Streetwise for Friday, August 17, 2018
Have you ever been watching television in the evening and the discussion turns to a company you are invested in …and the news is not good. A cold shiver goes down your spine and now you dread looking where your investment will trade when the markets open the next morning.
Take a deep breath and relax. Excepting events such as bankruptcy, you are not facing, to borrow the title of Francis Ford Coppola’s 1979 epic war film, Apocalypse Now.
Of course, it could also be good news, accompanied by a series of cacophonous sounds. One Wall Street commentator utilizes a discordant collection of sounds, which does little except ensure you are not napping.
Good or bad, what you are facing in these situations is referred to as event risk, the occurrence of unforeseen exogenous events that can, and often will, affect not just the immediate future of a company but all too often the overall market. Something we have seen too much of lately.
Event risk is more likely this month than at other times during the year. Why you ask? Because since 1970, August has historically proven to be one of the most volatile and dangerous months of the year. Specifically, August has accounted for seven of the 50 sharpest monthly declines in the Dow Jones Industrial Average during that period, with an average decline of 8.9 percent.
At the same time, baseless commentary implying that Armageddon is right around the corner can result in even experienced investors giving some consideration to liquidating assets, despite adverse tax consequences, and exiting stage left. That is exactly opposite of what you should do.
Yes, I know Wall Street can be brutal. This is especially true for investors with lesser resources on which to fall back on. The fact that August has a history of crushing investors’ illusions is therefore not going to make your life any easier.
Event risk also becomes more prevalent during earnings season, although for the reporting period that just ended many companies chalked up results that exceeded consensus estimates. And we will likely see a continuation of that trend when third quarter numbers are reported in October.
While you cannot prevent exogenous events from affecting your portfolio, positively or negatively, the effects are generally transitory and can be minimized through diversification.
Purchasing stocks with similar risk profiles can result in extraordinary returns…if Lady Luck smiles down upon you. Of course, the inherent risk is just as extraordinary. If instead you spread your selections across a wider spectrum of companies your overall return may be lower, but you reduce the probability of a severe setback, regardless of economic circumstances.
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, even a well-diversified portfolio is subject to some event risk. This is where dividends come into play. A dividend is a distribution of the earnings to you the shareholder. They are real money, not just some entry depicted on a balance sheet, or in an annual report.
As I have said time and time again, ad nauseum, there is no more accurate indication of fiscal achievement in a publicly held company than a trend of rising dividends. And once a dividend is paid, the money leaves the company’s control. They are not subject to manipulation or interpretation.
Because rising dividends generally only come from rising earnings, the result of rising revenues, dividend trends can provide a strong indication as to the likelihood for share price appreciation.
Moreover, dividend yields are closely watched on Wall Street. When the yield on a stock becomes abnormally high, often due to a falling share price, it creates interest, with the resulting increase in demand will often halting and even reversing a decline. Without dividends, you do not have this safety net.
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.RuddInternational.com.