Tuesday, August 30, 2016

Confessions Of A Recovering Trader

I did a bad thing.

I acted on an impulse and bought shares of a stock that wouldn't pass DivGro's selection criteria. In fact, I looked at the stock chart and based on what I saw, I decided to buy shares worth more than double the amount I usually spend on buys.

Before founding DivGro in January 2013 and subscribing to the philosophy of dividend growth investing, I was an avid trader. I looked at technicals and ignored fundamentals. I studied stock charts and trends, trying to determine the best entry points and looking for patterns that would suggest future price action.

In my days as a trader, I would often recognize or talk about stock tickers without even knowing the name of the company behind the ticker! Like most technical traders, I believed there was no reason to analyze a company's fundamentals because the stock price accounted for all that data. And charts told the complete story!

I used trend lines, channels, support and resistance, and volume analysis to confirm trends and chart patterns. I learned to recognize patterns like head and shoulders, cup and handles, double bottoms and tops, triangles, flags and pennants, and various types of gaps. I used several different moving averages to identify current trends and trend reversals, and certain indicators to form buy and sell signals.

While I was quite successful as a trader, the busyness of trading and the associated stress started to take its toll. I slowly started to broaden my horizons, first by reading more widely about fundamental analysis and value investing, then honing in on dividend and dividend growth investing (DGI).

At the end of 2012, inspired by several dividend growth investing blogs, I decided to create my own dividend growth portfolio and to share my thoughts in an accompanying blog while managing the portfolio. My first post on 10 January 2013 announced DivGro to the world and the rest, as they say, is history!

So what is this bad thing I did?

One of the weaker picks I've made for DivGro is PennantPark Investment Corporation (PNNT), a business development company focused on generating current income and capital appreciation through debt and equity investments. PNNT invests primarily in middle-market companies in the United States, through senior secured loans, mezzanine debt, and equity investments. 

I bought 215 shares of PNNT on 10 September 2013 at $11.63 per share, arguing that this Dividend Challenger with its 6-year streak of dividend increases was significantly discounted to my fair value estimate. The company paid dividends of 28¢ per quarter, so initial yield on cost (YoC) was a whopping 9.63%. 

Unfortunately, PNNT froze its dividend right when I bought my shares. Rather than sell the shares, I argued that for such a high yield, I could afford to take on more risk. Looking back, there's no doubt in my mind that I fell for the high yield. At about 10%, the dividend yield was exceptionally high and I should have looked harder at the sources of payment behind the dividend, the profitability of the company's business model, and the safety and sustainability of the dividend.

Not long after I bought the shares (red dot in the chart below), PNNT's share price started to decline, dropping all the way to $4.65 in January 2016:
Looking back at my monthly review for January 2016, I notice that PNNT's total returns were down 30%, despite receiving $602 in dividends from the company:
I considered cutting my losses on PNNT on several occasions, but taking such a big loss would have been rather painful.

After reaching the low point of $4.65, the share price started to recover – to my delight – and the recovery seems to be continuing unabatedly! The stock is up 28% year to date!

Of course, full recovery to my entry at $11.64 is still a very long way away... PNNT now trades for $7.89 per share, or $3.74 below my entry price!

And here is where my past as a trader entered the fray. Desiring to accelerate the recovery and based purely on the recent trend, I bought more shares of PNNT:

18 July 2016: Bought 785 shares of PNNT at $7.22 per share

Since PNNT still pays a dividend of 28¢ per share, my initial YoC for this buy is 15.51% and the average cost basis of the 1,000 PNNT shares is $8.17. The buy added $879.20 to DivGro's projected annual dividend income. 

Here's an updated chart with my new entry point (the green dot) and the average cost basis (magenta line) indicated:
And here is a snapshot of my PNNT position as of 28 August 2016. Total returns are now in positive territory due to dividends totaling $722. At $7.89, PNNT's current share price is still a little below my average cost basis of $8.17:
So, there you have it... I'm confessing to having done a very un-DGI-like thing. I bought more shares of a company that would not pass my selection criteria!

I'm taking a chance, a calculated risk. I'm hoping PNNT's share price continues to trend up. I hoping the company continues to pay rather than cut its dividend. I hoping the stock's 14% yield doesn't turn out to be a sucker's yield – at least not before I hit my average cost basis at $8.17...

If this trade pays off, I'll be satisfied but still a little ashamed that I've allowed my trader's past to usurp my investor's present, if only temporarily.

If it does not pay off, I'll learn a dear lesson and have a laugh about it all...

Either way, I'll sell my shares of PNNT soon, hopefully at or above $8.17 and hopefully before PNNT decides to cut the dividend.

It took me a while to own up and write this confessional and now I can carry on being the dividend growth investor I know I can be!

Happy investing and don't do what I did!

Thanks for reading! I hoped you enjoyed this article. Feel free to confess your own little transgression below (if you have any!). Or give me words of encouragement never to do such a bad thing again :-)

12 comments :

  1. Great post Ferdi. I would've done the same thing as you. Reset my cost basis to break even. Maybe you can sell covered calls on some of these to make side money.

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    1. :-) thanks for the confession!

      I wish I could sell covered calls on these -- PNNT options are very thinly traded and probably not worth pursuing. Even if it were, I can't trade options in the account that hosts my PNNT shares.

      I see PNNT is getting close to $8.00 now. Not much more to go!

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  2. I used to check premarket NASDAQ every morning looking for an opportunity to "fade a gap". I put millions at risk over several months to make about 3500 bucks. Now it is mostly selling options for income.

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    1. :-) thanks for the confession!

      I hope you're now sleeping well at night -- I would be very stressed if I had millions at risk! Slow and steady wins the race...

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  3. I believe PNNT continued to pay the dividends all the way through the 2008 crisis even while hitting lows of $3.00. It goes up and down but pays out a high dividend. I bought shares earlier this year around six dollars. Might be one to keep long term.

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    1. Thanks for visiting and commenting, Janet! I'm concerned about the fundamentals of PNNT. Another reason I'll be selling my shares at some point is that I'm preparing my portfolio for options trading. I need the cash to raise the number of shares of my other holdings to at least 100 shares each.

      If you bought at 6 dollars, you've done quite well -- congratulations!

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  4. Nice story! And I really hope it ends well for you. At least with dividends included you are already in the green.

    I don't know if I would have bought more in your case, but I do understand the reason behind it.

    Good luck!

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    1. Thanks Pursuit 2 Freedom -- yes, we'll see how it goes. I'm tempted to keep PNNT around for a while to collect more of the dividends.

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  5. It tough to see a company drop and then keep dropping. It's very emotional.

    Normally, people will sell at the worst time and take the largest realized loss possible.

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    1. You're right... based on what I've read, lots of people sold at the lows of the last recession and are still in cash. They've missed out on the recovery.

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  6. Hi FerdiS, you know how I feel about the blog (love it) so won’t go into that here.

    “It took me a while to own up and write this confessional and now I can carry on being the dividend growth investor I know I can be!”

    The question is – Would you have “owned up”, confessed as you say, if shortly after your second buy at $7.22 ---PNNT slashed the dividend to zero and the price plummeted to less than a dollar? Would you have posted that dreadful second buy? No need to really answer, because none of that happened so neither you-- or us-- will ever know that altered reality.

    To me your portfolio is transparent. You post your basis and current value for all your INDIVIDUAL companies. You post your buys and sells---And you have a “search” key that allows us to search past buys/sell. Those things are big. Most blogs don’t have this. Oh yes, they may post a list of companies and the value and call that their portfolio, but that is meaningless unless you can see the performance. I really don’t mean performance in the way most think about it. I look mainly at my dividend income—same as any DGI-- and not performance, but performance comes to play at the “buy price”. I want to look at buy prices and see if they are hunting down good values. Deep discounts on quality companies is the way to Alpha in my opinion.

    You and I have even had some discussions about buying too high (AAPL). As I get to know a blog and blogger I research their buy prices and rationale.

    1. If they are buying high just to get a name in their portfolio, I don’t want to follow

    2. If they are buying just because all the other DGI blogs are buying, I don’t want to follow

    3. If they admit they are buying high, but disclaim that because they have a long time horizon, I don’t want to follow.

    Believe it or not I see instances of this ALL the time. Numbers 1 & 3 are generally admitted to in the post, and # 2 is very easy to spot.

    Personally, I had not even heard of PNNT until your post so that is how far of my radar it is. Doesn’t matter, I am not hear to talk about the stock.

    PNNT is an investing mistake right? I think you are admitting that. You want to sell even if it comes up in price. Well, guess what, we all make mistakes. I think it is just as good to talk about those as it is the winners. Even with this “mistake”, if it is one, your total portfolio is a winner so why worry over one mistake?

    You are OK in my book FerdiS.

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    1. Hi Mike A -- thanks for your kind words of inspiration!

      I can safely say that PNNT was a mistake. Not because its share price dropped some time after I bought it, but because I used shoddy analysis to convince myself the high yield was worth the risk. I bought my first batch of PNNT shares in September 2013, just 9 months after starting DivGro. It is interesting to go back an read some of the stock analyses I wrote in my first year... I think I've learned a lot since then! I wonder if, 4 years from now, I'm going to say the same thing about what I'm writing now...

      The important thing for me is to learn from my mistakes. Sure, everybody makes mistakes... but I don't think everybody intentionally learns from their mistakes. By writing this "confession", I wanted to own up to my original mistake and (playfully) admit to trying something counter to the DGI philosophy in order to "fix" the mistake.

      I can't really answer your question if I would have confessed to this trade if it had gone terribly wrong. I definitely would have been even more embarrassed to admit it! On the other hand, I did confess to my disastrous SDRL buy... so maybe I would have.

      So far, despite the horrible performance of the stock, PNNT has continued to pay its frozen dividend. I lucked out. I'm hoping to grab a few more of these payments, then bow out of my PNNT position with some extra cash to spend. I'm up a few percentage points as it stands, considering that PNNT has paid back nearly 9% of my total capital outlay as dividends. Should the share price start to tank, I'll get out at about breakeven and call it a day!

      Cheers
      FerdiS

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