It's no secret that the market is overvalued now, and bargains aren't easy to find. Most cheap stocks can be found in financials, retail and bio-tech, all of which have headwinds that could take years to resolve. While I have no problem buying these stocks as long as I am comfortable with the risks behind the challenges they face, buying Gilead (NASDAQ:GILD) at a PE ratio of 8 is nowhere near as preferable as buying Coca Cola (NYSE:KO) around a PE of 20. Therefore, any cash that is deployed today will likely purchase a firm that is beyond the price that I would prefer to pay for them. There is no question that blue chips are overpriced, but today it seems as if you have to pay for quality merchandise. However, while they are overvalued, I am not concerned with purchasing blue chip firms at these prices. I currently am dollar cost averaging into P&G (NYSE:PG), McDonald's (NYSE:MCD), Exxon Mobil (NYSE:XOM) and Altria (NYSE:MO) among others, which are all relatively overvalued. But I do not lose any sleep over purchasing these stocks and others (Yet, that is. Late 90's valuations would likely keep me away).
Investment Safety and Valuation
The first reason is that I am seeking to generate cash flow away from my day job as quickly as possible. This is so I am not dependent on a singular income stream, and have options in the case of sudden job loss or emergency. There are several ways to generate relatively permanent and passive cash flow. One with access to a good deal of capital can invest in commercial real estate or residential living. They can then enjoy a stream of rents that hopefully exceeds the expenses required to operate and maintain the property. Another option would be high dividend and high yielding bonds. These would create cash flow that is greatly in excess of US Treasury bonds, and the high cash flow could be deployed into more stable companies. However, yields are high for these companies for a good reason. They are high risk, and may not still be operating within a few years. The high yield thus compensates you for that risk. With proper knowledge and management these can be good investments, but I am seeking passive income. Blue chips, on the other hand, are by definition the safest and highest quality firms to invest in. Most work with these stocks involves monitoring them so you can buy more on a downturn. They have simple business models, and while they have relatively lower yields, also return good sums of cash to their shareholders. Therefore, with my age, experience, and capital levels, they are the best source now if I wish to generate any income.
Second among the reasons why I do not hesitate much to purchase overpriced blue chips is valuation. Right now, valuation is not our friend. Purchasing shares of some classic dividend stocks will almost guarantee mediocre returns on anything bought today. However, valuation is also friends. When markets rise, many people can be caught up in the furor and purchase stocks blindly. The prudent investor will see that earnings may not be rising commensurately with the rise in prices, and decide to hold more cash relative to their asset holdings. This is smart investing. On the other side, valuation can also be our friend in a decreasing market. We can look at stock price declines of 50%, see that earnings have declined by only 10%, and jump right in. Therefore, while valuation is not my friend in purchasing stocks today, I can take solace in knowing that valuation can help me on the way down and will be the investor's friend again.
Lastly, I prefer to invest in blue chips, even at high valuations, because I like to purchase great companies at good prices (and today's prices are mostly not yet bad prices). This is partly because I have come to understand my investing temperament over the past few years. That temperament is I rarely get anxious to sell stocks I have long coveted and had an eye on, and I seek to build my portfolio on them. If I buy a blue chip that fits well with my overall strategy of storing wealth for the long term, then my selling finger rarely gets itchy with price declines or price appreciation. These stocks are still the foundation, even if the concrete is a bit expensive.
The flip side of my temperament is that I get anxious when I try and get too clever with my investments by buying things I may believe to be undervalued. Yes, I like to purchase stocks at a discount, and try to get good values for the stocks I store wealth in. However, when I purchase a stock I believe is undervalued and the stock soon appreciates, I typically wish to pull the sell trigger. This can be the case even when I covet the stock for years; I have been watching JP Morgan (NYSE:JPM) for some time, and finally had cash on hand to buy them during a dip (Brexit). The price has since appreciated a few percentage points, and my selling finger is antsy. However, because I bought it for both undervaluation and because it is a great company to store wealth in, my motivation for selling is greatly decreased. If JPM was a fair company at a great price, I would not seek to hold onto it much longer. Being one of the bluest of banks, however, means that I will avoid any mistakes related to selling it too soon.
Holding onto investments for a long period is a proven investment strategy, and blue chips are the stocks I have the easiest time holding onto. Buy and hold can help dodge trading expenses, avoid unnecessary taxes, and ensures you are invested on the stocks best days. Owning these firms forever also means you have an easier time not selling on the worst days, and have a good chance of accumulating more. Buying a good blue chip stock that I want to build my portfolio on helps me to avoid the selling impulse, even if the price were to appreciate. Therefore, most of the time I prefer to buy shares of a great company, and add to them in the event of a market downturn. If you buy a stock you think is undervalued, buy it because the stock is undervalued AND you think it is a great company. Otherwise, the temptation to sell may become too great if the price quickly climbs or it becomes even cheaper. That can lead to a litany of poor decisions.
Yes, the market and blue chip stocks are currently overvalued. However, there are still good reasons I keep investing. One, they are safe stores of cash that are easily accessible and knowable by the lay investor. Second, knowing they are overvalued now will help us to understand that they will eventually become undervalued again. Lastly, I sleep well at night, and have no problem buying and holding blue chip firms. When I purchase solely because of valuation, I tend to look quickly for an exit, especially if the stock appreciates quickly. Buying blue chips, even at today's prices, allows me to hold on for the long term and make prudent investing decisions. This prudence quickly goes away when I try to search too hard for value.
Disclosure: I am/we are long XOM,KO,MCD,JPM,PG,MO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.