Today, I wanted to discuss one of the hardest investment issues I've considered in trying to adopt a coherent investment strategy that will lead to success. For lack of a better term, I call this the debate between automatic dividend investing and active dividend investing.
One one hand, you have what I call "automatic dividend investing" where you simply identify the strongest six or seven companies in the world, and invest money into them every month. If you got $500 to invest, it would basically amount to this: $100 for Coca-Cola (KO), $100 for Exxon-Mobil (XOM), $100 for Johnson & Johnson (JNJ), $100 for Procter & Gamble (PG), and $100 for Colgate-Palmolive (CL) each month. For most, worrying about maximizing valuation wouldn't be the priority of this strategy (maybe you'd stop buying shares of Coke if the company traded at 28x earnings or something self-evidently bad), but for the most part the focus would be on acquiring an ever-larger stake in each of these firms with each passing month. Over long periods of time, such a dollar-cost averaging approach would likely generate investment returns commensurate with the underlying growth of the business. If Coke generates 10% growth annually over the next 25 years, it's likely the investor would experience around 10% growth.
The appeal of this strategy is that it has a fanatical focus on quality (the point isn't that you would choose the same firms that I did, but rather, that you would be regularly investing money each month into the companies that you believe to be the best). Also, it's a strategy that requires a much smaller time investment than value investing. If you know that 10-20% of your disposable income from every paycheck is going to buy shares of Coca-Cola, that can free up some of the time that you would otherwise spend researching investments. Considering that we each only have about 450,000 or so conscious hours walking this earth, it could possibly be more useful for us if we spend that time doing other things than researching investments. This thought process could be a much more peaceful way to approach investing: "I got this idea of what the top 15 to 20 firms in the world are. I'm going to try and take my disposable income from each paycheck and buy ownership stakes in each of these firms. I'll monitor the health of the stocks periodically, but for the most part, I'm going to focus on increasing my savings rate (either by making more money or cutting expenses) and living life."
This contrasts to another investment route that I classify as "active dividend investing." This requires digging in and looking up firms that most people outside of the investing world haven't heard of. It takes time to pick up on information such as the fact that Becton Dickinson (BDX) has a compounded dividend growth rate of 13% annually since 1962. Or that Owens & Minor (OMI) has a 13% annual compounded dividend growth rate since 1982. While the quality of these firms is quite good, it's not quite Abbott Labs (ABT) or Johnson & Johnson quality. And consequently, these firms take a bit more time to monitor. While it may always be prudent to make up with the quarterly filings and annual reports of your investment, it is probably more necessary to do that with Owens & Minor than Johnson & Johnson. The strategy of active dividend investing involves the practice of value investing. The entry price paid for the stock is a much bigger deal in this approach. While this requires more time and effort, it can potentially lead to more optimal results due to its more focused nature.
Eventually, I came to find that the strategy of active dividend investing fit my personality better than the more automatic approach. This stemmed from my realization that there are two ways to find safety in an investment.
The first is the company itself. The health and promise of longevity offered by Coca-Cola's business model is better than that of Research in Motion (RIMM). Finding excellent businesses is one way to find safety.
But price itself can also be a form of safety (or potential hazard). If I were to privately arrange to purchase 100 shares of Coca-Cola at $100 a piece, the performance of the business isn't going to be able to save me when I pay an irrational price. This phenomenon largely explains why Microsoft (MSFT) has offered investors such seemingly lackluster returns since 2000. The business performed fine and well-the earnings per share may have tripled, but the business certainly didn't because the company was priced so irrationally at the start of the millennium.
Essentially, my preference for the more rigorous approach came down to this personal judgment call: I'd rather spend the time searching for undervalued stocks such as Becton Dickinson because I think it would be a safer investment to buy shares of the stock at 13x earnings than it would be to buy Procter & Gamble at 24x earnings. Whatever higher earnings quality that Procter & Gamble brings to the table is offset by the additional safety that Becton Dickinson's cheaper price offers.
But still, I do think there is a certain temptation to just say, "Hey, I want to buy $100-$200 worth of Coca-Cola stock every month." The good news is that, as is the case with almost all issues in investing, we don't have to take an all-or-nothing approach. A blended strategy is perfectly legitimate. If you've got $500 per month to investment, it can be perfectly suitable for you to say, "I'm going to put $100 into Coca-Cola every month and dedicate the other $400 to the pursuit of undervalued and under-the-radar dividend growth stocks." It's hard to go wrong with many things when you take a balanced approach.