As a long term investor, is it better to simply invest in the highest quality and best companies knowing the stocks are usually priced at a premium? Or does it make more sense to invest in companies that are undervalued but not as high quality? I've been contemplating this a lot lately.
I want to own companies for 20, 30, maybe even 50 years. That's the holding period I have in mind. Does it really matter if I overpay a little bit for shares of Procter & Gamble knowing they will still be around and still paying dividends decades from now? Shouldn't I place my trust and money in a company like Johnson & Johnson that will continually pay me rising dividends and will likely never fail even if the P/E is high? Why do I even invest in lower quality companies that might not be around far into the future? Should I even hold companies like Southside Bancshares (SBSI) or Intel (INTC)? This is my retirement (hopefully early) we are talking about!
In the perfect scenario the best companies would also be undervalued. While these scenarios are no brainers they are also very rare. If you want to be an owner of Coca-Cola, arguably one of the greatest companies in the world, be ready to pay a little extra for the privilege. KO is rarely on sale. My calculations put a fair value price at $30. It hasn't been at that price since October 2010. Two years ago! Good luck finding Coke at 30 bucks...
What I've done in the past is keep a list of all the stocks I want to own and buy them when they are under or fairly valued. The problem I have is that even within this list of great companies, I believe some great companies are greater than others. These are my core stocks which include ABT, JNJ, KMI, KO, MCD, PEP, PG, and PM. Coincidentally these are the same stocks that hardly ever go on sale, but the ones I strongly feel should anchor my retirement plan.
I've been thinking about beefing up these core stocks regardless of price. Why do I consider KO to be a core stock if I won't even allocate a decent amount to it? Sounds hypocritical. These 8 stocks should be my 8 largest holdings.
I'm looking for ideas and input. What do you think?
I think you already know my thoughts on this: I dont worry about the stock price so much as whether its a good business. If it is, when you sell twenty or thirty years later, you will laugh at how litte you paid for those shares. I have to admit I dont own any of the stocks you listed in your article, so my opinion is even more worthless than normal:}
ReplyDeleteHaha. Pretty sure I over think things sometimes. Dividend investing is not rocket science. You might want to take a look at these companies, you already know what they do.
DeleteThis is a tricky one. If you've done your research and made the decision that those holdings will be your core holdings, then logically it makes sense to buy the shares at a fair price. However, I think it's dangerous to stop looking for value whenever possible. There is no guarantee that all of those companies will be solid investments (or even in existence) 20, 30, or 50 years from now.
ReplyDeleteSurvivorship bias can have a strong effect on investing. It's easy to look at today's blue chips and expect their dominant position will continue on into the future. But remember that blue chips evolve over time. Take a look back at some of the Dow Industrials components from 20 or 30 or 50 years ago. While you will see familiar names like GE and P&G, you'll also spot companies like Kodak, or Bethlehem Steel, or Sears, which were once dominant players in their respective industries and the envy of their competition. I'm sure each of them had their share of loyal investors too.
http://en.wikipedia.org/wiki/Historical_components_of_the_Dow_Jones_Industrial_Average
Plus, at least one of the companies you mentioned (INTC) wasn't even in existence 50 years ago.
I think it's best to constantly re-evaluate your investment choices and ensure that you continue to get a good value from each company. As markets change and evolve, you'll want to make sure you are not blindly allocating funds to the next Bethlehem Steel or Kodak. You'll also want to be ready to start investing in the next Intel when it comes along.
This is a great point, and its why I mostly stick to utilities and cigarette makers...if you plan on holding companies for thirty years, make sure you are looking at companies that will still be in business...I avoid technology stocks for just this reason, since there is no way of knowing what direction that sector will take in five years, much less twenty...OTOH, I am in T and VZ, which are technology stocks in their own way IMO, so there is a little crossover no matter what you do...
DeleteYou make a great point. I selected those particular stocks because they are likely to be around for quite some time. I'm confident all of them will be in business 50 years from now with the exception of KMI. Hmm... I might have to reevaluate that one. I was looking to only have one energy stock and chose between KMI and CVX. I'm now wondering if an energy stock should even be a core holding. Hmmmmm
DeleteKeep in mind that I have a portfolio of 30 stocks and will eventually get up to 35-40. It's just that I want the best companies to be the largest positions since their future is more certain. I'll still hold stocks from every sector but won't weight them as heavily. Then again sometimes bargains pop up and will screw up weightings anyways.
Thanks for the link and your thoughts. Very interesting!
Or perhaps I should just focus on 20 years ahead because 50 is too much!
DeleteBuffett has said," It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." While I believe this holds very true, I still do a combination of the above and just monitor those fair companies a little closer.
ReplyDeleteI love Buffett quotes. I think I'm going to focus on the wonderful companies for a while but will still keep an eye out for bargains.
DeleteI try my best to find a satisfactory combination of quality and value. I will not invest in a company if it is high quality but grossly overvalued. I will also not invest in a company if it is low quality but grossly undervalued. Thus, I look for high quality companies (recognizing that there's a range in quality from good to superb) available at reasonable valuations (preferably undervalued, but I am okay paying around fair value). However, I'll admit that it can be a tough decision at times.
ReplyDeleteThe problem with waiting for value on the wonderful companies is that it never happens. I can wait to buy KO below $30, but will it ever get there? If the stock market did give us the opportunity to pick KO at $29 I imagine it would mean we're in the middle of a recession. If that is the case other stocks will likely have better valuations still. Can't really win.
DeleteSince something like a KO or MCD is almost always trading at a premium I like to look at historical p/e's and the like. I'm going to start using historical yield as well, I think that will provide some additional insight. I'm going to bite the bullet and look to pick up shares when things look reasonable historically. I think that is the answer.
What do you guys think?
Compounding Income,
ReplyDeleteGreat topic here.
I don't think quality and value are necessarily mutually exclusive, even if it seems that way most of the time.
As my portfolio grows and as my experience as an investor grows, I like diversification more and more. It's easy to believe that KO, JNJ, PM, MCD and the like are going to be around 100 years from now and will continue to increase top line and bottom line growth as they always have. But there really is no way to know this. I supplant my lack of a crystal ball with diversification across businesses and sectors. That way I don't really need to pick winners and losers. As Executioner pointed out above, it was easy to believe many big blue chip companies throughout history were going to continue to dominate. Maybe Coca-Cola starts to really come up against health regulations, as the new N.Y. law comes to mind. Maybe JNJ continues to have issues with recalls and can't continue to innovate and eventually comes to a slow, prolonged downturn. Maybe the new cigarette labels in Australia take hold in the rest of the world and PM's brand strength is significantly reduced. Hard to imagine all this happening, but it could very well come to fruition.
I think the crux of this question lies in the importance of being an income/dividend growth investor and how that differentiates you from someone hunting for capital gains. Let me explain:
If I have 50 positions all equally weighted and one of the businesses I have an ownership stake in cuts the dividend completely, I only lose 2% of my income. That 2% loss is likely to be made up by the dividend increases in the 49 other businesses anyway.
Now, if most my portfolio is built up in 8 "core" positions and one of them cuts the dividend then that could cause a significant disruption to my monthly income.
A higher level of diversification allows a dividend growth investor to be relatively insulated from dividend cuts/reductions. On the other hand, this also limits the ability for a big winner to give you big capital gains.
Just my take on it.
BTW, like the new layout.
Best wishes!
Thanks for the reply. I see your point about not knowing the future.
DeleteI'm not suggesting to only invest in a handful of the best stocks. That's crazy! I currently hold 30 positions not including my preferred stocks or fixed income in other accounts. I will add even more companies over time.
I am suggesting it might be useful to weight certain stocks more than others. Perhaps the greatest dividend growth companies (core stocks) should get a 3% allocation in your model and the riskier/unproven companies 1%? I'm not sure I'd want tech stocks and banks being the same weight as the cream of the crop (KO, JNJ, WMT, etc,).
It all goes back to not having a crystal ball. I have no idea where tech stocks will be in 20 years or if banks will go through another round of failures. I can be reasonably sure people will still drink soda, eat hamburgers, shave with razors, and use shampoo to wash their hair. Hence my conviction in certain stocks that sell these products.
I think one thing you ought to be looking at is weighting according to income not market price. If all 50 stocks provide roughly the same income you are truly only losing 2% if something eliminates or cuts.
I'm still thinking my way through the core position stance. I'm leaning towards beefing up the companies I believe in the most! Again this is within a portfolio of 30-40 stocks + fixed income allocations.
It seems to me that a few times a year, the market gives us a "gift" of a pullback. Now we're in the midst of one of those times. I'd set some reasonable limit orders for your shopping list--prices at which you have a good chance of picking up those stocks. I don't think you'll pick up KO at 30, however judging from historic PE ratios, I think you could get it at 34-35. A lot of these stocks are always richly valued, so you'll never pick them up at a PE of 15. And in 20 years, you'll be glad you bought it at 34-35 instead of missing out on it at 30.
ReplyDeleteGood advise! I do appreciate the pullbacks and think it might decline even more with Hurricane Sandy hitting the East Coast. Indeed I have been targeting KO under $35! I like the way you think. I might settle for under $36 however. I've already held some of these stocks for 2 years and know I am capable of being a longterm holder. Some people aren't wired that way.
DeleteGreat discussion going on here. I like to try and balance both. Rather than talking in terms of abstractions, I'll use some real examples.
ReplyDeleteI believe in building around a Core of: CVX, PG, KO, JNJ, and MCD. I added to CVX in June during the big dip. Same with PG. I added KO at the beginning of the year before the recent rise.
YTD, I still haven't bought into JNJ or MCD. MCD looks very attractive now, so I'll probably add in the next few weeks or so. JNJ will have to wait until it comes back down to Earth.
In the meantime, I've been adding other companies which I also like and are more attractively priced at this time. Companies such as: NSC, KMI, APD, INTC, CMI, etc.
So, although I ultimately want to hold more of the Core stuff, since the market hasn't come around on these stocks, I've had to be a bit more patient. Which is fine, I'll add other solid companies while I wait.
As mentioned above, waiting around for KO may be a futile cause. In such a case, if KO dips to $36 or $35, I'll go ahead and add anyway. This will increase my cost basis, but in the long run, it probably won't matter much.
So, I try to add value when it's there, but stay conscious of the fact that I also want to keep building my Core. It's a bit of a juggling act, which is why I publish so many watchlist and wishlists. I need to remember what the gameplan is, b/c oftentimes I will deviate as I adapt to the market.
I should probably also add that when it comes to investing, I really feel like patience is a virtue.
ReplyDeleteIn the long term, I think any stock will eventually come around to attractive valuation. So, even if I don't get to add JNJ this year, there's always next year, and so on, so forth...
Good point. Maybe I should stop worrying about getting the perfect allocations now and instead make it goal over time. If a core stock is attractive maybe it should take precedence over all other buys. These types of stock seem not be on sale for very long! There will be good chances to pick up these stocks in the future, but you have to have money ready and pay attention to prices!
DeleteI say don't hesitate when core stocks are attractively priced and buy as much as possible.
I find myself flip flopping between CVX and KMI as a core position. I think both will be great investments for the next 10 years, but I'm not sure at the 20 or 30 year levels.