Investing vs Speculating

The Source for Dividend Investors

I’ve been wading into Ben Graham’s book, Security Analysis.  Ben’s the father of Value Investing and mentor to Warren Buffett.  Ben wrote The Intelligent Investor which I’ve referenced before.  His work originated in the depths of the Great Depression and his advice on prudent investing practice was sound then and remains so nearly 80 years later.

According to Graham, “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return.  Operations not meeting these requirements are speculative.”

This sounds straight forward, but what does it mean?  And what’s it mean to Dividend Farmers?

Safety, according to Graham, is protection against loss under normal or reasonably likely conditions or variations.  This doesn’t mean elimination of all risk.  That’s not possible.  Instead, it means mitigating risks associated with non-standard, ill-conceived, or otherwise highly improbable actions or events when selecting a stock to purchase.

Satisfactory return is a reference to the rate of return you are willing to accept – not the market, not Uncle Milt, not your broker – you!  This value is subjective but helps bound the degree of risk you’re willing to endure pursuing an investment return.  General wisdom holds that seeking a higher return means enduring greater risk to get it.

Practically speaking, how can Ben’s wisdom be applied?  From my perspective, solid dividend payers e.g., Dividend Champions, provides a safety filter for launching the investment operation.  

Firms in the Dividend Champion class frequently offer long-standing dividend streams, generally supported by healthy cash-flow and strong financials including low earnings multiples, solid price-to-book valuations, and sound debt-to-equity or assets-to-liability ratios.  Seldom are these firms found among volatile momentum categories.  This means my long-term risk is reduced through increased stability and predictability of investment returns.

Selecting from a filtered list like Dividend Champions lets me quickly locate firms meeting my definition of satisfactory return.  For me, that means a firm with an annual yield around 4%, a good possibility of dividend growth, and some probability of valuation growth.  If the yield is near 4% and grows a few percentage points each year while increasing marginally in stock price valuation, I know I have a solid firm with a high probability of delivering a satisfactory return over my long-term horizon.  

Because three components contribute to my satisfactory return, I’m able to mix and match without venturing outside my safety zone.  For instance, I might accept a firm with a 3% yield if I believe the dividend growth rate will be higher than normal.  If an offering has limited potential for growth in its stock price, but offers a higher yield, assuming the financial metrics are sound and its qualitative characteristics are positive, it may provide me a satisfactory return as well.

If I’m mindful of safety, understand my satisfactory return requirement, conduct due diligence on a few financial metrics, and start with firms already possessing some of these important characteristics, I’ll be mitigating risk within normal operations as much as possible.  Doing so means I’m operating according to Graham’s definition of an investing operation and not one of speculation.

Allocating my few dollars this way isn’t flashy.  However, I’d rather make steady progress toward my goal, sleeping well along the way, than hope my future arrives during a bull market vs a bear.  That’s the difference between investing and speculating.

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.