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.
Ouch.
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.
Diversification might be your only free lunch in investing, but tax loss harvesting is a nice dessert every now and then. I am a huge fan of the former, and see the latter as a ‘necessary evil’. I have only used tax loss harvesting once so far – selling out my total position in NOV when they reduced their dividend by 100%.
Thanks for sharing some addtional comfort on mitigating disasters.
BTW: speakin of Ackman, have you watched ‘Betting on Zero’? https://en.wikipedia.org/wiki/Betting_on_Zero
I found it interesting but didn’t necessarily agree with how Ackman was portayed (as a noble crusader).
Cheers
Tall Investing
TI,
Definitely. An investor has a lot of tools to limit the downside, knowing that upside is simultaneously practically unlimited. It’s a wonderful dynamic. While valuation, diversification, and tax-loss harvesting can all serve as protection, growing dividend income (especially over a longer period of time) can really mitigate disasters.
I haven’t watched that, but I also would not agree with Ackman being portrayed as any kind of noble crusader. The guy’s only interested in money. I’ve loosely followed his short on Herbalife, and any interest he would seem to convey in people’s livelihoods/wealth/health is pure camouflage for his own desire to solely see the investment succeed.
Thanks for dropping by!
Cheers.
Jason
It is refreshing to see a post mortem on a losing position from any investment blogger. While it might be painful makes you more credible and hopefully we learn something in the process. I have taken my ownKMI lumps and I am not sure I will be adding it back or not. I thought it was the perfect way to take advantage of the move to natural gas with out the risks of the fluctuations of the commodity itself, but I was wrong.
scott,
Yeah, I hear you. Sometimes things don’t work out. Nobody bats a thousand. But that’s why we diversify. The tax-loss can ease the suffering, but it’s those growing dividends (especially if they’re large and occur over a longer period of time) that can really mitigate disasters.
I think had Kinder Morgan just been a tad less aggressive – especially with NGPL – we wouldn’t even be having this conversation. They thought they could do more than they could. Moody’s rightfully called them on it. It’s not so much indicative of a problem with the business model (many other companies in this space kept paying/raising dividends over that span), but it’s rather indicative of mismanagement.
Thanks for dropping by!
Best regards.
I like your thought process of selling and picking them up again. It could be one of those classic Buffett analogies… Buy when others are fearful. Oil prices currently falling right now, KMI might touch the $15 level again but long term should be fine. Oil and Nat Gas are not going away any time soon. KMI just won’t make as much money. If their management does a better job staying within their means, could be a great turn around story!
ADD,
Well, KMI’s cash flow hasn’t really fluctuated that much. I really believe that had they been a little more prudent, we wouldn’t even be having this discussion. The only mistake I probably made with KMI was going a little heavier on the position than I should have. Otherwise, there wasn’t much to dislike, even looking back on it. The balance sheet was never that significantly deteriorated relative to peers, but they just kept pushing it…
We’ll see how it goes!
Cheers.
I had my eye on Valeant for a while and what happened with Pershing Square (not to buy, but just followin the story). Ackman really got throttled on that one. Denied that it was floundering for so long, and that one leak got out where he sent a super upset email to Valeant’s management. I knew when I saw that it was far gone since it showed the desperation. I was surprised that it didn’t tank even further when that hit the media outlets. Personally, for these reasons, I’m not big on stock picking and the like. I think the nail on the coffin was when I lost $20K on coffee futures. And I was like, what the heck am I doing with coffee futures? =)
Tim Kim,
Hmm, I can’t say I know much about coffee futures. But I do know that people love coffee and the experience around drinking coffee, which is a reason why I love investing in businesses that cater to that (like SBUX). Like I’ve written about so many times, successful long-term investing shouldn’t be a complicated process at all. I’ve found that following the KISS principle and thinking like an owner serves one well, generally.
Thanks for stopping in!
Best wishes.
You hit the nail right on the head about Valeant. They were a ticking time bomb. As for Kinder Morgan, you and a lot of others got burned by that one. Good that you were diversified and reaping dividends though. That helped break that loss (and of course the harvesting!).
Question: how do you keep track of so many holdings? That must take forever to watch over!
DR,
I watched the VRX debacle from afar for its entertainment value. Pretty crazy stuff.
As for tracking the holdings, I wrote about that a while ago at DM. It’s actually not hard at all. Seeking Alpha has all of my stocks in their portfolio tracker, and they send me emails whenever relevant news comes out on a business. I get something like 25-30 emails a day. And I’ll read only a handful of them that I deem important. It only takes a few minutes a day. Plus, it’s a fun hobby. Asking me about spending time on my portfolio would be like asking someone who enjoys cars about their spending time on fixing up rides. Different strokes for different folks, though.
Cheers!
Nice post that explains the inherent upsides of dividend stock investing. I too got burned pretty hard by KMI- it was my largest position before the dividend cut and subsequent stock drop. I’m holding steady and through diversification have absorbed the hit and just keep trucking along. Now I look at it as a coiled spring that will increase the dividend once the debt levels are a bit lower, and also expect it to happen by second quarter next year. We’ll see.
-Mike
Mike,
Right. A coiled spring. I agree. I truly believe that had they been just slightly more prudent, we wouldn’t even be talking about it. Moody’s would have never issued the warning, the dividend would have slowed/stopped its growth (at least temporarily) as a measure of caution, capital raises would have slowed, and growth projects would have slowed.
Many investors, especially novice investors, have implied or explicitly stated that the business model was at fault, as if the pipeline business is more volatile than they believed, or were led to believe. That’s really not the case. Other pipeline companies did just fine and continue to do just fine. And KMI’s cash flow didn’t fluctuate that much. Kinder Morgan just mismanaged themselves.
We’ll see how it goes, indeed. But I’ll have a smaller position, which is really just rectifying a previous mistake.
Cheers!
Great article Jason,
I agree that diversification in different sectors is the best way to avoid a unmitigated disaster. I also have sold stocks at a loss waited 30 days and bought it back. I do have a question if you don’t mind me asking how often do you check your stock that you own . I know Jim Cramer said one hour per week per stock of homework to make sure nothing is going wrong with your investment. I go over the quarterly reports, and read news that comes up on seeking alpha. I was just curious.
Cheers and have a great day Michael
Michael,
Diversification and tax-loss harvesting can definitely lessen losses, but this exercised showed just how powerful that growing dividend income is. I didn’t even own the stock that long, yet I collected back 14% or so of my original investment. Had Kinder Morgan mismanaged themselves a little later down the road, I probably wouldn’t have even come out behind. Of course, I would have preferred the incident never happen in the first place. 🙂
As for time spent, it’s really quite little. I noted that in a previous comment, above. It’s a few emails per day. It’s to the point now where I can scan a quarterly or annual very, very quickly, when the time comes. I’m pretty sure I’ve talked/written about this before, but the skill scales. When I first started, I was spending more time with less stocks. It’s now on autopilot, more or less. Plus, I invest mostly in companies that I don’t/shouldn’t have to babysit.
Thanks for stopping in!
Best wishes.
I too got burned by KMI. It was a good lesson on diversification and not getting too caught up in chasing yield. I closed my position for the tax losses as well but am not brave enough to buy again or forgiven Mr. Kinder yet 🙂 (But I still respect the guy overall)
Dennis,
Yeah, I still contend it had nothing to do with yield or the business model. I’ve had both other high-yield stocks and pipeline stocks treat me well, overall. Kinder Morgan’s issue was more specific to mismanagement. The good news is that they’re funding projects differently now, which changes their capital structure for the time being. Once it’s prudent, I imagine the dividend will come roaring back. Time will tell. 🙂
Cheers!
Jason,
One good quality you have is decisiveness – when you gather all the data you need to make a decision, you act on it. And that’s a good thing.
I personally think KMI is a hold in this situation – but I don’t foresee any major price swings in the next 30 days, so you should be fine. And who knows – maybe you will be able to re-buy at an even lower price. Up to Mr. Market.
Curious, did you see the 19% drop in Kroger today ? Would be interested to hear your thoughts on the stock at this new price.
Guy
Guy,
It’s an interesting dynamic. Kind of a hurry-up-and-wait kind of thing with me. I’m very lethargic, determined to let time and compounding work magic. But when something needs to be done, I’m very quick to act on it. I agree that KMI is a hold here. My guess is that the dividend and stock price will recover to pre-crisis levels after they fully right the ship. At the same time, the dividend cut limits one’s enthusiasm (especially as a dividend growth investor).
I thought KR was at a pretty decent valuation before, although the razor-thin margins, absolute size, low yield, and increasing competitive landscape kept me on the sidelines. One might have to re-value it if profit/growth is slipping, but I can’t imagine that re-valuation would be as substantial as the drop/re-pricing was today.
Best regards!
I’m wondering if KMI is the best candidate for your investment dollars (albeit a reduced amount, as you mentioned). Or are you being swayed more by diversification? I guess what I’m saying is, now that you’ve sold to harvest the tax loss, do you really need to buy back into the position. Isn’t it like a complete reset, where you’d be faced with the decision: what’s the best candidate for my investment dollars NOW?
Ferdi,
Well, like I mentioned in the article and the comments, I think the stock is worth much more than it’s currently being sold for. I also think the dividend will come roaring back once they fully right the ship. Both the stock price and the dividend aren’t far away from being supported by the fundamentals, as they’re not all that different than they were before. But not every stock is for every investor. So if KMI isn’t for you, then I’d seek out other opportunities.
Thanks for dropping by!
Cheers.
MORL fell more than 50% from my purchase price but I was in the green after distributions. Cash don’t lie.
FV,
In cash we trust. 🙂
Cheers!
Hey Jason
What a timely post?
I have some few stocks representing more than 5% of my entire investments due to the recent rally. My maximum of target for a single investment is 5%.
I was thinking what to do with those over-weighted stocks. But, after I read your post, I think I better trim down and take some profits.
Best regards,
FJ,
Happy to help and provide food for thought!
Diversification is obviously subjective. Some might think 5 stocks is more than enough. Some might say 20. Some would say 100. Others will just buy the S&P 500, meaning they believe no less than 500 stocks is appropriate. And some buy the world. It’s really an individual call. The more time that goes by, the more I believe in extremely broad diversification. You can have all your ducks in a row, but a company can still go and muck things up.
Best regards.
Jason,
Good write up there man. I too was and still am long KMI, and I feel that pain (however mine is a Roth account so there is not tax loss harvesting there). Still I agree, dividends are the aloe vera to the potential sunburn of investing. I like the Bill Ackman example, and he is supposedly a smart dude (Harvard and all). Still, its the simple things like paying me as a part owner that shows company strength. “Show me the money!”
– Gremlin
DG,
Those growing dividends definitely soothe. 🙂
Bill Ackman is an interesting guy. I’ve watched his moves from afar, mostly for entertainment value. My opinion is that his problem is hubris. We all get things wrong sometimes. That’s just how it goes. But I don’t think he ever really willing to admit he’s wrong, which is probably why he waited so long to unload Valeant.
I just try to be right far more often than I’m wrong. Meanwhile, growing dividends, diversification, and the tax-loss harvesting can all mitigate those potential disasters (when I am wrong).
Cheers!
I think you can throw a stone into a crowd and count on hitting someone that was burned by KMI. I myself bought more after the cut.
The point about diversification reminds me of the ACRP fiasco a couple years ago. That wasn’t particularly fun.
Sincerely,
ARB–Angry Retail Banker
ARB,
Yeah, you’re going to have those issues pop up once in a while. The point of diversification is to limit how much it hurts. But those growing dividends really mitigate what could otherwise be big disasters. Knowing I got a good chunk of my loss paid back to me in cash definitely soothes the burn. 🙂
Cheers!
Chalk me up as yet another DG investor who got “Kindered”! Thing is, I still had confidence in the company’s business model after the dividend cut, so I bought more when everybody was selling at around $14. When it got back up to about $22 I sold some of the old shares at a higher basis for a loss harvest and now am sitting on only -10% not even including the dividends I have received over the years.
Lesson is, don’t always sell when bad things happen to a company, even if it is a dividend cut. Some people have a rule to automatically sell if a company cuts their dividend. I don’t agree with that. I evaluated objectively and if I truly believe in the company, as I did in KMI, I will bite the bullet and buy more after the bad news. It is one of the hardest things to do in the investment world. It is like you are trying to fight out of a hole and they are pouring hot tar on you. . . But if you are right, the pain is temporary, and you claw your way back out.
Bad things happen to everybody in the market, it is how you prepare and how you react that matters.
Daniel,
I hear you. I also bought some when it was way down there, but I had such a large position already that I wasn’t really able/willing to go much larger. That said, I never lost confidence in the business model. The business model is solid. It’s just mismanagement, really. And that can undo even the best of businesses, if only temporarily.
However, if you diversify, collect those growing dividends, and take advantage of whatever you can (averaging down, tax-loss harvesting, etc.), your overall downside when sticking to high-quality dividend growth stocks should be minimal. The upside, though, is practically unlimited. It’s a pretty advantageous dynamic. 🙂
Cheers!