Two Investing Lessons From the Recent Market Dip

After a rough start to 2016, the market has begun to stabilize -- but that doesn't mean we've forgotten a few things we learned during the latest dip.

In this week's episode of Industry Focus: Tech, Dylan Lewis and Sean O'Reilly share two main lessons that this recent low point in the market cycle reminded them of. Listen in to hear why investors shouldn't mind seeing some of their favorite stocks sink and how a couple defensive positions can help keep you sane in the midst of a market downturn.

A full transcript follows the video.

This podcast was recorded on March 25, 2016. 

Sean O'Reilly: We're making tech investing great again, on this technology edition of Industry Focus.

Greetings, Fools! Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Friday, March 25th, 2016. Joining me in studio as my partner in crime, is the remarkable Dylan Lewis. What's up, man?

Dylan Lewis: It's fantastic to be back.

O'Reilly: I forgot what you looked like.

Lewis: Let me think ... the last show we did was three tech shows ago, right? Because I was gone for South by Southwest for two shows ago, and you did it with Evan Niu, one of our writers, and talked about Apple and Tesla (NASDAQ: TSLA), I think. And then, the most recent show was me doing sound bites from South by Southwest.

O'Reilly: Thanks for the day off.

Lewis: Right? (laughs) It's like, "Sean, don't worry about it, I got this one." So, Sean got a little break from hosting duties. It was kind of fun, I got to do all the intros and that stuff.

O'Reilly: Was it weird for you?

Lewis: It was a little weird, especially because I was here in the studio by myself, so it was basically just me talking into the microphone and Austin staring at me.

O'Reilly: There was cricket chirping in the background.

Lewis: Yeah.

O'Reilly: Are you going to go check out the cherry blossoms in the next few days?

Lewis: I think I will. Last year I didn't, and it was my first opportunity to check them out in D.C., so I feel like, this year, I have to go.

O'Reilly: I hear a lot of horror stories, like ... as I understand it, the odds are pretty decent that you might get trampled to death or something.

Lewis: Yeah, I'm thinking I'm going to go really early in the morning one day--

O'Reilly: Good call.

Lewis: --on my way to work, and check it out. Hopefully, next week, if you see me at my desk with my head on the ground, just tired, that's probably why.

O'Reilly: Cool. So, Dylan, the market's back. We might be out of the woods, I don't know, depending on what Janet Yellen does or something. We recovered from the big sell-off that essentially started the year. Seems like it's important to look back on some lessons that we may have learned so we can take those lessons with us into the future. So, what are a couple things you noticed, looking back at the way the market started in 2016? Maybe share some things you did as an investor, hint hint. And, to wrap up, maybe share something that our listeners can cue in on for their own lives and portfolios.

Lewis: I think, the last couple weeks, you've really noticed the hysteria surrounding market coverage dying down a little bit. On Fool.com in February, it seemed pretty frequent that we were running articles that were like, "Relax, don't do anything crazy, these things happen. You can't time the market, if you like stocks, stay with them, and don't panic-sell." And I think we're pretty much back to where we started 2016, relatively flat at this point. Which is, obviously, great. It's nice to see some stabilization there. And as someone that works in financial media, I think it makes our job a little bit easier when things are a little bit more settled. But, that said, I think when you hit stability, people tend to have a short-term memory and forget about the follies or the opportunities that were available a month ago.

O'Reilly: That they missed out on, yeah.

Lewis: Yeah. So, for this show, I thought it would be good to look back about a month, month and a half, and see some opportunities that I acted on, and some learnings that I had from this very volatile and crazy time in the market. 

O'Reilly: Awesome.

Lewis: First one, if you love a company that dips, pick up some more. This is a little bit easier with broad market sell offs. If you are seeing that everything's being sold off, then it's a little bit easier to be greedy, because you're not worried about idiosyncratic risk.

O'Reilly: If it's an isolated problem with LinkedIn or something, yeah. Not to pick on LinkedIn, I'm sorry. (laughs) 

Lewis: My example for this, my first Tesla buy was January of 2015. I bought in around $190. I think this was right around when there were the issues with some data coming out of China on--

O'Reilly: There was that, and later on, they were like, "Oh, they're not going to meet their monthly sales."

Lewis: Yeah. So, that was in itself an opportunistic buy. But, I added to that position on the earlier side of February in 2016, and that was at like $146. So, my dollar-cost average for the stock is now around $170, and this is really in part because I spaced out my buys and I was opportunistic on the dips. And I think the important thing here is, nothing about the investing thesis for Tesla really changed. Nothing material was different. I'm still investing in Elon Musk's leadership, his innovation, I buy into his vision. Nothing's really affected their position as a disruptor. They're offering sustainable transportation, no one's really doing what they're doing. And the growth in mainstream for them, it's such a long runway, and such a long growth story, that any of these little hiccups along the way, particularly huge macro ones that are going to impact everybody, that's really not going to change anything. So, they got dragged down by the broader market because it's a high valuation growth stock. 

O'Reilly: It bounced back ...

Lewis: They're doing great now.

O'Reilly: That's a funny chart, too. It's basically a V. (laughs) 

Lewis: That's what the S&P chart looks like for 2016 so far. But, I think the lesson here is, if you bind to the overall vision of a company, and the investing thesis is exactly the same, unchanged, if there are market conditions, whether they are big macro sell-offs because of worries about interest rates or what's going on in China, something like that; or even if it's something like a minor earnings miss -- if it doesn't materially change the investing thesis, it's probably a good time to think about buying some more. And I mentioned before, it's easier when this is a broad market sell-off, a little tougher when it's something that's specific to a company. But I'm going to apply this logic to something that I also own, more on the idiosyncratic risk side. An example of that for me right now is Taser (NASDAQ: TASR).

O'Reilly: How long have you owned this company?

Lewis: I've owned them for quite a while.

O'Reilly: You've talked about them since I met you. (laughs) 

Lewis: Yeah, I think my first position with them was in May of 2015. So, I'm personally down like 40% on my position on Taser. I first got into them, I got interested when the stock was pretty hot, and it was following several of the police brutality and shooting-related things, and the stock got really bought up around then. So, you look, and you say, OK, you're really in the red, you're down 40%, are you really thinking about getting gritty here? Yeah. The thesis is still intact with them. The company's namesake stun guns are still the less violent alternative to guns. The body cameras, the whole Axon line there, and the company's evidence.com back-end infrastructure, to me, is the answer that the general public and police departments are both going to want for what has been a series of terrible public incidents. 

And so, that thesis is still intact. It's just a matter of a much more attractive valuation now, essentially a 40% discount. And, because of that, you're able to pile up more shares than you were able to buy in the past. They've rallied a little bit recently after a strong Q4 report, and I think I've started to open up to the idea of taking another bite of them, and it's because I've seen -- they're starting to rebound. Some of the investments that they've made in the hardware segment have really started to pay off. You're seeing future contracted revenue for Axon and evidence.com starting to take off, and that's a great sign for the business. So, don't be scared of the sell-offs if the thesis is intact. And I think this is just another example of that.

O'Reilly: Awesome! Before we move on, I wanted to point out to our listeners that April is financial literacy month. In that spirit, we are giving away 10 books to 10 lucky winners. These books include favorite financial picks from David Gardner, Morgan Housel, and many more. To enter to win, just go to podcast.fool.com and click on the yellow Super Podcast link at the top of the page. Once again, that is podcast.fool.com. Dylan, you have your water, ready to go for number two? (laughs) 

Lewis: I'm ready for the second part of the show. I always take a huge gulp of water while Sean's doing the pitch.

O'Reilly: Alright, we're in waiting, we can't wait to hear.

Lewis: Number two -- even if you're a tech growth investor, I think it's important to be smart--

O'Reilly: You masochist. (laughs) 

Lewis: (laughs) I think it's important to be smart and pick up some stable dividend players. So, listeners, if you remember, in mid-November, the Industry Focus cast did a dividend week, and each host picked a dividend stock in their sector that they particularly liked. We all wrote up our pitches, and those are still available at dividends.fool.com, just wanted to point to people there. A quick rundown for the lazy -- in energy, I believe this was you, Sean, who picked Spectra Energy. Gaby in Financials picked Digital Realty Trust. Vince in Consumer Goods picked Philip Morris. I picked Verizon (NYSE: VZ) for Tech. And Kristine picked Johnson & Johnson in Healthcare. So, these picks went up November 16th, about five months ago. And they were all beating the market in that period.

O'Reilly: So much winning.

Lewis: (laughs) Yeah. And, the real reason I wanted to highlight these is, aside from J&J, even during the depths of the market bombing out in February, all of them were in the black.

O'Reilly: Who's winning there? Is that me?

Lewis: That does look like you.

O'Reilly: Oh, boy! (laughs) 

Lewis: Yeah. So, I did not want to bring this up to highlight our stock-picking prowess.

O'Reilly: I actually got lucky. (laughs) Oil's come back a little bit, that's it. (laughs) 

Lewis: Yeah. And, it's a very short holding period that we're looking at here. But, I think the performance during the overall market dip, particularly during the depths of it, really illustrates how important it is to have a couple defensive plays in your portfolio, even if you're someone who is super, super growth-oriented. And case in point, Verizon, stable telecom payer, and they've actually appreciated pretty nicely since the recommendation, they're up 18%. And you're catching a nice 4.5% dividend yield on that.

O'Reilly: That's so high.

Lewis: Yeah.

O'Reilly: Wasn't (unclear 10:11) at like 3?

Lewis: Yeah. I don't even know. But, I know, checking my own portfolio during February, it was really nice to have some peace of mind, looking at holdings like Verizon, Disney, Exxon, Costco, etc. These big, stable companies--

O'Reilly: To be your cornerstones.

Lewis: Yeah, to be your cornerstones. And this was a relatively short-lived downturn. But if you're looking at something that is months and months and months, even years, that becomes a lot, lot harder.

O'Reilly: Right. It would have been nice to own something like Procter & Gamble or something during the Great Recession, is the point. My takeaway from all the dividend picks we made back then was, it's better to be lucky than good, as I was. (laughs) Really quick, does Digital Realty Trust own offices and facilities for tech companies, basically?

Lewis: I believe it's a tech infrastructure REIT, but I could be wrong.

O'Reilly: Really? Like, they own the big warehouses for servers? Is that what I'm imagining?

Lewis: I think so, don't quote me on it.

O'Reilly: Don't quote us, I'm just having a conversation at this point.

Lewis: So, the lesson here is, balance out your portfolio. Looking forward, and I think--

O'Reilly: Are you still--

Lewis: I'm still very bullish on Verizon.

O'Reilly: I was about to ask that.

Lewis: So, if you are now -- maybe you were not really thinking this way in the past, but you're now enlightened, and thinking you need to have a couple of defensive plays, I'm still very bullish on Verizon. To me, the big trends that I pointed to, and you can see this at dividends.fool.com for the write-up, mobile data consumption is going to continue to grow. I think average smartphone usage is like 2.4Gb of data per month right now. That number's supposed to go up to like 14Gb by 2020.

O'Reilly: What?! Are we watching YouTube all day on our phones? When are people working?

Lewis: Yeah. So, they have the network to support that. And they have, I think 110 post-bid, 110 million post-bid. So, they have a really great customer base there. They have the leading network in America, according to RootMetrics. Another big trend for them, they're in place to be a big beneficiary of Internet of Things, machine communication means increased connectivity, and they have this fantastic network infrastructure to support that.

O'Reilly: That's the big debate with the Internet of Things -- what are these things going to use to talk to each other? It's either cell signals or just wifi-type things. And I don't really see another option other than cell towers for outdoors, at least.

Lewis: Yeah, and I think the company that's facilitating that communication, they're going to win big. With Verizon, again, the numbers haven't changed much since I did the write up, but the payout ratio is still in great shape. I think they're paying out about half of earnings as dividends, so, plenty of room for that to grow. And it's still relatively cheap, it's 12 times trailing 12-month earnings.

O'Reilly: Can you imagine, some of these huge, dominant companies trading at that?

Lewis: Sean, I think you might have had a rec in the same vein?

O'Reilly: I did, yeah. This company's always cheap, so I'm a little nervous. (laughs) My pick for tech, because my Spectra pick from when we wrote the dividend pick thing six months ago was obviously in the energy space, because I'm usually an energy and industrials editor, is Cisco Systems (NASDAQ: CSCO). Currently at $28 a share. I just look at what they're doing, and I remember they were one of the bubble stocks in 2000. They are not a bubble stock anymore. The stock's at $28, they earned $2.21 per share last year, they're expected to grow earnings per share to $2.7 by 3-4 years from now in fiscal year 2019, according to analysts polled at S&P Capital IQ. Just to add a little more color, market cap of $140 billion, so not quite a Microsoft or an Apple. Sorry.

Lewis: But some room to grow.

O'Reilly: Room to grow, exactly. Out of that $140 billion, though, you glance at the balance sheet, they have $60 billion in cash and short-term investments, which is like T-bills. People do that was Apple, they're like, "Well, they have $200 billion in cash, so really, it's valued at $500 billion."

Lewis: Yeah, you back out the cash for the valuation?

O'Reilly: Right. And doing that to Cisco, it's valued at 7.9 times trailing earnings.

Lewis: Wow.

O'Reilly: (laughs) 

Lewis: That's incredible.

O'Reilly: Ben Graham would be all over this. They have a decent foothold in the Internet of Things. The last I checked, they had this big Internet of Things report, and this was probably marketing material a year ago. But, they have partnerships with dozens of major cities over the world to start planning smart cities, connected cities, and all that stuff. Their current product line is, obviously, extremely important for our increasingly connected world, outside of just smart cities. I'm talking about routers and things. It's mildly important. So, all of this coupled with the dividend yield of 3.69%, it's meat and potatoes. I don't know what else to say. (laughs) 

Lewis: Yeah, and these are not the crazy, sexy growth rates that you'll see with some of the component manufacturers or semiconductor companies or--

O'Reilly: Well, when we were upstairs, and I looked at the earnings growth, and I was like, "Oh, only 2.7% ... oh well, that's fine." (laughs) 

Lewis: But you know, if you're seeing nice, steady, marching growth--

O'Reilly: Right, that's 10% a year or something?

Lewis: With these kind of companies, you're looking at total return, not just stock price appreciation. And personally, I'm someone who likes to DRIP my dividends. So, I reinvest them as fractional shares rather than taking them as cash. It's just something to keep in mind. Man, it was so nice to have some stability in my portfolio--

O'Reilly: Some rock.

Lewis: --when things were cratering. So, that would be my advice to people that are looking for lessons from this recent dip. To be opportunistic, particularly if the thesis is the same, and the market might be overreacting. And to make sure you're positioned to weather all sorts of storms, because this will not be the last one.

O'Reilly: Nope. Wise words, Mr. Lewis, wise words. Alright, well, thanks for your thoughts.

Lewis: Always a pleasure, Sean.

O'Reilly: Yeah. Let's get outside, enjoy the weather. 

you're a loyal listener and have questions or comments, we would love to hear from you, just email us at [email protected]. Again, that's [email protected]. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against these stocks, so don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I'm Sean O'Reilly, thanks for listening and Fool on!