Which Stock? May 6 2009

My apologies. This will not be the answer you were expecting. The question isn't so much which stock to buy. All the stocks in the list of dividend growth stocks I follow (ten financial and ten non-financials, roughly), and a few others, of course, are fine companies. Well, maybe there is one exception. The question is when to buy them? Valuation is all important (value priced)

This is why I keep track of things like yield, Graham value, book value, p/e, the trend of earnings and other valuation indicators. Valuation is the key. If you buy expensive stocks (read popular or high p/e), your returns in the long run will not be significant and you will most likely be better off buying a par-value instrument like a GIC. If, however, you have the patience to wait for the opportunity, and then pounce, you'll have a fine retirement income. With this strategy, most of the time, there is little to do: there's a lot of waiting.

What the market, as a whole, is doing can be a general guide. For instance, if newspaper headlines (front page, not the business section) are negative, the time could be getting close. To get more specific, do a price chart for an ETF of dividend stocks such as CDZ (Claymore Cdn Dividend and Income Achievers) or XDV to see what going on with dividend paying commons. Notice the low in early March 2009, for instance.

“How much difference does stock picking really make?” is the title of a section (Chapter 10) in Andrew Smithers and Stephen Wright's great book Valuing Wall Street: Protecting Wealth in Turbulent Times. It's the q ratio book *. Smithers maintains that investors should pay far more attention to the value of the market as a whole than they do to stock picking. On page 88, Smithers and Wright outline three reasons. “The first is that, getting good or bad returns from a reasonably well diversified portfolio of stocks is far more dependent on the performance of the average than it is on the variation of such a portfolio from the average. The second is that there is quite a lot of evidence that beating the average by stock picking depends upon luck rather than skill. The third reason, which is the central message of this book, is that even though successful stock picking is very hard, it is possible to tell when the stock market as a whole is over- or underpriced. The implication of this is that the crucial thing is not which stocks you pick…”

In the portfolios I keep an eye on, I divide stocks into two categories: financials and non-financials. There is a third category, and decades ago, I used to work in that industry, but resource and energy stocks are not noted for their long-term dividend consistency: I do not buy such stocks any more. If you are starting out, you would buy a financial or a non-financial. As I key this in the spring of 2009, financials offer the best value: a bank, an insurance company or a common from the Power group. Which one? Take your pick. Who knows what the future holds? There is much better choice in the non-financial group, but generally, they have weathered the storm better, so they are more expensive. A pipeline, an electrical utility, a communications company, retail and others (CNR, for instance). In a nutshell, that's it. In my own portfolio there are four stocks and cash waiting for a fifth: Power, an insurance company, a pipeline and a retail (food…a needed service). Twenty percent, roughly, in each provides, what I consider, adequate diversification. A small basket, carefully selected. I read somewhere (Mauldin, I think) that four stocks reduces risk by close to seventy percent.

* Valuing Wall Street is also the buy and hold “until too risky” book (Connolly Report Dec 2003 p.542: I must get around to posting that page 542 on buy and hold when we get back to Kingston. Should we have sold in 2003? Was it too risky then? The market (the greatest sucker rally in history, Jeremy Grantham called it) kept going up for a couple of more years). Markets do over extend themselves. As I write this in the Spring of 2009, we are overextended on the down side…at least we were in early March 2009 (Refer to Tom's Remark of March 10 inside). In hindsight, I do not regret not selling: we would have lost our great income producers, our terrific yields. I do, however, regret buying too early in 2008. I felt somewhat better, though, hearing that Mr Buffett bought a couple of Irish Banks in 2008. Valuing Wall Street is also another “add yield and dividend growth” book. On page 304, Smithers and Wright say: “The return that investors expect from a stock must be equal to the dividend yield plus the growth of dividends.” Think about that for a minute: it has to be true. And they did say “must”. It must be Wright! Say your are thinking of buying a common stock that has a yield of 5%. (This will not work for preferred, so I do not buy preferred). Suppose further that this stock's dividend growth is 5% also. What is your return going to be? Anyone can compute that: 5 + 5 = 10. You'll be receiving 10% on your investment. Wright? (and Smithers say so). Me too. And does that count the price gain? Suppose that the stock price goes no where. Do you still get your 10% return. Ten percent is a market beating return. Isn't the long term market return 9.7%? Do you believe. Are you a dividend growth investor? If not, look into it. evidence_it_works

• when_to_buy by Julius Caesar and others

Stephen Jarislowsky's great Canadian book The Investment Zoo has thoughts on which stocks to buy on pages 93, 96-97, 111, 114, 140-141.