Ticker Banner

Thursday, June 9, 2016

Turning Bear Market Into 'Buying Opportunities'

A Bear market is a market condition in which the prices of securities are falling due to widespread pessimism that causes the negative sentiment. During this time, many speculators and investors rush to sell their positions worrying that they will lose their portfolio value. Since there are more seller than buyer in the market, the pessimism only grows stronger which will eventually lead to a huge stock decline. Many people were told to stay out of the market during this time or maybe to sell all their positions in certain companies (I did this before and I regret it till now). However, you may be surprise to find out that you don’t need upward trend market to make money in the stock market. As for me who is a dividend growth and value investor, I tend to see things with long time horizons and see the bear market condition differently than most investors out there. You will see many great quality dividend growth companies trading at cheaper price. As a value investor, I tend to focus more on the quality of the business rather than the short-term or near-future share price. You shouldn’t be scared that the stock price has decline tremendously, in fact you should embrace it. I focus more on the quality of the business rather than the short-term or near-future share price. And knowing the quality of business, I use the bear market condition as an opportunity to purchase great companies. So what’s the reason behind it!

Cheaper Valuation

There are many great quality companies that are selling at attractive price during the bear market. To me, I treat the bear market as if it’s a sales season when department stores are selling merchandises at huge discounts (I usually do buy goods when it’s on sales anyways). I will seek for quality companies that have a history of positive earnings and cash flow. After knowing that the company seems stable and knowing that they are trading at a bargain price. I will actually grab some of these great quality stocks. Some of the basic method I use to know whether the companies are cheap or not is seeing its Price to Earnings ratio (P/E Ratio). This is a measure concept of seeing its current price relative to its per-share earnings. Depending on what kind of business, I prefer companies that have a P/E below 15. Another valuation metric I use is seeing its Price to Book ratio (P/B Ratio). A lower P/B ratio means the more undervalue the company is. Of course, you cannot just use this metric to see if a company is undervalued. There are many other important financial metrics need to be considered before investing.

Buying More Shares
Yes! The other reason of buying shares in a bear market is that you are able to purchase more shares. Instead of buying at $20, you are able to buy it at $15 or lower, depending on the market volatility. I mean why buy the same product for more expensive price when you can get it for cheaper. A great example is when you are in a super market where the cost of an apple used to sell at $1, but since the economy is bad, they are willing to sell to the consumer at $0.80 per apple. That’s a 20% discount and it can be a huge advantage for people who want to accumulate dividend growth stock at cheap price.

While even though the value of dividend paying stocks will most likely decline during a bear market, the company behind the stock should still continue paying dividends. Just like owning a rental property allows the owner to collect regular rental payments, owning a dividend paying stock allows the owner to collect regular dividend payments. Of course you have to make sure the company you invest in maintain the dividend payments and you have to make sure that you know what you are doing by looking at the company's financials statements. Trust me, do your homework diligently! You can’t blame anyone except yourself when you lose money.

The Awesome Part of Investing in Dividend Growth Companies in the Bear Market
I’m going to show you an illustration on how you can make money even in the Bear Market. Let’s say you purchase 500 shares of a $20 stock that pays a dividend of 5% and its dividends increase by 10% annually. The stock matches the S&P 500 historical average price return of 7.50%. If you reinvest the dividends after ten years, your 500 shares would grow to 842 shares at a price of $41.22 for a total value of $34,726.53.

Now let’s take a look at it at a different perspective. Let’s say that we encounter a Bear Market, let’s assume that the market was down for 10 years at 3% annually (Shit Happens!). It doesn’t sound like much but it’s pretty devastating to see your portfolio lost 26% of its value. However, if you have reinvested your money even during the bad times, you won’t have suffered a 26% lost. On the contrary, your $10,000 investment is now worth $18,245.38 if you have reinvested your dividends. You still make about 82.45% over a 10 year period time or on average of 6.20% compound annual growth rate (still better than leaving your money in the CD account). While the rest of the others are affected by the lost, your investment is generating nearly $3208.72 in dividend income every year which is a 17.59% yield on cost. 
Because the price of your stock was declining while you were still getting paid by rising dividend, you now own shares which is over 395 more shares than if the market had gone up 7.50%. Pretty Awesome right!?

Let’s Take This Illustration Further
You are going to be amaze with the performance result even though the market is declining year after year by purchasing stocks and reinvesting the dividends (especially when the dividend is growing). I will show you a graph below on how it works. I will pick a sample after year 10 as I just described earlier, where you have shares and the current price is $14.75.

Pretty amazing when you look at the numbers. After 20 years of stock decline that sent your stock price from $20 to $10.88, your $10,000 investment is now worth $233,350.79. Yes I’m super serious! That’s an average compound annual growth rate of 17.06% even when your stock was declining in value of 3% annually. After all, some of you guys might debate that this is just a theory, and there’s no way a company can keep continuing to raise their dividends at 10% annually during a recession. However there is data that can counter that argument. According to Robert Allan Schwartz, who studied the dividend growth rates of 139 Dividend Champions during the great recession, states that 63% of the companies continued to raise their dividends in each year from 2008 to 2010.

I hope from my research we can conclude that investing for the long term, reinvesting dividends is a great way to protect and grow your portfolio during market downturns. In fact, I want my dividend growth stocks to fall as I will be reinvesting the dividends to acquire more shares at a cheaper price. It will take a strong mind set controlling your emotion seeing your portfolio go down in value. That’s why I highly recommend you readers to really do your research and gain more financial knowledge so that you can withstand psychologically. If you can do all this right, you will see the great result 10, 20, or 30 years from now.