Thursday, October 24, 2013

"I Want My Stocks to Decline in Price for a Few Years So I Can Buy More Shares" - Get Real!

As a frequent reader at Seeking Alpha, I notice certain trends in investing and comment streams. Two of the recent high frequency comments that have been nagging me lately are the title above about wanting your stocks to underperform for several years so you can add more, and the other is benchmarking against the S&P 500.  The latter goes something like this, "I don't care how I do against the S&P 500, my goal is income and income growth."

I think both notions are ridiculous, and related, but I'll focus on the falling share price myth with this article.

Crazy as it seems, price appreciation in your stocks is DESIRABLE.  To illustrate the concept, I'll run a simple comparison of a model portfolio using a 15 year time horizon and the following assumptions:

  • Price appreciation/depreciation in the first three years as the variable to compare
  • A constant increasing price appreciation of 8% per year for the remaining 12 years
  • Steady increases in dividends - 8%/year for the entire 15 years
  • A 10%/year price decline in years 1-3 vs. a 10%/year increase in price years 1-3

Here is the data table for the 10% price decline in each of the 1st three years:

The "scenario 1" portfolio grew to $1.44M in value after 15 years and is spinning off $74k/year in income.  Next, I'll show a spreadsheet for the same sized portfolio, growing in stock price at 10%/year for the first three years, then settling into the same growth rate of 8% for the remaining 12 years.  As with scenario 1 above, dividends are reinvested at the end of each year:

In "scenario 2," we end up with a portfolio worth $1.78 M, spinning off annual income of $50k.  So which outcome is better?  Income investors might argue that the second scenario is better because you are receiving more annual income, even though the total value is lower by $340k.  This is kind of crazy to my way of thinking.  I can get the $340k by selling some shares (gasp), then re-purchase higher income producing stocks, specifically, the stocks in scenario 1 with a lower share price and therefore, higher yield.  In fact, if I liquidate the scenario 2 portfolio at the end of year three (double gasp), then purchase the same shares in the scenario 1 analysis, I get really great returns - the best of both scenarios, or scenario 3:

In scenario 3 we enjoy the first 3 years of 10%/year share appreciation plus dividends, then liquidate, and simply buy the exact portfolio over in scenario 1.  The new portfolio has far more shares in year 4 from which to grow and generate income.  By year 15, the portfolio in scenario 3 is worth $2.5M and spinning off $126k/year in income.

So, here are my two options presented side by side:

"I hope shares drop for three years so I can buy more with my dividends"
  • Year 15 portfolio value = $1,440,000
  • Year 15 annual income = $74,000
"I like when the price of shares rises because then I have more money"
  • Year 15 portfolio value = $2,455,000
  • Year 15 portfolio income = $125,500
This is a pretty stark example.  Liquidating the portfolio after 3 years of good performance would be very difficult, and trigger some nasty taxes if done in outside an IRA.  A more likely scenario, if I want more income, is to rotate into better yielding investments at better valuations after a few years of good performance;  exactly what I'm doing with the Chump IRA.

Regardless of the details, the difference in outcomes between rising and falling prices is pretty meaningful, and magnified further beyond 15 years.


In my mind, falling share prices are good only under the following circumstances:
  • If I don't own the shares falling
  • If I have cash ready to invest, and I don't own the shares falling
  • If shares of companies I'd like to own are falling more than shares I currently own
  • If you have a large chunk of cash from other sources, ready to invest now
  • When I have a short position in the stock (e.g. TSLA ;-))
I like it when the prices of my stocks RISE.

That's all for now,


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