If you have heard it once, you have heard it one thousand times. This age-old advice is the epitome of the saying “it’s easier said than done”.

In recent months, my favorite sector, the financial sector has taken a beating. Many of my favorite stocks are now boasting dividends in the mid to high single digits. These dividend yields are quite a bit higher than the average yields for these companies, not to mention that some of the largest banks in the gargantuan US economy are selling at 10-12 times earnings!

Enter Investor Psychology

Even though I have a long-term investment strategy and believe in the future prospects of companies such as Citigroup (C) and Bank of America (BAC), I still have a hard time pulling the trigger when all of the news outlets are forecasting nothing but doom and gloom.

Money is made when one is brave enough to accept a risk that few others are willing to take. We must be willing to step out on a limb and believe in our strategy from time to time, for there is no reward without risk!

Brave or Stupid…You Decide

A recent article in the Globe and Mail outlined the following, which I thought was a spectacular move, and outlines some of my own thoughts:

Bill Miller, the famed mutual fund manager at Legg Mason, might describe as predictable, but illogical, market psychology.

Studies repeatedly show investors place too much weight on information that’s (a) recent, and (b) dramatic. The multibillion mortgage writedowns at U.S. banks are both.

Mr. Miller, who beat the Standard & Poor’s 500 for an incredible 15 consecutive years, has been getting enthusiastic lately about U.S. financial stocks. At the moment, he looks foolish and stupid. Two years from now, he’ll be thought of as brave and wise.

What Mr. Miller is referencing is a common strategy known as contrarian. Being a contrarian is just as it sounds. Contrarian investors buy solid stocks that have fallen out of favor with investors, mainly due to recent news and “panic“.

Buffettology

Mr. Warren Buffett actually played a contrarian role the last time that the financial sector was out of favor in the early 1990′s. Buffett took a large stake in Wells Fargo when everyone else was running far and fast from the financials. If you take a look at a 15 – year chart for Wells Fargo, you’ll see that Buffett looks Brave and Wise now, not Foolish and Stupid!

Buffett also made recent headlines for his investments in Goldman Sachs and General Electric, not to mention a NY Times article in which he proclaimed that his personal portfolio is currently being invested in United States equities.

Are you prepared to look foolish and stupid for a few months in order to look as brave and wise as Warren Buffet in the future?

If so, you too could be taking double digit dividends (and capital gains) to the bank 10 years from now!

Of course, Mr. Buffet is regarded by many as one of the greatest investors ever. On Tuesday, through his holding company Berkshire Hathaway Inc., he invested US$5 billion in Goldman Sachs, a Wall Street brokerage firm that have been in the spotlight since the fall of Lehman Brothers and the buyout of Merrill Lynch last week.

So why is Mr. Buffet’s investment significant? The financial sector has been crushed by the credit crisis. Canadian financials are down more than 10% so far this year and their American counterparts are off by more than 30%. One of the most unfortunate and irrational consequences has been that many financial companies are being painted with the same brush regardless of  the sector of the financial business they’re in (banks, insurance companies, brokerages etc.), how they do business, or where they do business.

The lines between high quality, low quality and no quality have been blurred by continuous negative headlines. Buffet’s massive investment in “Goldman” signifies to many investors that there are still high quality firms within the sector.  

There Are Still Strong Financial Businesses

First, Buffet’s investment demonstrates that astute investors continue to focus on fundamentals and valuations despite the emotion that’s driving markets. They understand that confusion creates opportunities to add well-managed, high quality assets to their portfolios at great prices. Case in point – Goldman shares were down more than 40% on the year prior to the Berkshire Hathaway announcement.

Secondly, this is an opportunity to highlight the strength of Canadian banks, which have unfortunately been lumped in with their American peers. Investors should know that unlike their U.S. counterparts, Canadian banks are strongly capitalized and have well-diversified businesses, among other differentiators such as the srtict Canadian governmental regulations that prevent the degree of meltdown that is happening in the United States.

Adversity not only exposes the weakest companies, it can also highlight the strongest. Like Warren Buffet, long-term investors should focus on high quality companies with attractive investment valuations and strong balance sheets. Because when the turmoil ends, and it eventually always does, these firms will be even more valuable and will likely continuing their leadership.

Here is a quote that sums up how us dividend investors might feel at the moment:

…Because when everyone else is doing the logical thing and shoveling money into growth stocks that are shooting to the moon, only a big fat idiot would stubbornly sit on a portfolio of boring dividend stocks that are, for the most part, doing jack squat.

It’s interesting that he mentions high flying stocks like Potash Corp. and Research in Motion as being the ones that he missed out on, while he talks about owning our favorite dividend growers – banks, insurers, pipelines and drug makers.

How Far Can You See?

When investing in dividend growth stocks , it isn’t about making a killing this week or this month.

• It is about investing for the long haul and watching your dividend income rise consistently year over year while your “investor” counterparts are searching for the next hot tip.
• It’s about holding onto that dividend paying stock and not worrying about the stock price, as long as that dividend keeps growing.
• It’s about protecting your hard-earned money from inflation and making your money work for you.
• It’s about knowing the company can’t fake a cash dividend.
• It’s about money in your pocket.

Over the long term we know (and Heinzl reiterates) that dividend growing common stock prices also out perform those stocks that pay stable or no dividends.

So What Now?

There is a famous saying from Warren Buffett that goes something like this:

“Be fearful when others are greedy, and greedy when others are fearful”

Of course this is easier said than done, otherwise we’d all be running a multi-billion dollar company like Berkshire Hathaway.

While it may take some serious resolve to start loading up on some of our favorite dividend payers, most notably banks stocks, sticking to a long term plan will make you rich in the long run.

So, to echo the words of Mr. Heinzl I’ll end with this quote:

Am I going to sell my dividend stocks to buy these high fliers now? Hell, no. If anything, I’ll be adding to my existing positions, and reinvesting the extra dividends in even more shares to take advantage of the magic of compounding.

So, don’t worry about the water cooler talk and stick to your plan. Soon enough you’ll be saying goodbye to the water cooler forever when the compounding effects of your rising dividend income begins to exceed your salary!

Here’s to your wealth!

Home Depot (HD), the world’s largest home-improvement retailer, gained on news Edward Lampert, the billionaire who built his fortune by investing in beaten-down retail stocks, bought a $484 million stake during the third quarter.  Home Depot is well off of its 52- week high of $42.00 as it sits below $30 .00 today.  This brings its dividend yield to a very tasty 3.0%!

 CarMax (KMX) rallied after Warren Buffett’s Berkshire Hathaway (BRK.A) disclosed a 6.4% stake in the biggest U.S. used-car dealer.  News of Buffet’s investment has CarMax stock up over 3.0% in pre-market trading…Looks like the Oracle still has a mighty influence on Wall Street!

As mentioned in the previous article on the topic of contrarian investing taking calculated risks can lead to huge profits when we are willing to look like fools in the short term.

I wonder if Buffett will see the same fortunes with CarMax over the next ten years that he saw when he invested in Wells Fargo in the 1990′s when everyone was running scared?