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Beta & Market Corrections

I happened to be reading an article on SA recently when I came across this paragraph:

"Companies must pay a dividend and increase it regularly. I prefer dividend yield above 2.5% but will consider slightly lower yields if yields are growing much faster than the average rate for the industry. Companies that have cut the dividend within recent years or have a history that includes multiple cuts will not make the list. I require a positive cash flow that includes the ability to pay long-term debt coming due within the next five years. This is to provide certainty of viability in case the credit markets freeze up again as happened in 2008 and 2009. Companies that post losses in earnings from ongoing operations will not be considered. I also do not like stocks of companies that tend to fall further than the broad market index, S&P 500."

The first 4 criteria soundly perfectly desirable to me. For a dividend growth investor, they all are important traits even if your absolute criteria have slightly different numbers. When I got to the last one (bold emphasis is mine), I had to pause. I've heard this many times phrased various ways - especially the all-important back test.

Investopedia defines beta as:

"A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates the expected return of an asset based on its beta and expected market returns."

Simply put, beta is a statistical measure of how much the stock price changes in relation to the S&P 500 or the overall market depending on the source calculations. Many sources I've seen use the average over 2 or 5 years and update it periodically. After seeing the above, I went back to my portfolio spreadsheet and updated the betas of all my stocks to take a look. About half of them had changed and about 1/3 of the portfolio has a beta of 1.0 or greater.

Theoretically, anything with a beta over 1.0 will change by a greater amount than the S&P 500. That's great in an up market because your portfolio value is growing faster than the S&P 500 but, according to others, that's not desirable during a correction or bear market. That means companies such as Aflac (NYSE:AFL) with a beta of 2.0 is not wanted. How about Walgreens (WAG - 1.4) or Wells Fargo (WFC - 1.4)? GE (GE - 1.6), CSX Corp. (CSX - 1.4), Cisco (CSCO - 1.4), 3M (MMM - 1.2), Caterpillar (CAT - 1.8), Emerson Electric (EMR - 1.4), General Dynamics (GD - 1.2), Air Products & Chemicals (APD - 1.3), Vornado Realty (VNO - 1.4) all have a high probability of declining more than the S&P 500 because of their higher betas. This list isn't all inclusive and I've purposely omitted many popular dividend growth stocks that hovered around the 1.0 mark (0.9 - 1.2) because that could change either way with a few good or bad months under their belt.

In that case, you can start narrowing down the CCC list, or whatever screening method you use, quite a bit. Yet, many of the above are widely held and people often mention they'd like to add to them during a correction. Some are even on my watchlist waiting for a buying opportunity.

Some will say "Well, I'll buy them for the upswing and then get out before they drop". That presents several problems for me; 1.) Now you're timing the market. Not many people can do that consistently. I know I can't., 2.) You're adding more trading of your holdings with each trip incurring transaction costs. In a taxable account, now you may have a tax liability to further reduce your return., and 3.) You're missing out on some of the compounding if you're in and out of a security at the wrong times.

Additionally, many say that total return is the only thing that matters. In that case, wouldn't something that goes up faster than the S&P be a good thing? What about the downside trip? Wouldn't you just be better off buying an index fund or funds and letting the market determine your returns?

Personally, I really don't care as much about what happens during a market drop. What I'm looking for is companies that are performing well, or maybe better worded as well as I am expecting, and that can continue to increase their dividend stream over the years. To me, the portfolio value is not as important as the steady income stream that just keeps inching upward faster than inflation so I can pay my bills in the future. Sure, no one likes to watch the market value of their portfolio value going down when Mr. Market is not cooperating. Yet we all feel like geniuses or smile inside watching our portfolio participate in a good upswing -- especially if we're ahead of the S&P 500.

However, I can see some benefits of the tendency of higher beta companies going down further than the market during a correction or recession.

During that time when AFL or WAG have dropped back down to the 30's or 40's (currently trading in the $60 range) during a market break, my purchases and reinvested dividends are buying more shares and a bigger piece of the earnings and dividends going forward. Hopefully, management can navigate the short-term challenges so they can benefit when the market comes back and at a faster rate than the overall market. That's why we look to the earnings reports, management's projections and see if they match their results, etc. In other words - due diligence or analysis.

My thought is, don't base your investing decisions only on statistics and "look backs".

This wasn't meant to disparage anyone's investing methods. I'm just musing on something I read. What I do is different than what others do. You need to find what works for you and your comfort zone. That's my opinion, what's yours?

Disclosure: I am long AFL, CSX, WAG.