Take What The Market Gives You

Summary

• There's no need to force the issue when accumulating DGI stocks.
• Stay patient, stay discplined, focus on quality first, then value, and you will succeed.
• It may take years to build a properly diversified DGI portfolio, but slow and steady wins the race.

This article was previously published on widemoatresearch.com 

I just went through my watch list and identified all of the dividend growth stocks that were trading below my fair value estimates.

There were 23 of them.

That’s great. It means that even in a market sitting at record highs, investors in the accumulation phase of their dividend growth journey have the opportunity to buy shares of blue chip companies with attractive margins of safety attached.

Admittedly, some of these discounts were rather slim; however, as I’ve said many times, in the timeless words of Warren Buffett,

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

In short, when you’re building a dividend growth portfolio (or any portfolio, for that matter), focusing on owning the highest quality assets over the long-term is the simplest and easiest road to success.

I could throw numerous quotes that they teach on the first day of Value Investing 101 at you right now which would make a similar point.

For instance, Jack Bogle, famous investor and founder of the Vanguard Group, once wrote,

“The real money in investment will be made not out of buying and selling but of owning and holding securities.”

At this point, all of my readers know that I believe that time in the market, as opposed to timing the market, is the most important resource that investors have.

It’s this time that will allow the compounding process that dividend growth investors require to generate vast sums of money to take place and eventually flourish.

I’ve written countless words about the process of buying and holding blue chips, collecting their dividends, re-investing those dividends, and allowing our passive income streams to snowball down the path towards financial freedom.

But, the exercise that I performed today regarding my watch list reminded me of a topic that I have yet to discuss with readers here at Wide Moat Research in detail: prioritizing the combination of quality and value, over all else, including diversification, throughout the accumulation process.

Last week, I published a piece here which was focused on the importance of diversification. In that article I said that diversification was the closest thing to a free lunch that investors can find on Wall Street and therefore, I believe that maintaining a prudently diversified portfolio is an important risk management practice to adhere to. However, I want to be frank: there is no need to rush the diversification process.

Of those 23 blue chip dividend growth names that I believe to be trading below fair value, 12 of them (meaning more than half) came from just 3 sectors.

I believe that there are 5 healthcare stocks offering investors an attractive discount right now, 3 defense contractors (which fall into the industrial category), and 4 REITs.

And generally speaking, I’ve found that this is how the market works.

For whatever reason, the group-think that drives investor sentiment tends to inspire the market to ebb and flow in distinct directions, which creates buying opportunities in particular areas of the market.

Right now, healthcare, real estate, and defense appears to be out of favor (and therefore, on sale). In 6 months, the changing investment landscape could easily shift and lead to different sectors or industries becoming unloved. And, when that happens, the areas of the market that people love to hate right could morph into the next market darlings.

With that in mind, I want to say that I don’t believe that investors should focus too much on proper diversification when buying shares because if you’re someone like me who takes what the market gives you consistently over time, eventually, the fickle sentiment that creates value will provide opportunities to accumulate a wide variety of stocks.

I say this because I have people ask me – all of the time – whether or not I have an idea in a particular sector or industry that they’re interested in owning.

Some are more forceful, making it clear that they have cash burning a hole in their pocket, and yet, they only want to spend it on shares from a certain sector.

To me, that’s not the best approach to have when it comes to the market. While I think it’s great to have a plan, as far as asset allocation targets go, I don’t think it makes sense to force the issue when it comes to meeting those target weightings. Simply put, there’s never any reason to be in a hurry to hit asset allocation goals.

Haste leads to mistakes.

I’ve always found that taking what the market gives me is the best approach because when we buy cheap stocks, we not only increase our margin of safety, but also raise our yield on cost, resulting in higher passive income potential on a limited pool of investable capital.

Maintaining such a narrow field of view when it comes to equity selection so may end up in an investor chasing momentum just for the sake of diversification. And chasing momentum, regardless of the inspiration behind it, is always going to be a bad long-term habit for a dividend growth investor to develop.

This is especially the case when just starting out, but I think the logic holds true for anyone still interested in buying equities: quality should be the first priority, followed very closely by value.

Following that simple formula is likely to result in outstanding long-term returns. And, if my experience means anything, I suspect that a disciplined focus on accumulating irrationally cheap blue chips will not only lead to a sizable and fast growing stream of passive income, but also a portfolio with acceptable exposure to all targeted sectors/industries over time.

Using this strategy, it may take years for a well diversified portfolio to develop. Yet, that’s not a problem for someone who is disciplined with their cash position and ensures that they always have dry powder on hand to take advantage of the market’s weakness.

And, in the meantime, while we’re waiting around to meet our asset allocation goals, we can bide the time by counting our steady flow of dividends – because let me assure you, nothing soothes portfolio management fears like a reliably increasing passive income stream.

If you’re interested in building a reliably increasing passive income stream of your own, or you’re looking for ideas with regard to the best undervalued blue chips in the market today, come check out The Intelligent Dividend Investor.

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