Not too long ago, I wrote an article on Seeking Alpha about selling General Electric (GE) before it fails investors again. I knew there are lots of GE shareholders and I expected to get thrown my fair share of tomatoes. After all, we have all our reasons to hold share of one company instead of another and someone telling you it’s a bad idea may hit the wrong button.
There was something very surprising in the comments thought. Especially coming from supposedly educated investors. Several shareholders commented they would keep GE because they bought it at $6-$9 during the 2008 market meltdown. I don’t really understand why the price they paid 9 years ago, means something today. In fact, the price you pay for a stock doesn’t really matter and I’ll tell you why.
Paper profit is only good… on paper
Ok… so you bought GE at $6 and it’s now trading at $30. The first thing I want to tell you is congratulation. It was a risky guess, but you were right, that’s great! But now, do you still think GE is the best buying opportunity now? Would you buy more GE shares at $30? If the answer is yes, then it’s okay. This means your investment thesis is still good and you believe GE is a strong company that will continue growing.
But if you tell me you bought GE on a momentary and exceptional drop, maybe it’s time to revise your position. Because over the past 5 years and over the past 10 years, GE is underperforming the S&P 500. GE appeared to have become a great investment only for those who bought it during the first 6 months of 2009 while it was trading at its lowest point.
Upon my analysis, my guess is that GE stock will stagnate in the upcoming years as the company isn’t showing strong growth vector and is struggling to increase its dividend every year. Therefore, GE shareholders could sell their shares and cash their profit!
Yeah, but I’m already making 250% profit on this trade since 2009, I can keep it for another 10 years and reap the dividend. True, but imagine if you take your profit and buy another strong company now that will not only pay a strong dividend but will also bring you stock appreciation?
Between you and me, I think MMM and HON will outperform GE in the next 10 years.
Yield on cost is interesting, but there is more
Another point made by GE shareholders was their yield on cost. Let’s say you bought GE at $8. The company now pays a quarterly dividend of $0.24 or $0.96 per share. Based on your cost of purchase, the stock yields 12%. This is quite impressive. Once again, those investors have made a great move back then. But what is happening now?
Now, an investor that had used $10,000 to buy GE at $8, receives $1,200 in dividend per year (12%). His shares also worth $37,500 as the stock price is around $30 these days. With $37,500, all you need to find is a company paying 3.2% yield to receive the same amount of money in dividend.
This changes the whole perspective. If you go out on the market and look for a 12% yielding stock, you will find nothing but risky picks. However, if you look for a company yielding between 3% and 3.5%, you can find plenty of interesting companies. Companies that show better growth potential in the next 10 years than GE. Because unless you have picked GE during its sweet spot at the beginning of 2009, this stock has underperformed the market since the techno bubble in the 2000’s.
A good investment makes your portfolio bigger
I expect two things from my portfolio going forward: #1 increasing its dividend payment each year and #2 increasing its value each year. Because this is what good company do. Therefore, it’s only normal if you keep any stock for a while that your price paid would become ridiculously low.
This is where we all tend to become more lenient. For example, I’m holding on to my Coca-Cola (KO) shares right now as I bought them a few years ago, and they show a nice profit on paper. However, can KO really continue to contribute to my portfolio now? The price has been stagnating for a good 2 years now (if it’s not more!). Let’s not go crazy here and sell any stocks that has underperformed over the last 2 years. My point is to always review your holding and confirm if your investment thesis is valid. While reviewing Coca-Cola, I must find more reason than simply “I keep it because I make X% of profit on paper”. This is not a good reason to keep any company.
So, tell me, why to keep a stock just because you bought it low?
I might have missed the point, but after this post, I really wonder why one would keep an investment simply based on their paper profit or their yield on cost. I think there could be strong opportunities out there, don’t you?
I like your thesis Mike, but one good reason to keep a stock that has given you a hefty profit is TAXES. I hold many of my stocks in non- registered accounts, and would give a lot of the profits back to the government. Also, buying and holding good mature blue chip dividend paying stocks forever is not a bad idea. I add to them (i.e. TD) when they become on sale
Michel from Huatulco 🙂
Hello Michel,
I hope you enjoy your time in Mexico, we just arrived in Guatemala this morning :-).
Taxes is a very important point. I sometimes forget about it as I have all my portfolios invested in tax sheltered accounts. In fact, in 20 years from now, I don’t see how Canadians will pay taxes on their investment between the TFSA and the RRSP!
cheers,
Mike
I do the same thing. Why throw away a 7% y/c for let’s say MSFT to grab 50k. What will I do for income? Yes I can reinvest in other stocks at these crazy prices and start over again? Yes, I will lose some paper profits but with a bit of luck I will have a good income for life.
You make good Points.
Yield on cost is irrelevant to me. Like you say, sell and get another, maybe higher or more sustainable yield on the current price!
The tax comment as mentioned above is not yet applicable in Belgium. Key word here is not yet.
hahaha! don’t worry, you will be taxed one day! lol!
We met another family from Belgium during our trip in Nicaragua, They were travelling in a pickup truck with a tent on top! amazing!
Cheers,
Mike
I look at yield on cost as a prospective tool – say I like a company today, have $1000 to invest and it is at a decent price at say 15 – 16 times earnings, and is expected to grow earnings and dividends at a rate of say 7%/year. It yields say 3% today.
If the company can keep this up, and I spend those dividends on my lavish lifestyle every year, the investment will generate $30 this year, $60 in 10 years, $120 in 20 years etc. So in my simple model, it will be worth roughly double in a decade and double again in another decade
But as you noted, real life is a little messier, and does not move in a straight line. Also, I have found in my regular observations that selling something to buy something else has typically been a bad decision. So in the case of the people who sell GE today, they may actually be worse off if they buy something that yields 8% today ;-(
As usual, we do not know how things will turn out until a few years after our decision 😉
Hello DGI,
you are right, selling just for the point of selling is not a good idea either. It’s important to stick to your investment plan, no matter what happen on the market!
cheers,
Mike
Ive sold 3 different positions. Hydro one, Concordia healthcare and a small airline.
Hydro I really dont see it doing well, I sold Concordia at 33$ thank god! and this other airline has actually increased $1.50 per stock since I sold it. No question that money from those sales went to other good companies. But I find its hard to buy and sell. I was debating teck at 4$ at the start of last yr but didn’t believe in coal. Missed out on massive gains. I would be tempted to sell now if I held it but at the same time copper looks to be on the ups.
Great article and would be one that I would be debating, but I think you make a good point. Get a safe 3% yield and laugh as that increases
Yeah! I like when stocks keeps increasing their rate and giving more reasons to keep them!
cheers,
Mike
I agree with Michel. Taxes are a significant issue for me. I have to calculate the net proceeds available to reinvest after the sale and then determine the rate of return of the replacement investment.
Hi Mike
I once sat in a meeting of the Marketing Dept, the company President, et al. The conversation was pricing of a new product we just started. The conversation evolved around our costs, comparative products on the market, positioning items for market share etc. Everyone had a different theory of why it should be priced higher or lower etc. Finally the president cleared everything up. He said simply that we should price it at whatever the market would bear. It didn’t matter if our costs were lower or higher. If the selling price was wrong, it would not sell. Period. The same with GE. It is worth what it is today. Yesterday is gone. Is it a good investment today? Period.
Yes I get emotionally attached to mine also. But it is what it is.
Jamie
I understand the rationale that GE worth the price it is because an investor just paid that price. However, price of goods will not change like price of stocks on the market. For example, no matter how much time you wait, the iPhone7 price will not drop to $50 and bounce back to $700. It will remain stable until the next generation of phone will arrive. GE stocks may go up and down in the next 12 months.
Cheers,
Mike
Great article. The economic term for this is “opportunity cost” – what return are you giving up by keeping your money in one investment compared to others that are available to you? In doing that calculation, you should factor in the capital gains tax as discussed above, but don’t get sentimental about how well the stock has done for you since 2009. It’s not sentimental about you. The only argument for holding on would be if you believe that it’s past success is because of a good management team – and that that team is still running the company.
Well explained! This is all about the opportunity cost!
cheers,
Mike