8 Investing Lessons I Had to Learn The Hard Way

I bought my very first stock 20 years ago this month.

It was TD Bank (TSX:TD)(NYSE:TD), in case anyone is wondering. Shares had fallen because of some now-forgotten issue that was important at the time. I seem to remember paying $27 per share, but old stock charts indicate the split-adjusted price would be around $17, so let’s go with that.

It was in my old TradeFreedom account, if anyone remembers *that* name. It was set up for more active traders, charging a mere $9.99 per transaction. These days $9.99 is considered a ripoff, but it was cheap in a world where so-called discount brokers were still charging $29.99 per trade.

All the under 30s reading this just had to retreat to the fainting couch. Yes kids, we really did pay that. It was a hell of a lot better than full service brokers (still a thing in the early 00s) which charged closer to $100 to get in and out of a stock.

I held for around a year and then sold for a nice gain. I cycled the profits into some oil & gas royalty trust, enticed by the big dividend and discount to book value. Oh, Lordy, did young Nelson love discounts to book value.

Selling TD was the wrong move, of course. My investment would have returned 12.5% annually over the next 20 years, enough to turn a $3,000 original investment into something worth $31,625. I’d also have 361 shares, which would generate an annual income of nearly $1,300.

Not bad for a small position I could have easily tucked away and held forever.

Selling too early isn’t the only painful investing lesson I’ve learned over the years. In honour of my 20th anniversary as a stock market investor, let’s take a look at seven other important investing lessons I’ve had to experience the hard way.

Dividends Matter

After revealing a few weeks ago how I can now cover all my family’s (my wife, me, and 46 cats) expenses in dividends, a few folks questioned my line of thinking. One even suggested I had “brain damage” for focusing on dividends when there were so many attractive total return opportunities out there.

Dividends allow me to:

• Live a comfortable life without ever selling a single share

• Keep up with inflation

• Not have to worry about market downturns

• Receive cash flow each and every month

If that’s a brain damaged way to approach investing, then bring on the damage.

Yes, I realize there are drawbacks to dividends. They are double taxed, although there are multiple ways the second entity in that can decrease their tax bill. A paid out dividend does immediately decrease a stock’s book value. There are certain advantages to doing buybacks instead of dividends, except many boards are quite bad at buybacks (Facebook, come on down!). And so on. I’ve heard the arguments. They have merit. But for me the pros easily outweigh the cons.

For years I eschewed dividends, preferring to invest in deeply undervalued companies. Some paid a dividend; most didn’t. I’m much more satisfied with today’s approach.

I’m not a contrarian

When I first started getting interested in the stock market I’d watch BNN’s Market Call every single day. One guest that really piqued my interest was Benj Gallander of Contra the Heard, who invested in contrarian stocks. His track record over the years has been remarkable.

Over the last 10 years, Gallander’s President’s Portfolio is up 19.1% annualized. In fact, he’s posted similarly good results since starting Contra in 1992.

A young Nelson discovered Gallander and tried to copy him. Some of the investments were successful, but many were not. I invested in a lot of melting ice cubes, companies that were slowly moving closer and closer to obscurity. The gains were not enough to make up for the losses.

What went wrong? A few things, actually. I was often too early, buying far before the stock had bottomed. I needed to look at these names with a far more critical eye. And I always seemingly picked the wrong ones, with many of the names I passed on delivering excellent returns.

Concentrating

I really started getting serious about stock market investing around 2015 or so. Rather than split my investment dollars between private and publicly-traded investments I focused on the latter.

Many of the smart investors I followed owned just a handful of names. Both Buffett and Munger told us all diversification was for losers. (Not even paraphrasing. Direct quote! Okay, maybe not) So I went all-in on a handful of ideas that did not turn out so well.

I shorted the Canadian banks (through long-dated puts), betting a crumbling real estate market would shock the banking system. I couldn’t have been more wrong.

I invested in Aimia (TSX:AIM) mere months before Air Canada announced they were taking back Aeroplan. Thank God I bought the preferred shares after the stock tanked. That decision turned a loss into a gain.

I put cash into Extendicare (TSX:EXE), a second-rate long-term care operator that was cheap with some cash to spend on an expansion. I still hold Extendicare today, and it hasn’t been a disaster, delivering approximately an 8% total return. Thank God I bought when it was cheap.

One that worked out well was Directcash, the ATM operator. I collected a massive dividend and then was taken private at a 50% premium. At least I had one work out.

It wasn’t long until I stopped concentrating, preferring to diversify widely. The latter has worked out much better. Even if my returns would have gotten better concentrating.

Chasing big yield

Nelson with 20 years of investing experience has little trouble identifying stocks with a risk of a dividend cut. The symptoms are pretty obvious.

But a younger Nelson wasn’t quite so smart. He would see names with a massive yield and be enticed by the dividend. The aforementioned royalty trusts were one big culprit.

Even after those traumatic experiences, I’m not opposed to buying a stock that has recently cut its dividend or even one that has an unsustainable payout. As long as the price-to-earnings or price-to-free cash flow ratio is low and I’m confident in the stock’s ability to recover, I’ll buy. I do far less of this now than I did ten years ago, but I’ll still dabble.

The right way to arbitrage

I’ve invested in dozens of arbitrage situations over the years, primarily two different versions:

1. Merger arb - making small profits over the short-term as one company buys out another

2. Odd-lots arb - buying 99 shares of something and tendering my shares to a large buyback that has an odd lots provision.

Both are lucrative if you do them in a TFSA and you’re smart about it.

I’ve learned a few arbitrage rules over the years that have served me well. They are:

1. If the spread between the current price and the offered price seems too good to be true, it usually is

2. Focus on small deals most institutional investors can’t participate in

3. Avoid high profile deals at all costs

4. Focus on stocks where if the deal falls apart you won’t mind owning the stock for a while

5. Be selective. There will be other deals if the one you’re looking at doesn’t seem rock solid

6. Diversify. I don’t care if Charlie Munger made a bunch of money on the government taking over B.C. Power. There will be more deals, and you won’t be able to participate if make an ill-informed all-in decision.

Hell, I’d argue that an investor can easily make 20-30% per year on a $10,000 investment strictly from these types of arbitrage situations. There’s just one problem. It doesn’t really scale. It’s a fun beer money hobby, but nothing more.

Focus on quality

Too often I’d take a look at an out of favour sector and end up with two stocks that piqued my interest.

One is cheaper but lacks quality. It has underperformed over time. Usually management has lofty turnaround plans to get the stock back to past glory.

The other is more expensive but has everything else going for it. The balance sheet is better. Management is clearly more skilled. The assets are clearly higher quality. Customers like them more. And so on.

The better one wins over the long-term just about every time.

This is easier said than done, of course. Lots of time identifying quality is more of a feel thing than something that can be ascertained from a checklist. And when you’re choosing from two stocks that seem like they’re about the same quality, there’s a certain amount of logic in picking the cheaper one. But it never works out in the long run.

Insist on excellent long-term results

I learned something a few years ago, and it staggered me. Most stocks don’t actually create any long-term wealth.

Think about the world of small caps. There are thousands of shitty little gold miners or lithium producers or junior oil stocks that promise they’re only months away from striking some big deposit.

They’re always only a few months away.

Meanwhile the share price is slowly dwindling to zero and the only people making any money are the fortunate few who make up the management team. This goes on for years — even decades sometimes. Not only do they create no value, but they die a slow and painful death.

Then there are thousands and thousands of stocks that aren’t quite that obvious, businesses that trade in a range, going up and down as a myriad of factors influence them but not actually creating any sustainable long-term wealth. If these stocks pay out much of their earnings as dividends they’re tolerable. If they don’t — and most don’t — they’re silent wealth killers.

The lesson is simple. Insist on stocks with a long-term history of solid total returns. That’s what I do. I buy good stocks and try to hold them for a very long time.

The bottom line

Mistakes are good and everything, but ultimately I wish I would have known 20 years ago what I know now. I’d simply put my money to work in high quality names and go to the beach or something.

I guess I had to learn these the hard way but let me tell you. My mistakes over the last 20 years easily cost me six figures. Maybe even seven figures. Some days I desperately wish I could go back in time and fix them. Screw killing Hitler. I’d find a way to use the machine for my own personal gain.

The good news is for the average person during the first 10-20 years of your investing journey, your savings rate matters the most. You can survive all these mistakes, just like I did. My hyper aggressive savings rate erased a lot of sins.

And I still ended up in a pretty enviable position. Even after screwing up a lot.