Deep-down in my soul, I am a contrarian. The third quarter market run-up converted most of the great dividend stock buys into ‘ok’ buys (at best). As September came to a close, I felt a sense of excitement entering October. This is the month that stocks have traditionally gone on sale. I was prepared to make a double allocation (or more) depending on the level of the markets decline. It didn’t happen. Once again, investor emotions drove the market in an unpredictable direction.
To that end, a recent article in Forbes discussing investor emotions caught my attention. The salient takeaway from the article was:
The assumption that investors are rational agents is bunk. We are not rational. We’re human. Even the most brilliant investor can be swayed by emotions into making irrational decisions that result in financial loss.
This is quite easy to illustrate looking back at the last three years. Logic had very little to do with movements in most stocks. Knowing this, there are some things that long-term buy-and-hold investors can do to profit from these irrational moves in the market.
I. Dollar Cost Average In
When the market is rallying, we generally should be buying fewer shares than when it is declining. Our emotions left unchecked will lead us to do the opposite of what we should be doing. Investors are often compelled to buy when the market is rallying, then sell when it is declining. So how do we guard against this?
Dollar cost averaging [DCA] is one way. DCA is a strategy of investing equal dollar amounts on a regular basis over specific time periods. For example, you might choose to invest $2,000 each month in your income portfolio, no matter what the market is doing. This will lead to more shares being purchased when prices are low and fewer shares purchased when prices are high. The overall effect is to lower the total average cost per share of the investment, over time.
II. Keep A Watch List Of Great Stocks
Unfortunately, great stocks that perform well over an extended period are noticed by the market and will often carry a premium that makes them difficult for a value-based investor to purchase. Consider these dividend stocks from near the bottom of the cycle at February 27, 2009 to the end of September 2009 (prices are on a dividend adjusted basis):
Eli Lilly & Co. (NYSE:LLY) $28.16 to $32.57 up 15.66% [Analysis]
Chevron Corp. (NYSE:CVX) $59.01 to $69.82 up 18.31%
Pepsico, Inc. (NYSE:PEP) $46.95 to $58.66 up 24.94% [Analysis]
Kimberly-Clark Corp. (NYSE:KMB) $45.51 to $58.98 up 29.60% [Analysis]
The Coca-Cola Company (NYSE:KO) $39.76 to $53.70 up 35.06% [Analysis]
CenturyLink, Inc. (NYSE:CTL) $24.53 to $33.60 up 36.98%
3M Co. (NYSE:MMM) $44.45 to $73.32 up 64.95% [Analysis]
Are these stocks 15%-65% intrinsically more valuable at the end of September compared to the end of February? I don’t think so. We as investors must understand valuation and be prepared to act.
III. Have a Plan and Follow It
You need to have an investment plan. More importantly you must have full confidence in your investment plan. Otherwise, you will be a slave to emotion which will lead to very undesirable results in your portfolio.
Long-term buy-and-hold dividend investors look at bear markets as their friends. It is a wonderful time to add quality companies at great prices and increase our average yield.
Disclosure: Long LLY, CVX, PEP, KMB, KO, CTL, MMM. See a list of all my income holdings here.