Monday, 12 March 2012

Dividend Trap – How to know if you have fallen into one.

Since I am living off my dividends, I thought it would be fun to share my past mistakes and pains. It should appeal to sadist amongst you.

Before you read further, it’s not a post on how to find good dividend plays. For that, you may to go to other more authoritative business finance sites or bloggers. 

I’ve no clue how to spot stable companies that constantly grow their dividends over many years. Not from year 0 at least. But in year 10 looking back, I can!

My growth and income selections are quite similar to another fellow blogger’s way of finding 10 baggers – by discovering many that are not! Thank you CW8888.

So how do I know I’ve fallen into the dividend trap?

First, a quick painful snap, ouch! Followed by the slow drip, drip, loss of my blood.

Capital loss

This one is easy. After buying my “perceived” excellent dividend play, the market price starts to go below my buying price.

Since I defer to the market, I’ll treat it the market is pulling one eye down at me with its finger. Yup, I’ve overpaid!

I’m not so full of myself that I can convince myself only me that’s got the weight of the company right, everyone else is voting “wrong”. Those silly sellers!

Buying when there’s blood in the street makes sense. But not when the blood on the street is mine! Quick! Can someone call the ambulance?

Like the wolf in the wild, I’ll rather bite my foot off and escape. Better this than to hope the hunter will come and release me from the trap. 

“Oh dear, look at you poor furry thing. I release you. Go. Be safe now you hear?”

Yeah right. Writing fairy tales is one thing. Believing in them is another!

Shrinking dividends

I’ll skip going into yields. No, not just because I hate percentages, give me a break! 

If I go into yields, I’ll go bonkers debating whether we should calculate using the price I’ve bought or based on the current market price. Or should we use the trailing 12 month yield or use the forward 12 month yield.

Let’s keep things simple: Bought dividend stock ABC - kiam chye char roti (Sorry, I can’t help it. It’s a Singapore’s nursery rhyme of sort)

Example                       Year 1             Year 2              Year 3              Year 4
A                                 $1,500             $1,520             $1,550             $1,600
B                                 $1,500             $1,480             $1,450             $1,400

Which do you prefer as your annual dividend pay-check? Assuming the stock price remains the same for the 4 years? 

The slow drip drip loss of dividends is much harder to decide – unlike the quick pain of capital loss. 

I would like to give my investment in this “prodigal child” sometime to recover. We don’t disown our child just because of one stumble do we?

But when do we say enough is enough? Wait 10 years to find out?

That is why I am more a Growth and Income speculator over pure Dividend plays that focus too much on yields or future growth in dividends. 

I rather have some paper capital gains as my margin of safety while collecting my dividends as icing on the cake.

If and when the market crashes 10-20% in a single day, I’ll have a better chance escaping with my money back.


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