It seems panic is beginning to set in the market. Stock prices are falling across the board with investors fleeing out of stocks and back into ‘safe assets’ such as gold and cash. The technology stocks have been hardest hit due to their elevated valuations. Earnings have been strong so far this year suggesting that the recent stock market correction seems at first glance to be a compression in valuation levels as opposed to anything nastier.
Whilst many people would be frightened and panicked by the recent stock market sell-off, I have argued on this site numerous times that falling stock market prices are a good thing. This is especially true if you are still in the asset accumulation stage of your lifecycle. The only people that should be slightly concerned about falling stock markets are those in retirement who are living off their investments by selling stocks every month (this is why I am an advocate of dividends) and those who have no intention of adding a single penny more to the markets.
For the rest of us, falling prices are a good thing. I like to look at it as dividends being on sale. When stock prices are down, you get more dividends for the same amount of money invested. You get more bang for your buck. Let’s look at a real world example using BAT below.
BAT is a company that I have followed for a long time. The underlying business has strong economics and the company has a solid history of outperformance. Yet I did not own this company for a long time. The reason, valuation. The stock price had always been too high for my liking.
Let’s look at the BAT price last year as an example. The stock price price was £54 a share. It was trading at a Price to Earnings Ratio of over 20! Crazy for a defensive company. On top of all this, the dividend yield was only 3.2%. So for every £1,000 invested in the company, you only get £32 in dividend income. People who were buying at these levels must have been crazy!
Contrast that to today. I bought BAT shares at £33.80 a piece. The share price has dropped close to 40% from the highs made last year. Yet the earnings and dividends have grown higher to new record levels. BAT now trades at a fair valuation level. And with the dividend increasing to £1.95 a share, the dividend yield is now 5.8%. So every £1,000 invested now gives you £58 in annual dividend income.
With the drop in share price, the same £1,000 now buys you £26 more in annual dividend income. Just by being patient and waiting for valuations to reach more sane levels, I have bagged myself £26 a year in free money – and this amount will only grow in time.
The above should show you two things. The first being valuation matters. Don’t just randomly buy stocks at high valuation levels as stocks will eventually mean revert and cost you a lot. The second being that lower stock prices allows you to pick up more dividends for the same amount of money.
BAT is by no means the only quality company that has seen its share price fall. With stock prices falling across the board, I took the opportunity to deploy cash into the markets at what I deem as fair levels. The stocks I bought during my October stock purchase programme (LINK), in addition to my 47 shares in BAT, are:
- National Grid – Bought 20 shares at £7.85 a piece
- Vodafone – Bought 135 shares at £1.50 a piece
- RelX – Bought 12 shares at £15.30 a piece
- Sage – Bought 32 shares at £5.59 a piece
- Fundsmith Emerging Market Trust – Bought 17 shares at £11.05 a piece
In total, my investment this month in the six companies mentioned above will yield me a dividend of £126 over the next year. Looking at the portfolio as a whole, I am now expecting an annual dividend income of £2,806.
I also bought shares in Nichols PLC last week but as this was an outright purchase, I will do a separate post on it. This purchase will further push up my annual dividend towards my near term goal of £3,000. Onwards and upwards!