Streetwise for Friday, August 25, 2017:
Ever had a peaceful evening in front of your television when suddenly the discussion is about a company or industry you are invested in…and the news is dismal. A cold shiver racks your body. Now you dread to even think about where your investment will trade come morning.
Take a deep breath and relax. Excepting events such as bankruptcy, you are not facing “Apocalypse Now”, to borrow the title of Francis Ford Coppola’s 1979 epic war film.
The other side of the coin is that your investment is discussed positively amid a series of cacophonous sounds that appear to be the trademark of one show. Either way you are experiencing event risk, one of greatest short-term hazards associated with equities.
The occurrence of unforeseen exogenous events can and often will affect not just the immediate future of a company’s securities but also that of the overall market, something we have seen too much of lately.
There are times when baseless commentary can imply that Armageddon is right around the corner. So convincing is the rhetoric that even experienced investors have been coerced enough to briefly consider liquidating assets, despite the adverse tax consequences, and exit stage left. Which is exactly opposite of what you should do.
Certainly, Wall Street can be brutal. This is especially true if you have limited resources to fall back on. Yet, going to cash and locking in losses is not only a mistake, it is senseless.
Our economy is achieving a level of normalcy despite almost daily rounds of political upheaval. However, even moderate economic growth can negate to a degree even the most insidious event risk. Yes, a rising tide floats all boats. Of course, when the tide goes out you get to see just who is swimming naked.
Event risk is most prevalent during earnings season and this season was no exception, despite companies chalking up results that exceeded Street consensus. And we will likely see a continuation of that trend when third quarter numbers are reported starting in October.
Although you cannot prevent negative exogenous events from occurring, and despite the effects being usually transitory, potential damage can be minimized through diversification.
Yes, a lack of diversification can result in extraordinary returns…if Lady Luck deems it to be so. For example, investors with disproportional amounts of Apple have done exceedingly well. Yet, the inherent risk is also significant.
By spreading your selections across a wider spectrum of companies, your overall return may be lower but you dramatically reduce the probability of a major setback.
Diversification is sort of a modern-day alchemy. It has the effect of transforming a heterogeneous group of securities into a portfolio with predictable characteristics. Its secret is simple. The weakness of one security is balanced against the strength of another.
However, because even a well-diversified portfolio is subject to some event risk, there is an anecdote…dividends. Dividends are real money, not just some accounting entry.
Furthermore, the most accurate indication of fiscal achievement in a publicly held company is a trend of rising dividends. Dividends are not subject to manipulation or interpretation.
Because rising dividends are generally the result of rising revenues and subsequently rising earnings, dividend trends are a strong predictor of potential share price appreciation.
To see why, consider that dividend yields are closely watched on Wall Street. When a dividend yield becomes abnormally high, often due to a static or falling share price, it creates attention. Investors are drawn in and the increased demand will generally halt and then reverse the decline. Without dividends, you do not have this safety net.
Note to Readers: I will again be teaching two courses for Ringling College’s Lifelong Learning Academy – Introductory Investment Analysis and Portfolio Management. Classes begin on September 25 and run every Monday for 8 weeks. Registration begins August 29. Call 941-309-5111 or go to www.RCLLA.org. Classes fill quickly!
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.
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