stock be bought with an entry price of 38-40, but if the stock were at 37, NOT to buy it. That really made me recognize that some pullbacks are OK while others are not. And, more important, if the stock price goes down to that “37" which I thought would be better for me, but makes you hesitate, then obviously, my thinking needs some realignment.

I thought, maybe you can help straighten me out with your view about buying “high.” I know, in your estimation, the stock has higher to go, so in your thinking, the stock is NOT high. In fact, when you said to NOT buy at 37 but buy at 38-40, it really rang home about how you interpret the health of a stock, which is in opposition to my “careful” method.

I believe Cabot Benjamin Graham Value Investor will be more to my liking, but since I ventured into the stock market in 2006, (preferred stocks only) and experienced the 2008 meltdown (I owned Lehman Bros.), I have been leery about buying stocks that are going up. But, in doing this, I have lost out on the huge gains that have taken place since March 2009. (Yet, interestingly, my biggest gainer was a Philippine company called Jollibee which paid no dividend and also Cheniere Energy which also paid no or low dividend.)

Perhaps, you have some “words of wisdom” regarding my reluctance to buy stocks purely for their possible gains. My fear has been that if the market tumbles, I not only earn nothing, but possibly lose a big portion of the value of my portfolio.

I still intend to buy stocks that return dividends, but I believe it may be worthwhile to mix in other “good, well run, healthy companies” that happen to be going up in price. I need to see that as something positive, not something to run from.

If you respond, I will appreciate your thoughts very much.

Sincerely,

Rich S.
(currently living in the Philippines but returning to the states next year).

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Rich raises three main points, and there are several factors to consider here, but I’ll start with the biggest one, his personality, which guides his investing style.

ONE: INVESTING STYLE

Rich clearly craves-and is comforted by-the reliability of dividend payments so he can pay his bills. He doesn’t need great growth; he wants the security of being able to meet his living expenses. And while he doesn’t say that his current assets are sufficient to make that possible, I get the sense that he’s close to it. Furthermore, the entire tone of his letter makes it clear that the risks that come from buying and owning stocks that don’t pay dividends are simply too uncomfortable for him.

Thus, dividend-paying stocks-and other investments that provide regular income-are what he should focus on.

And thus Cabot Stock of the Month is not the best Cabot advisory for him, as only a minority of the stocks recommended there typically pay dividends.

Cabot Benjamin Graham Value Investor is a better choice, as it does recommend good stocks that are cheap. If Rich buys these, he has the comfort of knowing that downside potential is small while upside potential is substantial.

But perhaps the best choice for him is Cabot Dividend Investor, which we launched just this year and is specifically designed to bring an investor a growing stream of dividends-ideally, but not necessarily, in retirement.

Which brings me to a brief digression.

Contrary to the teachings of mutual fund marketers, your investing style need not be dependent on your age.

I write frequently here about high-potential growth stocks that are changing the world because those are the stocks I’m most interested in. That reflects the personality of my life (evident in driving in Ireland without insurance among other things), and that guides my investing style. My very first investment, for example, was Mylan Labs, the first maker of generic drugs. Amazon was a big winner, as was Tesla Motors more recently. I’ve had losses, too, but I sell them quickly, and then forget them.

But my father was an even more aggressive investor than me! He’d frequently have more than a third of a portfolio invested in one aggressive growth stock. And he could shake off a loss of 20% and jump right back into the market targeting another high-flier-even when he was much older than me.

My daughter Chloe Lutts Jensen is still developing her style, but one thing is clear; she has a better understanding of the fine points of income investing than my father or I ever had-or wanted to! Before she joined Cabot, she wrote about debt instruments for two institutional publishers, and she’s the chief architect of IRIS (Individualized Retirement Income System), used in Cabot Dividend Investor.

You can read more about Cabot Dividend Investor by clicking here.

In sum, people in retirement don’t need to invest conservatively, and young people don’t need to invest aggressively. What’s most important is that you use a system that fits your personality and allows you to sleep well at night.

TWO: BUYING LOW

In real life, whether we’re buying tomatoes or cars, we’re taught to hunt for bargains-lower is better.

And Rich is correct in looking for low prices in quality stocks that are temporarily on sale. If you can buy a dividend-paying stock on sale, your yield (based on your cost) will soon be higher than it will for people who bought higher, whether before or after you.

But buying low is not recommended when buying growth stocks! Yes, buying dips is recommended, as in the example Rich S. mentioned where I recommended buying between 38 and 40.

But there’s a fine gray line between a normal dip and the change from an uptrend to a downtrend. In the case Rich mentioned, I determined that 37 was that line. When a growth stock you’re interested in shows abnormal weakness (suggesting it’s beginning a real downtrend), you’re usually better finding a stronger stock. For a good example of a growth stock that entered into a downtrend, take a look at Coach (COH). Someday it will be a bargain, but right now the sellers are still in control, as they have been for years.

THREE: MARKET CYCLES

In his letter, Rich is asking permission (in a way) to invest more aggressively for capital gains, even though he’s been uncomfortable with that idea for years.

To me, that sounds like a man who’s seen other people profiting from a bull market and who is now considering changing his system to join the crowd. And to me, that’s a warning. In every bull market, the very last person to get on board gets hurt. I’m not saying that we’re there yet, or that Rich might be that person, but I’m wary of people switching to an uncomfortable system to join a trend that’s mature.

SUMMING UP

One of Cabot’s main goals is to help you find the investing system that’s right for you, and I hope I’ve helped Rich do this. In the next section, I recommend the third of this year’s series, “10 Stocks to Buy & Hold Forever.” But even though I enthuse about it, it might not be right for you. If you have any questions, write me, or call Cabot Customer Service.

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10 Stocks to Buy & Hold Forever

The goal, remember is not to identify stocks that can give you a decent long-term return, like Johnson & Johnson (JNJ) and DuPont (DD). You can hold those forever, but they won’t make you rich.

I want to identify the next Amazon (AMZN), the next Apple (AAPL), the next Google (GOOG) and the next Green Mountain Coffee Roasters (GMCR).

To recap, the key attributes I look for are these:

1. A product or service or business model that is revolutionary.

2. A mass market.

3. A company that’s still small enough to grow rapidly.

4. A company that is not respected-perhaps not even known-by the majority.

5. And last but not least, a stock that’s trending up, indicating that investors’ perceptions of the company are improving. This is important because perceptions are always at least as important as reality.

Also, I keep in mind the words of Thomas Phelps, who wrote “Perhaps the greatest advantage of all in buying top quality stocks without visible ceilings on their growth is that when we do so we give ourselves the chance to profit by the unforeseeable and the incalculable.”

In these days where information flows so rapidly that we risk drowning in it, I like Mr. Phelps’ reminder that the unknown can be even more important. It reminds me to think long and hard about where a company might be years down the road, when it’s far out of sight of the vision of today’s analysts.

Which brings me to today’s stock, number three in the series, “10 Stocks to Buy and Hold Forever.”

SolarCity Corp (SCTY)

SolarCity is one of Elon Musk’s companies, the other two being Tesla Motors (TSLA) and SpaceX, the rocket company. That alone is not reason enough to buy it, but it does tell you management is creative and thinks big.

So let’s get right to the big part. SolarCity is looking to be the biggest solar power utility in the U.S. and possibly the world. Like many other companies, SolarCity will install photovoltaic panels on your roof. But unlike most other companies, SolarCity will do it for a very small cost.

Instead of paying big bucks to the company, you simply sign an agreement to purchase electricity (at a lower price than you’re paying your present utility) from SolarCity for decades. The company retains ownership of the panels, and its profits come from the difference between what you pay (month after month) and what SolarCity pays to the institutions financing its efforts. (They expect to profit, too.)

Revenues were $60 million in 2011, $127 million in 2012 and $164 million in 2013, so the trend is clear. Earnings are generally invisible, because the company is investing in growth today. Analysts estimate the company will lose $2.67 in 2014 and $2.20 in 2015.

But eventually profits will come, as installed systems outnumber sales efforts. And eventually, if management achieves its goals, SolarCity will be huge. Already, the company has inked contracts totaling $2.5 billion over time (up 97 % from last March) and its megawatts deployed are also booming, generally doubling in 2014 and 2015.

But SCTY today is a very volatile stock, so if you can get on board at a low point, you’ll be much more likely to hang on for the long-term.

And that’s why I’m featuring SCTY today.

The company came public in December 2012 at 8 and rode the great bull market of 2013 higher, interrupted by one 46% correction (ouch!).

But the uptrend resumed, with the stock hitting 88 at the end of February. But then came a disappointing earnings report, and then came the broad market’s takedown of all growth stocks, and 10 weeks later, SCTY was down 48%!

Note: The long-term prospects/potential for the company didn’t change a whit in that time. But the short-term fundamentals did, and the market environment did, and as a result, SCTY is now on sale.

But the long-term trend remains up, and there’s a ton of potential buying power in the wings, as SolarCity transitions from a money-losing start-up to a money-making utility that will eventually pay dividends.

So, you could buy here, remembering that this is not a normal Cabot growth stock recommendation or a normal Cabot value stock. It’s a “possibly-awesome buy while it’s down and hold forever stock.” If you’re comfortable with that, good luck.

Otherwise, take a look at some more timely short-term ideas in Cabot Top Ten Trader, which gives you 10 stocks every Monday with precise buy ranges. With the market shifting back into higher gear over the past couple of weeks, I’m optimistic the latest recommendation will do very well.

For details, click here.

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Chief Analyst, Cabot Stock of the Month
and Publisher, Cabot Wealth Advisory

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Timothy Lutts is Chairman and Chief Investment Strategist of Cabot Wealth Network, leading a dedicated team of professionals who serve individual investors with high-quality investment advice based on time-tested Cabot systems.