This is a guest contribution written by Ben Reynolds at Sure Dividend. Sure Dividend uses The 8 Rules of Dividend Investing to build high quality dividend growth portfolios.
The financial community likes to segregate investments into different styles.
You have ‘value’ investments, ‘growth’ investments, ‘income or high yield’ investments, etcetera.
In my view, this is much ado about nothing. It is true that different investors have different needs. An investor in their early 20’s isn’t going to need the same level of current income as a retired 70 year old investor.
At the end of the day, all investors are looking for the same thing: The maximum amount of total return for a given level of risk and income.
Whether that return comes from the price-to-earnings ratio rising from 10 to 20 or from the company growing its earnings-per-share by 100% shouldn’t matter.
This article gives an overview of value, growth, and dividend investing and shows how they culminate in dividend growth investing.
Value investing traces its roots back to Benjamin Graham. Graham is often called the ‘father of value investing’.
Graham’s approach was to look for ‘cigar butt stocks’ – stocks that had been discarded by the investing community but still had one ‘puff’ of value left in them.
An example would be a company whose assets less liabilities were worth more than its stock price. Graham devised a number of more in-depth strategies beyond the scope of this article, but the basic idea is to spend less than $1.00 on $1.00 worth of value.
So if a stock was trading for $10.00 per share, but had a value of $15.00 per share, it would be a good value. The quote below is from Benjamin Graham’s mentee, Warren Buffett:
“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
Finding the true value – the ‘intrinsic value’ of a business is imprecise. You can never say exactly what the fair value of a business is, but you can come up with a reasonable estimate.
Some things are easy to quantify. A stock trading for less than its liquidation value is almost certainly undervalued.
Other items are more difficult to quantify. What is the value of the Coca-Cola (KO) brand, for instance? It’s a lot, but how much?
What is the value of quality? A company with a strong competitive advantage should trade at a premium to a marginal commoditized business, but how much?
The appeal to value investing is how tidy it looks – everything has a number. The downside is that just because something is given a number, it doesn’t mean it’s accurate.
Finding the intrinsic value of businesses worth significantly more than liquidation value is difficult and imprecise.
Next, we will cover growth investing. Read More