We all have all read that it is our responsibility as dividend investors to buy stocks in companies that we know and that we can understand. There is also the mindset that one should invest in companies that you are a passionate user of the products the company produces. I had an interesting conversation with a colleague of mine the other day and this is one his primary methods for choosing a stock to invest in. For example, he loves the new Coke Zero and recently bought the stock. As a learning-minded individual, I asked him what sort of analysis he did on the stock to make his decision. His answer to me was stunning.
He responded with his three criteria for choosing to invest in a company:
1. He must be an avid user of the company’s products;
2. He must see that there are a lot of people like him, who have a high passion for the product; and
3. The company must be considered as a blue chip stock by the investing public. To him, this meant that the company had been around for a long time and was a huge, well established company.
That is it – that is all the analysis that he does. There is no review of earnings or cash flow. After some reflection on his part, he said that the most important factor was really the blue chip status of the stock. This provided him with the comfort and historical perspective on how well the company has done in the past and how well they will do in the future. He ads that we can’t predict the future so buying companies that are big and very well established provides him with the risk / reward trade-off that he is comfortable to him. These companies are the big powerhouses in the stock market and obviously know how to run their companies and the analysis is not worth his time. He has a long (15+ year) investing time frame that will provide him with some protection on his timing for his purchase (i.e. it does not matter what price he buys at as over long periods of time these blue chips have usually gone up). He looks to the future by looking actively for people who are using the products – how ingrained are the products in our daily lives.
The interesting thing about his portfolio with mine, is that we hold very similar stocks (Coca-Cola, Procter & Gamble, Royal Bank of Canada). He bought these will very little formal analysis and I bought them with a more in depth process. Who is right? We both got to the same spot, but using different roads. Further, he also believes strongly in international diversification and holds a large portion of his portfolio in an global index fund. This got me to thinking – is all my extra work for nothing and I should just simply invest in stocks like he does – we get to the same spot anyway?
I don’t think so. The real risk of this strategy is that he will not be bought into why he took a position in the company and if and when the “stuff” hits the fan, you will not have the data or understanding to make an informed decision with. People overreact and let emotions make their decisions for them, and a lack of understanding could lead you to rash decisions. Looking at the fundamentals of a stock provides you with background and context with which to make these decisions. Investing is not acting on emotions but buying on fundamentals like dividend growth.
What are your thoughts on my colleague’s strategy? Please use the comments to provide me with your input.
I’ve always believed that are more than one ways to investment heaven.
However, your colleague’s investment style leaves him vulnerable to to a lot of market risks that he wouldn’t understand.
He could instead pick the companies that meet his criteria and then consult with someone like you who could run the numbers for him before investing.
buying stock just because you love it does not sounds very logical to me. it’s just emotion and no logic back up, i think one should have a logical system to pick and sell stocks.
I personally am a big fan of Yahoo and all their great content sites. I’m not a fan of google anything cept maybe search — and ok ok — analytics — but still. Yahoo.. If only they could get their act together on the street and get some attractive revenue. I would definately buy YHOO, simply because I love their products.
I lean more towards your position, but recognize my own limitations when it comes to analysis. I feel my investment goals are met by focusing on value, dividends and dividend growth, and confidence in a business’s long-term viability. I therefore tend to focus on large-cap stocks that have a long history of rising dividends, while selling at prices I feel comfortable paying. Buying well-established, well-known companies keeps you in a good place, but without consideration of price vs value adds significant investor risk.
Have to agree with the sentiment that there is far too much emotion in a decision like this. Researching a company because you like the products or services they provide is fine, but buying the stock without at least checking the fundamentals of the company isn’t a sound policy.
It sounds very similar to the investing strategies I’ve heard of from quite a few older individuals who decided at some point in their life to invest on their own. Many simply glanced over financial statements and placed much more emphasis on brand power and the companies ability to sell more product each year to more customers.
Never buy with your heart! I don’t think it is ever a good idea to fall in love with a company’s stocks. Stocks and funds were meant to be bought and sold. They are empty stakes in a company’s assets. Once the company’s position no longer reflects the share price, you move on.
“The real risk of this strategy is that he will not be bought into why he took a position in the company and if and when the stuff hits the fan, you will not have the data or understanding to make an informed decision with.”
Do you have an example of a time when the stuff hit the fan and you were able to make a better decision than your friend? Just to play devil’s advocate: what if Coke (or PG) suddenly came out with a horrible product, or more likely, came out with no new products, and some competitor had a whole bunch of new competing popular products. Because of his style, your friend would immediately see this, and maybe exit his position. If you are too focussed on the fundamentals, it could take a couple of quarters for the company’s lack of vision/ingenuity/etc to appear in the fundamentals. At which point the stock may already have partially sold off.
Understanding your friend’s investment style is important, even if it’s only because there are (more than a few) people out there who invest in similar ways.
BTW, Coke Zero is awesome.
It is an interesting approach, I don’t really have much to add to what everyone has already mentioned about it, but what did kind of bother me is when you said “it does not matter what price he buys at as over long periods of time these blue chips have usually gone up.” Yes, price matters less than if they guy’s timeframe was a couple of years, but it matters a lot nevertheless. It could be a difference of as much as 4-5% in additional annual return on that stock, if he bought it at a premium to the stock’s intristic value at the time of the purchase instead waiting for the right price. So yeah, price definitely matters and it is a big part of Warren Buffett’s investing strategy – great company and great price.