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.