For safety, bet the average - not the trend

Protecting against loss while generating a satisfactory return is the essence of Value Investing.  As Howard S. Marks, Founder, Oaktree Capital Management, stated:

“The key to success lies in avoiding losers, not in searching for winners.”

Unfortunately, too many investors are driven by sound bites and social media posts.  The goal: find the investment rocket launching their portfolio to galactic heights.  They’re searching for “winners” among IPOs, momentum plays, fads, and who knows what else.  Investment safety is an afterthought – until it’s too late.

One way to increase the safety of my Dividend Farming practice is to look for stability and predictability in investment opportunities.  Strong dividend paying stocks have been a great way for me to do so.

Firms with long histories of dividend payments, particularly firms growing those payments, offer a level of stability non-dividend payers don’t.  They’ve shown an ability to generate sufficient cash to pay those dividends over extended periods.  Cash is fact.  Profit is theory.  Focusing on facts (cash) reduces my risk while being side-tracked by non-facts (profit expectation) increases it.

Consistent delivery of dividends makes estimating future cash flows more reliable which reduces risk.  A company with an unpredictable history of cash generation and market volatility makes accurate forecasting problematic – my guess is as good as the next guy’s.  In such cases, it’s easy to fall victim to trend-itis.  The technical trading crowd takes full advantage.

Trends:

Trends are either up or down; they’re binary.  If I bet the up and it goes down, I lose.  What’s more, a change in trend can be considerable.  The lack of directional predictability and potentially large scale shifts in magnitude increase risk by making it difficult to project where my investments are headed.  It’s akin to driving down the interstate as fast as you can while blindfolded.  It may be exciting, but you increase the probability of going in the ditch – or worse.

Long-term Averages:

Long-term averages can pay off.

Long-term averages, however, smooth the ride.  The binary outcome becomes a range offering greater probability of success.  In other words, results generally revert to the average over time and typically don’t stray far from it.  This fact reduces the likelihood of a large miss in my forward estimation mitigating my risk to a degree. 

Long-run dividend histories offer a readily definable average and target range.  The same can’t be said for momentum investing that simply bets the over / under.  The latter becomes a function of buy low / sell high - market timing.  The timers enjoy limited success.

Looking forward through a stable, predictable lens, improves my investment vision.  The better the vision, the lower the risk.  That’s why I prefer to bet the averages with Dividend Champions and not the trends.

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.