Published May 13th, 2015
Investing in dividend stocks requires the correct mindset. A business owner mindset is critical for sustained success when investing in dividend stocks.
A successful business owner knows that not all businesses are the same. Some businesses possess superior economics to others. A choosy business owner will only be involved with high quality businesses that have some form of protection against the ravages of competitive markets.
Competition is great for consumers. Competition brings down prices while raising quality. The beauty of markets is choice. If consumers do not like a product they are not forced to buy the product. Instead, they bring their business elsewhere.
This feature of competitive markets is what makes them so beneficial for consumers. Consumers really do have all the power. If a business does something evil that offends enough people, it will go bankrupt and competitors will take over.
Profit margins become razor thin in the most competitive markets. When competitors can quickly enter a market and produce a similar product, whoever sells for the lowest price wins. This effect can be seen in declining prices and improving quality in virtually all electronic goods.
Of the 53 current Dividend Aristocrats, only Automatic Data Processing (ADP) and AT&T are even tangentially related to technology. Neither is on the cutting edge of technology. Automatic Data Processing is a payroll processor, and AT&T is a telecommunications giant. There’s a reason why more technology firms aren’t on the list.
It is because technology changes quickly and is highly competitive. The rapid change in the industry makes traditional barriers to entry such as regulatory capture and patents less effective. They are less effective because rapid evolution in the technology industry makes slower forms of barriers to entry outdated by the time they become enforceable.
Business owners with an eye for long-term wealth generation and stability will avoid fast changing industries. Instead, they will focus on heavily regulated or slowly changing industries. The leading businesses in this type of environment can enforce and strengthen their competitive advantages.
Warren Buffett’s dividend stock portfolio is filled with this type of business. Companies like Coca-Cola (KO) and Wells Fargo (WFC) have long histories and operate in slow changing industries. People will always drink beverages and will always need a place to safely store their money. The banking industry and the beverage industry are here today.
Warren Buffett recently invested in IBM (IBM) stock which is in the technology industry. The company has a very long history of success and is the exception to the rule that technology stocks tend to have shorter lives. Even so, IBM’s future currently looks much less certain than the previously mentioned Coca-Cola or Wells Fargo.
A business owner looks for sustained growth and cash flows they can count on to keep rolling in. The value of a business is ultimately the sum of its future cash flows discounted to present value. Businesses with uncertain or risky cash flows are worth less than a truly high quality business.
A company like Coca-Cola or Kimberly-Clark (KMB) – the makers of Kleenex – have strong brands in slow changing industries. These companies’ premier products are likely to be the same 10 years from now as they were 10 years ago. There is not much that can be done to improve upon a Coca-Cola or a Kleenex.
When you invest in dividend stocks, look for quality. Look for businesses in slow changing industries. Look for businesses with strong competitive advantages that insulate the company from outside competition. Strong competitive advantages help sustain growth and keep margins high.
The best businesses will show positive cash flows regardless of the economic environment. They will show steady or increasing profit margins as their competitive advantages continue to grow. Dividend Aristocrats and Dividend Kings are a good place to start looking for these high quality businesses.
Thinking like a business owner helps dividend stock investors to see the market as more than a giant casino based in Wall Street instead of Las Vegas. You are buying fractional ownership in real businesses. When you do buy fractional ownership in a business, make sure it is a business with a strong competitive advantage that you are confident in holding for years, not days or months.