Tuesday, April 28, 2009






For my regular readers the below may seem a bit repetitive. However, the fundamentals of good teaching include constant repetition, summary, and drill.

Thus it's critical to occasionally review the key points of income stock investing.

So, dear readers, here's a review of the Must-Avoid 7 Deadly Sins for Income Investors.

Part 11B will briefly review the best of the specific recommendations covered thus far in this series.

1. Ignoring the Overall Market Trend

While you don't have to attempt to time market tops and bottoms, one should always be aware of the markets' overall trend. In particular:

A. If the market is in an established downtrend

Invest only funds you can let sit, and be very selective about what you do buy. Also, because down trending stock prices usually move in a downward channel, set your buy prices near the lower range of that declining channel if you want to try to get the lowest near term price.

Don't confuse this with picking an overall bottom. In an established downtrend, assume prices will ultimately head lower until there are clear signs of a reversal.

B. If the market is in an established uptrend

You can be more aggressive, accepting lesser yields for stocks that are appreciating with the idea that you'll take some profits when the trend fades. Again, however, stocks don't trend straight up or down. Usually up-trending they fluctuate within a rising channel, so try to set your buy prices near the lower end of the rising channel.

C. If the market is in a trading range

Set your buy orders at the low end of the range (support) and consider taking at least some profits at the upper end (resistance).

2. Ignoring Likely Support and Resistance Points – The Keys to Knowing When to Buy and Sell

Those familiar with technical analysis can skip this section.

While income investors are justifiably more inclined to be long term buy and hold investors, they should still be well versed in enough technical analysis and chart reading to identify support/resistance price levels for choosing buy prices (or selling puts for extra income) and resistance levels for selecting points to consider taking some profits (or selling some covered calls for extra income).

A. Definitions

What are these? In their simplest forms:

A support level is simply the lowest price that a stock has reached over a given period before stopping its decline and then reversing direction and rising. It’s like getting the stock on sale. The more times that level has been reached but not breached, the more tested and reliable it is.

A resistance level is the highest price a stock has reached over a given period before halting its rise and then declining. The more times this peak price has been reached but not penetrated, the more tested and reliable it is.

In short, support and resistance define the likely lower and upper range in which a stock price fluctuates over a given time.

Note: Once breached, support becomes resistance, and resistance becomes support. In other words, if a stock had never declined over the past 5 years below $10 and then falls below it and stays below for more than a brief period, the prior $10 support level is now consider a resistance level. That is, as the stock price approaches $10 it will be expected to retreat and thus this might make a good selling point. If, however, the stock rises above $10 and stays above it, that price again becomes a support level.

There is plenty of good, free information online about the different kinds of support and resistance price levels. Some, like trend lines and price support levels, will make intuitive sense. Others, like Fibonacci retracements and extensions, may not.

However the following list of types of support and resistance are widely followed and used, making their influence a self fulfilling prophecy by virtue of their sheer popularity.

So if you want a clearer idea of when to buy (or sell puts) or sell (or sell covered calls), study the following concepts.

B. Basic Types

Most Basic

Definition of price support and resistance

Trend lines


Moving Averages

Bollinger Bands

More Advanced

Fibonacci retracements and extensions

Parabolic SAR

Classic chart price patterns

Classic candlestick patterns

There are many more I could give here, but this section is obviously for those new to technical analysis.

C. Sources of Free Study Materials

1. Your own internet search

To search out free sources on basic technical analysis, use search terms like:

“Technical analysis” AND Introduction

“Technical analysis” AND (support OR resistance)

2. A few specific recommended sites include:

General Investing Education Sites


Foreign Exchange Trading Sites

Because technical analysis is so heavily used in forex trading, these sites often have good education resources on various aspects of technical analysis. Once you learn about it and want to test your ability to use it, they also provide free practice accounts for 30 days where you can try to paper trade and test yourself. There are many, but here are a couple I liked.

www.avafx.com It’s concise and clear, a good place to start for a quick overview. I also found their email and live chat support very responsive and helpful when questions arose. If you want to practice technical analysis with a free practice account, their trading platform was easy to use and had good yet easy charting tools. I’m involved with forex trading, and my experience with them thus far has been good.

To access their free technical analysis materials:

Click on the RESOURCES tab on the upper horizontal navigation bar, then

Click on Education Center at the top of the left margin

www.babypips.com/school A wide selection of often good but brief technical analysis topics. Choose from a variety of levels and subjects in the left margin

3. Assuming Lower Yield Is Necessarily Safer

Many intuitively equate lower yield with greater stock price or dividend stability. Yes, in theory, perfectly functioning markets should automatically and instantly assign safer companies lower yields and vice versa in relation to their perceived risk levels. In fact, perceived risk and reward usually are inversely related, especially in periods of relative market calm.

However, markets are often neither rational (especially during historically extreme bull or bear markets) nor fully informed, nor up to date with reality. In strong bear markets such as this one, even solid stocks sell off with the general market as investors indiscriminately sell stocks to raise cash and reduce risk of further loss. Thus their yields rise proportionally.

For example, if a stock cost $10, and pays $1 of annual dividends, it yields 10%. If that price drops to $7, yet net income or funds from operations (in the case of MLPs and certain income funds) remain stable, the dividend holds steady, and the stock now yields 14%. In this case, the yield does not reflect increased business risk. Of course, it may, if the stock is cyclical and performs along with the overall economy, as is the case with many non-essential consumer and luxury goods stocks, heavy manufacturers, real estate, etc).

Thus the high yield can simply reflect the overall market's weakness or misperception, not necessarily a problem with the company. This is especially true for dominant companies in recession resistant niches like utilities or other power generators, firms with largely fixed revenues via long term contracts with stable customers, dominant or near monopoly suppliers of critical services or products like energy infrastructure MLPs or income funds, certain communications service providers, etc.

Again, virtually all stock prices follow the market. Thus even the largest, theoretically more stable firms' stock prices drop in approximate proportion to the overall market along with medium and small cap stocks in more recession proof niches that may offer better yields and performance.

A. Defining Acceptably High Yields

While what constitutes an acceptably high yield for income is debatable, it's clear that the typical sub-5% yields seen in blue chips or "dividend aristocrats" companies will leave you with virtually nothing after real inflation and taxes.

Yes, over time they do grow their dividends, but rarely is that annual growth dramatic enough to make a significant difference. For example, if the annual yield is 3%, and the company raises the dividend 10% (an unusually high rate of dividend growth) you're still only getting 3.3% per year. Real inflation (i.e. the actual cost of living for those of us who eat, use energy, education, medical services etc) is usually well above that level. You need a large principal invested at that rate to have anything left after real inflation and taxes.

One of the few upsides of strongly bearish markets such as this one is that it’s possible to find very solid companies with reliable yields above 8%, because:

Even prosperous companies see their stock price pummeled and thus their dividend yields rise in proportion to the price declines as panicky institutions (who hold most of the shares) and individuals sell indiscriminately

Even when panic selling subsides, the residual heightened fear in bear market raises risk premiums as investors wait buy only the most tempting (i.e. lowest price, highest yielding) bargains.

Thus under these conditions, I try to find quality companies yielding at least 8%. Yes, high inflation and taxes could wipe this out too, as could selling at a loss greater than your income. That's true for every stock.

B. Low Yield Dividend Stock Investing Is not the Same Thing as Income Investing

However, your odds of profiting are obviously better with steady high yields than with steady low yields.

With low dividends, your only chance to really profit is with price appreciation, which will be hard to get until the market enters a sustained uptrend, which is currently not expected. The most optimistic speculation is for a flattening market remaining in a trading range for the coming years. That means short lived rallies. Try to catch them early if you can, but that's attempting to time the market. Few are consistently successful at that.

Remember, stock prices follow the overall market, and the shares of larger, more established firms have been hit just as badly as those of smaller firms.

4. Neglecting to Check If the Yield Is Sustainable

On the other hand, the underlying business must be able to sustain and ideally grow the dividend. Whether you do the research yourself or use a newsletter like mine, it's critical to check the sustainability of the dividend. As mentioned in prior articles, you need to focus on overall business health, and especially on payout ratios and how income, funds from operations, and cash levels compare to current and future debt obligations.

5. Failing to Calculate Minimum Needed Yield

If you need $80,000/ year, and you have $500,000 to invest, what overall yield do you aim for? Divide income be principal: 80,000/500,000 = 16%.

Ok, 16% is not realistic under current conditions unless one accepts higher risk levels or we get further periods of panic and new lows that produce opportunities for such yields. That may yet happen, though it will take courage to take substantial positions at that point.

But this illustration does show that the investor needs to be pushing for the highest reliable yields possible. Those with larger portfolios can be afford to diversify more into lower yielding stocks, those with smaller ones will need to choose between a narrower focus on higher yielding albeit quality stocks, and a somewhat lower yield with a more diversified mix and theoretically lower risk.

6. Failure to Diversify Currency

In the not so distant past this was almost irrelevant for US investors, who for generations had held the world’s safest currency backed by the world’s most stable economy. No longer.

Now currency diversification has become critical, and failure to do so will probably be the biggest single mistake most U.S. income investors will make in the coming years.

With the US government committed (thus far) to printing about $13 Trillion in new dollars, (about a year’s worth of US Gross National Product) a steep devaluation in the USD's purchasing power seems inevitable at some point, and major overseas buyers of US dollars are very unhappy about that. Understandably, the major buyers of US Treasury bonds like China and Japan would like to further diversify out of the US dollar. Admittedly, though, it’s unclear how they’ll do this without hurting their own reserves or exports. Assuming they ultimately do reduce their demand for US Treasury bonds, this means declining overseas demand for dollars and thus further pressure on the USD likely at some point in the coming years.

This is a massive problem for income investors based in US dollars.

Why? Because income investors are by definition usually in liquid currency denominated assets, their fate is tied to the currency in which that security is denominated.

The solution is to own stocks and bonds denominated in different currencies (some more based on exports (Yen, CAD, AUD) some more on capital flows (GBP).

Caution: All other currency groups are also expanding money supply, and few are successful at predicting foreign exchange trends. Thus some diversification into high dividend investments that are based in other currencies is essential.

Just some of the great examples mentioned in Part 11B include ARLP,ATGFF, ATPWF, BP, BPL, CEL, ERF, ESIUF, EPD, FTE, GLHIF, INRGF, KMP, LINE, MMP, NRP, PMBIF, TNH, TPP,VE, VETMF, WIN.

7. Failure to Invest in Inflation Resistant Stocks

Unfortunately, protecting your purchasing power will be more complicated than merely buying income stocks tied to other currencies. All currency blocks are expanding their money supplies, and that will at some point lead to erosion in their purchasing power, aka inflation.

What makes a stock inflation resistant? The ability to pass on rising costs to its customers, aka pricing power. This comes from businesses based in some kind of vital tangible asset or vital commodity, the price of which rises in proportion to the dollar’s decline. Energy, precious metal, agricultural and other key commodity businesses fit this category. Pricing power can also come from being a dominant or monopolistic provider of a critical service that allows the firm to pass along increased costs to customers. For all the bad press about them, certain large and rural telecommunications companies are good examples of this, as are certain energy infrastructure MLPs in the US and Canadian clean energy and energy infrastructure firms.

8. High Dividend Stocks To Consider

Our newsletter discusses these in more detail, but see Part 11B for a brief review of the best stocks covered thus far and of stocks to be examined in future articles in this series on The High Dividend Investor’s Collapsing Dollar Survival Guide.

9. Conclusion, Disclosure & More Info

Here in Part 11A of this series on the High Dividend Investor’s Collapsing Dollar Survival Guide, we reviewed key mistakes that income investors must avoid in order for their portfolios to survive and prosper.

In Part 11B we’ll briefly review the best of stocks covered thus far and still to be covered.

Disclosure: I have positions in most of the above mentioned investments.

Interested in learning more about investing in stocks that provide reliable high dividends with better transparency, appreciation potential, and liquidity than bonds? Visit http://highdividendstocksguide.blogspot.com Also, watch for coming notice of our quarterly newsletter, the High Dividend Stocks Guide Newsletter.

No comments:

Post a Comment