What just happened this past week? After a year and a half of smooth sailing, volatility reeked havoc in the stock market this past week which resulted in huge fluctuation in stock prices. For investors with cash on the sidelines, it provided a good opportunity to ‘buy the dip’ and buy certain shares at 10 – 15 % off. I do admit that I was a little slow in reacting to the initial sell-off as there were a number of shares offering attractive valuations. But thankfully I was able to pull the trigger and buy myself shares in a company I have been following for a long time now – RWS Holdings Plc (LON:RWS). Before I talk about this stock purchase, let me just write a little about the importance of holding cash.
Many investors have recently become complacent. They have this ideology that they should be invested 100% in equities (stocks) at all time as the stock market only has one direction of travel – upwards. Their thinking has been distorted by this immense bull run we have had over the past several years. They think cash is a huge drag on returns and want to hold as little of it as possible. They have this perception that the opportunity cost of sitting on cash is too great. They have a Fear Of Missing Out by not being fully invested in the stock market.
But having cash in your account as an individual investor is a must. Most institutional investors (such as mutual funds) don’t hold cash in their portfolios as they need to outperform benchmarks over time in order to stay relevant. As an individual investor, you have no such qualms. You can do as you please and holding a proportion of cash in your portfolio gives you a safety net. By having cash in your accounts, you will be able to buy into stocks at great prices were a correction happen to occur. Just look what happened this past week. There were a number of quality holdings that were on offer at attractive valuations. But the only people that could take advantage of this opportunity were those with cash on hand. For the rest, they just had to sit back and wonder what could have been. And this past week is by no means an anomaly. The real anomaly has been the calm amulet behaviour over the past 18 month. I’m sure we will see more dips, corrections and sell-offs in the future. Markets crash all the time. You should, at minimum, expect stocks to fall at least 10% once a year, 20% once every few years, 30% or more once or twice a decade, and 50% or more once or twice during your lifetime. Those who don’t understand this will eventually learn it the hard way. And those that do understand it can set strategies in order to benefit from this.
Going forwards, those that hold cash in their portfolios will be the beneficiaries of any market sell off. But in order to benefit from this, you need to be strategic. During a market sell-off it is best to concentrate your efforts on the highest quality businesses as opposed to the cheapest ones. This is because high quality businesses share prices usually only fall in a wider market sell off so you only have a limited window of time to buy shares at attractive valuations. Furthermore, shares in these high quality businesses are usually the first to recover in any market upturn and they usually fly higher within a few short trading sessions.
My Purchase Of RWS Shares
Thus this past week I was able to buy shares in high quality business RWS Holdings PLC. The company is the world leader in translation, intellectual property support solutions and life sciences language services. The company’s translators possess considerable know-how, which represents a strong barrier to completion. They need to combine a language with a science based skill. The intellectual property market that RWS serves continues to show steady growth which reflects the worldwide growth in scientific development and patent protection. This is a strong competitive advantage the company possess as it produces services the market needs in ever growing quantities and will allow RWS to continue to earn its above average returns on capital over time.
With good returns on capital, RWS can reinvest some of the profits in further developing their services – as they have been doing over the years. That might be in the form of organic investment in facilities or capabilities, or buying other firms to infill those capabilities and expand operations. The rest can be returned to the shareholder, in the form of dividends or share buybacks. The steady stream of cash flow to the investor provides some payback today, and is a basis for capital appreciation tomorrow. This fits in perfectly with my investment strategy of investing in companies that provide a good starting yield, and real dividend growth in the long run.
Although RWS is currently trading at a Price Earrings ratio of just over 20 (which is higher than what I am comfortable with), its growth profile and capital light business model make buying the company attractive at the price I bought it. At my purchase price, I expect RWS to provide returns of 12% – 16% per annum which is something you cannot say about many stocks in todays market.
I bought 194 shares in RWS this past week for £3.74 each. RWS currently pays a dividend of 6.50p which means that I can expect an annual income of £12.61 from this purchase.
It is interesting to point out that RWS has been increasing its dividend by 15% and I expect this to continue in the medium terms. So whilst £12.61 is the annual dividend based on last years figures, I can expect £14.50 from the company in 2018, £16.67 in 2019, £19.17 in 2020 and £22 .05 in 2021. Investing in dividend growth companies is the gift that keeps on giving. It is no surprise that more than 137 years of data point to the inescapable conclusion that owning dividend-paying stocks, and then reinvesting those dividends, beats all other investment approaches hands down. So if dividend-paying stocks make you yawn, it’s time to wake up and smell the cash.