Learn from my Mistakes: Stick with your Winners & Embrace the Dividend
Unless you are the type to go all-in on a single stock, the biggest investing mistake you are going to make is not going to be buying the wrong stock but rather selling a great one too early. However, letting your winners run can be a challenging feat, particularly during market downturns when every other stock appears undervalued, and the star of your own portfolio begins to lose momentum. One of the most underappreciated aspects of dividend investing is how it can entice you to hold onto a great stock for a growing income and help avoid such a mistake.
Why selling a great company carries risk
But how, you might wonder, can taking profits ever really be a mistake? The answer lies in understanding that while purchasing a new stock inherently carries risks, selling out of a good company holds the potential for a different kind of risk - missing out on future gains. While buying a stock can, at most, result in a 100% loss of your investment in case the company goes bankrupt, the gains you forgo by selling prematurely can be boundless. You can think of it as the inverse of shorting a stock.
I made this very same mistake two years ago when I made the decision to exit my position in Novo Nordisk (NOVO B) in favor of investing in the still-promising CRISPR gene editing technology. Over the seven years, I held the company’s stock, Novo Nordisk exhibited consistent growth, driven by continued demand for its products and making big strides towards its next big hit - Wegovy.
However, with a rationale at the time, of Novo Nordisk trading sideways for a while, being low on cash, and overlapping in sector, I thought it would be a great time to secure profits and start this new investment venture in CRISPR with the money I had made. While I did manage to double my original investment by selling a winner I missed out on a further 350% gain as Novo Nordisk skyrocketed in the following years.
Novo Nordisk recently beat out LVMH to become Europe’s most valuable company. With its miracle drug Wegovy, which encourages weight-loss and significantly reduces risk of cardiovascular diseases it has even managed to dethrone Johnson & Johnson as the second-largest pharma company only behind Eli Lilly.
Likewise, I sold Nvidia (NVDA) by the end of 2022. If I had stuck around for just another six months, I would have taken home an additional 200% profit. I did so because wanted to double down on another investment in the semiconductor industry and concentrate my exposure to it. In fairness, it is important to note that missing out on gains can also occur by choosing to overlook new investment opportunities or better ways to allocate your capital. This is why this described line of thinking does not apply to selling out of just any old stock. We are specifically talking about winners here - stocks that outperform the market significantly over the long term.
Another concrete example I can share is my investment in Microsoft (MSFT). I have intermittently reduced my shares in the company since acquiring them in 2014. I have done so for various reasons: to put down a deposit on an apartment, to diversify, or to reinvest in other areas. There can be many good reasons to sell a stock - and in some cases, you may not even have a choice. However, taking on the challenge of beating Microsoft’s continuous growth is a difficult task. Its valuation has increased by more than 850% since 2014, and none of the reinvestments I have made into my portfolio using funds from selling this stock have come close to achieving these kinds of returns.
This is how Microsoft has performed over the last few decades. The green dots on the graph represent times when I have bought shares and the red are when I have sold. Since acquiring my new strategy I have stopped selling completely as I have come to realize that I am much better off just raking in the dividends.
The power of compounding dividends
What is the common thread among these three remarkable stocks, apart from their renowned quality? They all offer a dividend, albeit a modest one, below 1%. When I first began shifting my strategy toward dividend investing, I was warned to not chase a high starting yield. Many investors end up during this, including myself, but precisely these kinds of unassuming dividends have taught me a valuable lesson: the power of compounding dividend growth in a quality business. These seemingly unimportant small yields are reason enough for why I should never have sold a single share in the first place, except of absolute necessity.
Let me put this into perspective: Even a small dividend can wield significant power. Take Microsoft, for instance, currently yielding a dividend of 0.82%, comfortably fitting within what it has historically maintained. If I had held onto every share of Microsoft that I acquired back in 2014, I would now see 10% of my initial investment returned to me this year alone - passively. Because I have sold quite a few shares, my annual return from Microsoft is closer to 6% - still good, but not the same. Naturally, having sold also means that I have secured profits, but as I previously mentioned, none of the reinvested funds have grown anywhere near the pace of Microsoft.
More importantly, in contrast to stashing my funds in a high-yield savings account or investing in a bond yielding in the same range, the underlying asset may continue to grow. Moreover, Microsoft has consistently increased its dividend by an average of around 10% per year. When accounting for all this, compounding really starts to take effect, and even a small dividend yield like this can turn into notable returns.
Granted, the calculation becomes a bit more intricate due to having sold some shares in the past, so instead, I have created a table that works on a per-share basis:
Assuming the same historical annual dividend growth following 2023, I would have made back my entire investment from dividends alone by 2030 - had I kept every share purchased in 2014 at an average price of $42.55.
Even to me, that is surprising! By not selling shares - by doing nothing really - you could have made back your entire investment from dividends alone in just 16 years all while you get to keep every single share of an investment, which as I mentioned previously, has so far has netted me more than an 850% return.
Is there a catch?
Yes, naturally, there is a risk in holding onto your shares rather than selling out for a profit. Staying invested, even in a winning stock, means you may experience occasional volatility and temporary dips in value. There is even a risk that it could go entirely wrong, although that risk is small with a great-performing company. However, a company paying a dividend is a sign of health and a growing dividend often aligns with growing earnings. The dividend is a measure of excess cash flow deemed better served to shareholders, profiting directly, rather than invested back into the company.
It is worth noting, though, that a high yield for a company could also signal that the company is starting to stagnate or has reached its ceiling for growth. Like many things in life and investing, finding the right balance is crucial. Generally, this specific type of risk increases with higher yields. But for the long-term investor, there should be no reason to chase a high starting yield, as I have attempted to prove in this writeup, that even a small dividend can make a big difference.
For the conservative investor there also comes concentration risk: The issue of letting a single or just a few positions dominate your portfolio’s overall returns. A stock such as Microsoft may even grow faster than you are able to add new funds to your portfolio. Therefore, trimming big positions can be wise - and in some cases, such as for big funds, even necessary or legally required.
Finally, I do need to acknowledge that these calculations do not account for the impact of taxation or inflation. Investing for dividends may not be the most tax-efficient compounding method and is often criticized as so. On the flip side, my examples also do not account for the compounding effect of reinvesting your dividends. This strategy is in fact, utilized by Berkshire Hathaway (BRK) and is a big part of what has made this investment fund so successful. Rather than the company paying out a dividend itself, Buffet assumes this responsibility on behalf of his shareholders: He holds onto his best-performing stocks such as Coca-Cola (KO) and Apple (AAPL) for years, even decades at a time to continuously reinvest the dividends they generate into new ventures or more shares of these very same quality companies. Dividends are a great way to generate wealth - dividends can support your efforts in building up new positions, keep you engaged, and motivate you to not sell out during uncertain times - all while gradually securing profits along the way. Staying invested over the long term has historically proven to be the right thing to do, with markets averaging a 7% to 8% annual return.
So if your best-performing stock happens to pay a dividend, consider staying invested for as long as possible. Avoid making the same mistakes I have and miss out on future growth. No investment strategy is perfect, but if this one is good enough for Buffett, perhaps it is also good enough for you? A consistent and winning strategy could eventually lead you to financial independence and doing it this way allows you to live a good life without having to cannibalize the fortune you will build.
Disclaimer: I am not a financial advisor, the opinions expressed in this article are entirely my own – always invest at your own risk.
