The term “unmitigated disaster” comes up quite a bit. I’ve heard it many times throughout my life, usually referred to as a disaster that was fairly catastrophic in nature.
In investing parlance, an unmitigated disaster would be an almost complete loss of one’s entire investment. A great example of an unmitigated investment disaster might be the loss suffered by Pershing Square Holdings Ltd. (PSH) and its shareholders when Bill Ackman invested in Valeant Pharmaceuticals International Inc. (VRX) and subsequently lost, perhaps, more than 100% of the initial investment. To make matters worse, Bill Ackman is a very concentrated investor, and Valeant was an extremely large position for his firm.
Valeant had a lot of warning signs. There are many things wrong with this business.
But one glaring reason why I would have never even looked at the stock in the first place is due to the lack of a dividend.
Don’t tell me how profitable you are; show me.
If a company is growing profit, I want my rightful share of it (as a shareholder, which is a part-owner of a publicly traded company). As profit grows, so should my check.
Well, Valeant had and continues to have a lot of financial issues, which is probably just one reason they never paid a dividend.
And so you have an unmitigated disaster on your hands. Had investors been collecting a growing dividend all the way along, they’d at least have something to show for the investment, assuming they didn’t sell out at the perfect moment before/as news of potential impropriety came to light.
However, a growing dividend can turn an unmitigated disaster into a mitigated disaster.
And I’ll show you what that looks like.
I started investing in Kinder Morgan Inc. (KMI) in September 2012. I eventually amassed 225 shares at a cost basis of $7,528.78 ($33.46/share).
Well, Kinder Morgan became a little too aggressive with its capital structure over time, especially on the debt side. Moody’s issued a warning on this, sending its shares plunging. Since Kinder Morgan still operates much like a master limited partnership in terms of how it raises capital, this was a potential death spiral for the company. If it couldn’t readily raise capital via debt due to the already-high level of debt and the increased cost of debt due to a downgrade, and if it couldn’t readily raise capital via equity due to the drop in the share price, the company was going to have a very serious problem on its hands. That’s partly because it’s a highly capital-intensive business model.
And so the feeding frenzy began, where a drop in the share price begat further drops. Kinder Morgan was shortly thereafter practically forced to cut its dividend in an effort to appease Moody’s, which would simultaneously help the company internally fund its ongoing growth projects.
When this starts happening, you have very little time to absorb what’s happening and make a call on it. Being a very patient and long-term investor, my first inclination any time there’s a potential issue is just to hold and go about my life.
This almost lethargic approach to investing has generally served me very well, as the vast majority of my long-term investments have rewarded me handsomely. I sit on my hands, collect and reinvest dividends, and watch my wealth and passive income rise month after month.
However, not every investment is going to turn out great. Dividend growth investors aren’t immune to losses, problematic businesses, or bad managerial decisions. And so that’s why we diversify. Indeed, I own a slice of more than 100 of the world’s best businesses for this very reason.
Diversification, being one more arrow in my quiver, has also served me well, as the issues with Kinder Morgan barely caused a blip on my radar.
Furthermore, the growing dividend income that Kinder Morgan was sending me throughout my investment mitigated what would have otherwise been closer to an unmitigated disaster.
Before showing you what that looks like, let me preface this by saying that I recently sold out of my entire stake in Kinder Morgan as part of a tax-loss harvesting strategy (which I’ll go over shortly). My 225 shares of Kinder Morgan have netted me total proceeds of $4,292.47 ($19.08/share).
So that’s a loss of $3,236.31. Expressed another way, it’s a 43% loss on the original investment.
Perhaps not catastrophic, though, as diversification diminished what could have been a much larger capital loss (had Kinder Morgan been a much larger percentage of the portfolio).
But it sill hurts.
However, Kinder Morgan was a high-yield dividend growth stock paying me a large and growing dividend during the entire time I was a shareholder, mitigating my loss somewhat significantly.
I’ve collected a total of $1,070.78 in dividend income from Kinder Morgan during the time I held my shares.
So that means I actually lost $2,165.53 on the investment, or 29%.
That mitigates the loss fairly substantially. You can see I collected more than 14% of my original investment in dividend income alone, and I only held shares since 2012 (which isn’t a very long time, relatively speaking). Had Kinder Morgan suffered this meltdown a few years later, the loss would have been mitigated even further. At some point, it would have been very difficult, or even impossible, to come out behind.
Moreover, I sold the shares recently so as to trigger a tax loss on this year’s tax bill, which will likely save me somewhere north of $400 (assuming a 15% tax bill on realized capital gains this year, which this loss is offsetting). That brings the loss down below $1,800, or ~23% of the initial investment. Still not fun, and still not a desirable outcome, but also very much a mitigated disaster.
For the record, I plan to re-initiate a position in Kinder Morgan after the 30-day tax-loss harvesting period expires (later this month), as I feel the shares are worth more than the ~$19 they’re currently selling for – and I also believe the dividend will come roaring back within the next year or so. Time will tell, although the position will be smaller than what it was before (as I’m also acknowledging the position shouldn’t have been as large as it was in the first place).
Almost every investment I’ve made has been a near unmitigated success. That’s what’s so wonderful about dividend growth investing: the advantages are almost completely unmitigated over the long run, while the disadvantages are simultaneously severely mitigated; upside is almost infinite, while downside is heavily capped. Stocks can register, theoretically, infinite gains, while losses are generally no more than 100%. Well, growing dividends reduce that potential “100%” number with every payment. As dividends grow, that number lessens.
But not every investment is a winner, and this is a case when things didn’t turn out so well. I’m not afraid to show the wins and the losses. Can’t have rainbows without a little rain.
That said, diversification and tax-loss harvesting can limit losses, when/where issues arise (which they inevitably will). In addition, although not the focus of today’s article, making sure one sticks to buying high-quality dividend growth stocks when they’re undervalued further insulates one from possible losses.
But growing dividends serve as a massive form of mitigation, mitigating what would otherwise be potentially unmitigated disasters.
How about you? Have you had some mitigated disasters? How’d they work out?
Thanks for reading.
Image courtesy of: iosphere at FreeDigitalPhotos.net.