Especially stock market beginners get in touch early with ETFs and / or dividend investing, in part thanks to the respective communities and influencing faces. You can see both strategies separately or also in combination. However, a common thing I see e.g. on Twitter / X and YouTube is that these people promote them as being bullet-proof, save strategies. As a risk-focussed investor myself, I am clearly missing this crucial element.

Summary and key takeaways from today’s Weekly
– Are you prepared for possible sector rotations and / or a decade of broader markets moving sideways?
– In the dividend section I discuss yet another recent example of a dividend cut – painful for the stock’s evangelists.
– High-yielding ETFs aren’t the holy grail, either.

If you are investing by only seeing chances and no risks, you are likely to fail.

Though I am not saying that ETF and / or dividend investors will fail for sure, nearly everyday do I see things from these crowds that make the hairs on my neck stand up.

That’s why I am driven to write this Weekly – to have a look at and write down the risks and failures of ETF and dividend investing. Hopefully this will open one or the other pair of eyes.

Likely you have already heard “motivating” sentences like:

• “I am investing for the long term, short term actions do not matter”
• “Stock prices don’t bother me, because I am only counting my dividends”

While these phrases are not wrong per se, they can be misleading. And the frustration, especially among younger investors who haven’t experienced a true bear market, yet, can be even higher if unexpected things happen or take longer than thought.

In the early days of this blog, I already wrote an article about ETFs and their under-appreciated concentration risks. You can find it here (click here).

Maybe one or the other of my long-time readers will remember that I wrote about the MSCI World Index having more than 1,000 stocks (giving uninformed investors a pretend diversification feeling), but just the top 10 already having a weighting of around 20%. In other words, their fate decides about the index.

This sounds more like a strong concentration, not like a broad diversification.

Also I have already written several times about dividends.

Cuts are a mega-trend of this decade, at least for so long as interest rates will stay higher for longer. The survival of an indebted company has a higher priority than holding up a fragile series of consecutive payout hikes.

Many are still under-appreciating this risk.

Being it present or coming cuts, even among seemingly “safe” dividend aristocrats and kings due to their historical numbers. So far, I think I haven’t been completely off track. More and more “surprising” dividend cuts are being announced – often using less dramatic words like

• “adjusted dividend policy”
• “reset dividend”
• or “new competitive dividend”

This happens even despite “conservative balance sheets”.

Today, I want to dig a little deeper and add a few things. No matter what strategy you personally have, it always pays to use your own brain.

Don’t be fooled by platitudes, instead use common sense and facts, not emotions.

Since I have started this blog and my memberships, the average total return of my closed ideas is +13.4%, beating the S&P500 and the iShares MSCI World ETF.

The outperformance “live” is much higher, looking at all my ideas.

^{per 04 October 2023 market close}

Before you touch ETFs…

Every investor is free to do what he / she thinks is in the best personal self-interest.

No question about that. I am also a big proponent of experiencing some failures here and there to learn by being directly involved. Although one can read what others have done wrong, it is not the same effect on you as if you’ve made a mistake yourself.

Though I certainly will not be able to replace your personal learning, hopefully this Weekly will give some valuable input.

Doing a mistake is the first part – the other is to reflect and learn from it.

The broad masses see ETFs and or dividend investing as the most proven, reliable and safest strategies out there – some even as the holy grail. I’d be cautious with such wordings. The presented arguments even sound plausible, if you do not question them.

If you diversify, you are less affected by individual stock price declines. Makes sense.

Companies that paid a dividend three decades ago will likely continue. Why not.

No wonder the answers to a survey from July (i.e. before the current correction) pointed exactly in these directions as to which strategies will be pursued in the second half of 2023.

We can summarize it as follows:

• dividend investing is the top answer – by far
• then you have “hot topics”, promising future growth like AI, renewable energy or EVs where either valuations are high or the steam is already out
• number three corresponds with ETFs – total stock market index

Dividends, hot topics and ETFs – I don’t want to say that I am standing completely on the other side of things, but close to.

I like dividends.

But they have to be really fat, as we have high interest rates. If you search a bit, 10% or more are not uncommon anymore. Why buy a stock yielding only 3% where the dividend is only being raised symbolically? Also, the companies must have strong balance sheets and not worry how to refinance the next debt maturity.

My members received two exclusive reports with ideas offering at least 10% dividend yields that are fully covered by free cash flows and also accompanied by buybacks.

The former for example even has net cash on the balance sheet and it repurchased 3% of its stock – in just one quarter. The latter realistically could have a yield of even 15%.

Chasing hot topics is self-explanatory – no thanks. I prefer to look where others don’t.

And broad market indexes – also not my case, as they are less diversified than thought and the companies with the highest weightings are mainly from the tech sector. Maybe you have heard of the recent news that Chinese officials are said to be forbidden to use iPhones? It does not have to come this way necessarily. Ask yourself: where is the upside and where the downside?

But when something happens in the tech sector, the whole index will likely go down.

Don’t forget that with broad market indexes you get mainly two things: at best and pre-cost, market-like returns and at worst, you are going down with the market.

Retail investors are often a good contra-indicator.

Retail investors at the beginning of a cycle are rather skeptical and / or fearful, when there is stress in the markets. When the dust settles or a topic becomes mainstream (plus big gains have already been made), they then jump on the bandwagon which leads to higher valuations via multiple expansions and less favorable risk-reward situations.

The last point is the really important one for me.

What are more things one should be aware of when talking about ETFs? I want to show you a few slides from my presentation which I held in summer.

The core message of the first slide is: markets can take many years and even more than a decade to reach new highs. It can be really unnerving when a market goes sideways.

The more so, if you see something else going up where you are not partaking. Impossible?

• energy during the 1970s?
• commodities between 2000 and 2008–2011?
• energy during 2022?

And we are talking only about nominal highs – not inflation-adjusted.

As I am trying to be as realistic and optimistic at the same time while not taking part in crash-prophecy, I am advocating to be prepared for broader markets possibly to go sideways for many years.

While I do not know if or when this happens again, history is often a good teacher. I don’t see the current levels on par to the 1929 euphoria, far from it.

But who says that the 1965–1980 period – where there were rich valuations among the biggest companies (the “nifty fifty”) and high inflation due to supply shocks (that ironically could repeat again) – could not repeat in a similar way?

Not exactly the same events, but broader markets going sideways?

I do not know what the future exactly will bring. There must be sound investment theses, not just that something worked in the past and it will just continue to do so. Favorable risk-reward ratios, ideally high optionalities and situations that are even decoupled from the broader economy.

That’s how I pick my best stock ideas for my members.

Keep in mind that in the past, there have always been sector rotations.

There are times when energy is dominant. Currently, energy is clearly under-weighted while tech for my taste is too popular. And tech is not just tech, as companies like

• Amazon (ISIN: US0231351067, Ticker: AMZN)
• Tesla (ISIN: US88160R1014, Ticker: TSLA)
• Alphabet (ISIN: US02079K3059, Ticker: GOOGL)
• or Meta (ISIN: US30303M1027, Ticker: META)

are not even officially in the tech sector.

There were times when commodities – energy and basic materials – had a weighting of more than 20% of the S&P 500.

Look where they are currently in the bottom-right corner.

Rotations are absolutely normal, as there are cycles.

The business cycle is the more commonly known one, but there is also a commodity investment cycle that decides about the supply of commodities.

You always had a higher risk-reward ratio when you positioned yourself in the unloved, less popular sectors.

However, this is not the secret sauce alone.

When looking at energy and / or commodity companies, you also need to check the supply and demand situation as well as cost structures in the industry – at the minimum. But if you find a supply-starved sub-sector like silver (see here), then it is a good starting point for more research.

To close this sub-topic, I want to remind you that the biggest companies don’t stay the biggest indefinitely. There is also a cycle that affects them.

Did you know that Kodak, Lucent, AT&T or different Japanese and Chinese stocks have had their time when they were among the ten biggest companies by market capitalization?

Do you really think today’s top 10 will be the top 10 at the end of this decade?

If you want an overview of a good set of rules, here you are:

Dividends flow – until they don’t

You better don’t solely focus on what happened in the past, but instead try to figure out what’s going on in the business currently. Often numbers tell the truth more precisely than management does, especially if facing a tough decision like a dividend cut.

It is easy to be brainwashed by a pitch based on the past like a dividend series.

I wanted to present you the recent case of W.P. Carey (ISIN: US92936U1097, Ticker: WPC), a real estate investment trust, REIT, that owns mainly operationally critical commercial real estate, having tenants from the industrial, warehousing or retail sectors. But it also has some office properties.

WPC was until a few weeks ago a highly praised REIT, having a “safe” dividend.

But it has fallen from grace quickly.

It takes time to build trust, but only a moment to completely destroy it.

Pundits on all platforms were heavily advocating to buy the dip nearly every second day of this pretend high-quality REIT. I don’t want to attack anybody here directly, hence no screenshot, but you can see for yourself in which direction most recommendations went prior to the announced dividend cut on 21 September 2023 (see here). But you can also search YouTube or Twitter / X.

WPC has been raising its distribution to shareholders for 25 years, i.e. it even qualified as a dividend aristocrat, embarrassing those advocates even more as they likely were blinded by the series of the past, instead of having a look at a few mission-critical numbers.

It should be clear what happened.

A transformation was announced. Concretely, WPC announced on this day to leave the office space. What sounds like a non-spectacular announcement, as this was even a non-core activity for the company, however, was accompanied by a dividend cut “reset dividend policy”.

The new payout ratio on the then lower earnings post separation will likely result in a painful cut of approximately 20%. A shock for the crowd of evangelists.

The stock of WPC was not a great performer, having had its all-time high in 2019 even.

But you can see how the downtrend accelerated with the announcement, almost reaching the 2020 panic-lows now.

Was this really such a big surprise?

Management claimed priorly to having a “conservative” balance sheet. The net-debt to EBITDA ratio was somewhere around or slightly below 6x which for me is a manageable level, but it is by no means conservative.

Especially not, if you dig deeper past the headline figures.

WPC had low average cost of debt due to having exposure to Europe where interest rates have been close to zero. They made use of it. You can see on the following chart that their debt maturities have not been structured favorably at all with lots of debt being due over the next three years:

Between one and two billion USD due every year until 2026.

These numbers have to be put into perspective. As you can see now, EBITDA as well as operating cash flows have been around a good billion USD recently – before investments and the dividend!

So, even without looking at these two factors, a repayment would have been impossible. The dividend alone at the old level cost almost 0.9 bn. USD or the entire operating cash flow. Any growth in rental income would have been pressured by higher interest rates.

Hence, no air to breathe.

So they had to act, but frankly, this could be seen already quarters ago. Management seems to have banked first on interest rates to stay low and then to fall again.

I just don’t understand how people fall in love with companies that have weak and unfavorable risk-reward ratios?

This leads me to the last part of today’s Weekly, a mixture of ETFs and dividends – dividend ETFs. While one or two companies cutting their dividend likely won’t cause any bigger damage here, making the diversification even useful, one should not expect too high yields.

For example in search for “high dividend yields”, I found the Vanguard High Dividend Yield Index Fund ETF Shares (see here). The dividend yield is just a smidgen above 3%, barely being worthy called “high yield”.

Its biggest positions are also nothing special.

On the positive side one can at least say that these dividends seem to be more on the safe side, though I would not expect huge increases.

The international alternative, called Vanguard International High Dividend Yield Index Fund ETF Shares (see here), has a slightly higher yield, but it is also less than 5% – not much in this interest rate environment.

I don’t know about you – certainly there’s an element of subjectivity to it – but “high yield” for me should be higher than interest rates and bond yields.

But the issue is that you will then stumble upon extremely indebted companies like 3M (ISIN: US88579Y1010, Ticker. MMM), AT&T (ISIN: US00206R1023, Ticker: T) or Verizon (ISIN: US92343V1044, Ticker: VZ).

This is not a great deal for a serious and risk-focussed investor. Let the gamblers chase every dip. Stocks of such companies massively increase the risks, while also lacking a clear upside scenario.

If you are searching for an above-average dividend yield with a low payout ratio and a best in class balance sheet, then this idea might be for you.

Conclusion

Are you prepared for possible sector rotations and / or a decade of broader markets moving sideways?

In the dividend section I discuss yet another recent example of a dividend cut – painful for the stock’s evangelists.

High-yielding ETFs aren’t the holy grail, either.

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