How long should you keep building cash?
I wanted to elicit some help from my fellow bloggers and dividend growth investors on an issue that's been bothering me, especially in the current market environment. So thanks in advance to everyone. I happened to miss the dip in price on several high quality companies such as Coca-Cola and Proctor & Gamble early Monday morning and therefore didn't get to purchase any shares. Although I would have purchased had I set my limit orders the night before. Being a dividend growth and value investor, I'm always conscious of trying to pay fair value and usually less with an additional margin of safety built in to my purchase price when I analyze a company.
While I believe that valuation is a key driver to determining your future returns, I find myself perplexed in the current market. Most of the dividend champion stalwarts are trading above fair value and in a lot of cases by a considerable level. So I'm left with the option of building cash or investing with sub-par future total return possibilities. While I'm fine with building cash to a certain extent, I'm in the lucky situation with about $4,000 is the least I'll save each month that is specifically earmarked to invest, so that cash builds really quick. So if I wanted to continue to invest in the current market I would focus solely on quality.
That's enough rambling for now. I guess the issue is, say through my analysis I determine that I will pay no more than $40.50 per share of Coca-Cola. That's great and all, but KO closed trading yesterday at $41.43. What if the share price never falls below $40.50 and you can't purchase the shares? The adjusted purchase price is to account for the missed dividends while waiting to purchase the shares. Or simply Adj. Price = Target Price - Cumm. Dividends.
If I miss just one payment, then I would need to drop my purchase price down to $40.22 to have the same value as if I had purchased at $40.50. Miss a years worth of payments and the adjusted price drops to $39.36. 2 years? $38.14. 5 years? $33.95.
Here's how it works out if you start with the recent close price of $41.43.
It would take essentially 3 dividend payments to get your adjusted price down to the level you wanted to purchase at anyways. Two years of payments and you'd have an adjusted price of $39.07.
Now I know a lot of this assumes that there's not more compelling valuations in some other truly great companies. And it's not like I'm a great predictor of what's to come with the markets. I've been sitting mostly on the sidelines since about February. Guess I was a bit early on that one. And if you believe that in the long term, total returns can be estimated by Yield + Dividend Growth Rate, then it's not like Coca-Cola is really going to offer that bad of returns. With a current yield of 2.70% and estimated dividend growth rate of 7%, you'd be looking at 9.70% total returns. No complaints there.
With the transfer of May's savings to my brokerage account, I'm now sitting on over $19k in cash waiting to be put to use. That's around 19% of my approximately $100k portfolio's invested value (i.e. excluding cash). While some of this cash is spoken for to cover the margin requirements for my open puts and I wouldn't be comfortable trying to get it all invested since some of my puts are currently in the money, meaning I'd be forced to purchase shares upon expiration. How should one go forward in a market that seems to be in general on the high side? I don't want to expose too much cash to some of the possibly lower quality companies or companies that don't have an established history of growing their dividend, even if they're at better valuations. In the event of a huge slide in the markets or another turn in the economy, the high quality companies will remain in tact. I can't really imagine a scenario where Coca-Cola, Proctor & Gamble, Johnson & Johnson or ExxonMobil go out of business without the whole country falling apart. Of course, your cash would be more useful as toilet paper in that scenario.
I guess the question boils down to what level of cash, if any, would you consider to be enough before you'd start making purchases despite the higher valuations? And do you think dollar cost averaging into the stalwarts with the extra cash is a good idea even though valuations are on the high side?