While my goal with DivGro is to build a growing dividend income stream, its fun to see some stocks perform well enough to become home run stocks. These stocks present dividend growth investors with some tricky questions. Are the stocks suitable for further investment, or are they now overvalued? Is it appropriate to increase the average cost basis of a position by buying more shares?
When I look at my portfolio, I see many stocks that have gone up significantly after I bought shares. Buying more shares would increase my average cost basis, something I've tried to avoid so far. But is increasing average cost basis necessarily a bad thing?
My sixth home run stock is Main Street Capital Corporation (MAIN), a principal investment firm that provides long-term debt and equity capital to lower middle market companies and debt capital to middle market companies. Portfolio investments are typically made to support management buyouts, recapitalization, growth financing, refinancing and acquisitions of companies that operate in diverse industry sectors.
MAIN is one of the stocks in my portfolio that I've added shares to even at higher prices. Below is a chart showing the 5 occasions I bought shares of MAIN:
My average cost basis is $21.71 and average yield on cost (YoC) is 9.95%. With MAIN trading at $34.55 per share, the stock yields 6.42%.
MAIN has not yet reached doubler status as far as its stock price goes. However, I've collected more than $2,000 in dividends from MAIN alone, for a payback of 42%! Adding dividends received to unrealized capital gain totals $5,056, or 101% of my initial investment.
Returning to the questions in the introduction, should I buy more shares of MAIN even if doing so increases my average cost basis?
My fair value estimate is $35, so MAIN is trading at about fair value. Although I prefer a 10% margin of safety, I would be OK buying shares at this level. If I do so, though, my average cost basis will increase.
I've seen comments by a Seeking Alpha contributor, Chowder, in which he advocates buying shares of a great dividend growth stock that continues to experience higher earnings expectations, even if the stock is trading above fair value. He calls the strategy dollar-cost averaging up.
I think I understand why Chowder follows this strategy. He argues that the fair value of a company will increase with higher earnings expectations and that the stock price will follow. The strong often get stronger.
Looking at MAIN's performance and how I added to my position over the time, perhaps the idea of not buying shares because you want to avoid increasing your average cost basis is silly. I'll be revisiting this strategy in the coming weeks.
Updates
While MAIN is my sixth home run stock, I only have 4 home run stocks in my portfolio right now. Here are updates of the other home run stocks:
- My first home run stock, General Dynamics Corporation (GD), has returned 141% at an annualized rate of 40%. My fair value estimate is $155, so the stock is trading at fair value.
- My fourth home run stock is Altria Group Inc (MO). The stock has returned 105% at an annualized rate of 41%. My fair value estimate is $62, so the stock is trading at a premium of about 8% to fair value.
- While I still count Reynolds American, Inc (RAI) as a home run stock, it no longer shows a total return above 100%. The reason is I bought more shares of RAI to round out my position to 200 shares, increasing my average cost basis. The stock has returned 89% at an annualized rate of 40%.
Do you have home run stocks in your portfolio? Please let me know in the comments section...
Congrats on hitting home runs! Talking about multiples, here. :P Defense stocks have done pretty well since the Iraq war has started. Had we have any vision and money back in 2001 we'd probably sitting pretty right now. :P
ReplyDeleteYou're so right! Stocks like GD, LMT, RTN, NOC, and even BA have done really well since the early 2000's. Wish I had gotten in earlier... (Sad that the "sin" stocks are performing so well!)
DeleteThe first book that I read about how to trade in stocks said "keep buying when the stock is going up". And "sell gradually if the stock is in a downtrend". But it's difficult to do, mainly for psychological reasons. And that's why automating the process could be a good idea. For example, by using dollar-cost averaging, and continuing to buy more and more no matter what, for as long as you believe the company has a good business.
ReplyDeleteIt makes sense to me! In my by-gone days as a trader, I looked for stocks that were trending up and bought shares, with a tight stop to protect myself from sudden downside moves. It mostly worked!
DeleteThe difference here is that you first find a fundamentally sound stock, look for earnings surprises and positive guidance, then buy more shares -- so riding the wave higher.
Thanks for visiting and commenting!
Congrats on another homerun. I don't have a problem dollar cost averaging up as long as there's value compared to what the business is worth. If that's not there then averaging up does no good even if the company is firing on all cylinders.
ReplyDeleteWe're sitting on 6 in our own portfolio including dividends with one more about 3% away from joining the club. Also 2 of those 6 are getting close to 200% returns but time will tell when they cross that mark.
All the best.
Six (and almost 7) home runs are fantastic! Congratulations! I wonder what I would call a stock that returns 200%! :-)
DeleteI think the point Chowder makes is that he dollar cost averages up because there is value due to the positive earnings outlook. So I agree with what you're saying -- as long as there is value its OK to buy more shares!
Cheers
FerdiS
100% return is great! I love 2-baggers. I always find it hard not to sell when stocks go up by so much.
ReplyDeleteI only have 2 in my portfolio as of right now. I had Teck Resources at $3, I sold at $10 and now the stock is at $23 :(
Its tempting to sell, but one should always look at the future prospects. If further growth is likely, just hang on and enjoy the ride.
DeleteCongratulations on you duo! The Teck Resources story reminds me of several similar stories in my past. Its a bit painful to recall!
Congratulations! It's even more cool how your dividends payments are what got you there and the stock price hasn't moved all that much. Don't know if you have dividend reinvestment turned on, but this is an ideal situation. With a flat stock price the last couple years, the dividends can purchase more shares. Keep up the good work!
ReplyDeleteI agree -- dividends rock! Personally, I don't like dividend reinvestment because of the many small lots it creates. I prefer collecting dividends, building up a decent amount and then buying the most suitable stock available. In my Scottrade account, I utilize their so-called FRIP account (flexible reinvestment plan). It allows me to buy shares of anything I want commission free.
DeleteI got one that just went over 400 percent. It has room to grow a lot more I believe. Of course the dividend is suffering a bit but the gains it's had is a lot more than the dividends would have been
ReplyDelete400% is fantastic! Congratulations!
DeleteI think it will be several years before one of my DivGro stocks return 400%...
Hey Ferdi, huge congrats! As Warren Buffett kind of alludes to, if you invest in a good company the price will eventually catch up. And poorer ones you might never get there.
ReplyDeleteWe've very recently just had our first home run: ALtium. Very happy with that :)
Tristan
Thanks, Tristan -- congratulations on your first home run! I remember fondly when GD became my first home run. I bought below $68 and its trading above $152 now. (If only I bought more shares at the time!)
DeleteCongrats on yet another Home Run Stock! We had it on our watch list earlier this year but the stock has continued to rise since. I think we have missed the boat on this one but glad to see somewhat has reap the benefits from the dividends and increase valuations!
ReplyDeleteKeep it up! AFFJ
Thanks, AFFJ -- I like MAIN a lot and I think it is trading at about fair value now. So perhaps not to late to get on the boat?
DeleteAll the best,
FerdiS
Pretty good there FerdiS. I don't have any yet but hopefully will soon. It is hard now to find a good dividend growth stock on sale at a low price to it's value.
ReplyDeleteCheers,
DFG
The thing is with solid dividend growth stocks, if you keep them long enough, they'll eventually become home runs. MAIN is not even close to doubling my cost basis – it is dividends that turned it into a home run.
DeleteAll the best!
I like your concept of the home run stock. It's definitely a sign that you made a good investment decision. I don't have any of your home run stocks in my portfolio, but GD is a stock that I have considered.
ReplyDeleteAs mentioned above, eventually, all good dividend growth stocks should become home run stocks -- by just being invested in them long enough! I think it is a bonus if you pick up a stock that becomes one relatively quickly, as was the case with my investment in GD. MAIN is an example of one investment that has taken much longer to become a home run stock -- and it has done so mainly through dividends.
DeleteThanks for commenting and all the best!