Beta & Market Corrections

[Dividend Watcher]

Just happened to be reading one of K202's articles on SA when I came across this paragraph:

Quote:I would like to reiterate some of the simple rules that I use as filters to find prospects companies for my master list. Companies must pay a dividend and increase it regularly. I prefer dividend yield above 2.5% but will consider slightly lower yields if yields are growing much faster than the average rate for the industry. Companies that have cut the dividend within recent years or have a history that includes multiple cuts will not make the list. I require a positive cash flow that includes the ability to pay long-term debt coming due within the next five years. This is to provide certainty of viability in case the credit markets freeze up again as happened in 2008 and 2009. Companies that post losses in earnings from ongoing operations will not be considered. I also do not like stocks of companies that tend to fall further than the broad market index, S&P 500.

The first 4 criteria soundly perfectly desirable to me. When I hit the last one (bold emphasis above is mine), I had to pause. I've heard this many times phrased various ways -- especially the all-important back test.

Presumably, beta is a statistical measure of how much the stock price changes in relation to the S&P 500. Many sources use the average over 2 or 5 years and update it periodically. So I went back to my portfolio and updated the betas of all my stocks to take a look. About half of them had changed.

Theoretically, anything with a beta over 1.0 will change by a greater amount than the S&P 500. That's great in an up market because your portfolio value is growing faster than the S&P 500 but, according to K202 and others, that's not desirable during a correction or bear market. That means companies such as Aflac with a beta of 2.0 is not wanted. How about Walgreens (1.4) or CSX Corp. (1.4)? GE (1.6), WFC (1.4), CSCO (1.4), MMM (1.2), CAT (1.8), EMR (1.4), GD (1.2), APD (1.3), VNO (1.4) all have a high probability of declining more than the S&P 500 because of their higher betas. This list isn't all inclusive and I've purposely omitted many popular dividend growth stocks that hovered around the 1.0 mark (0.9 - 1.2) because that could change either way with a few good or bad months under their belt.

In that case, you can start narrowing down the CCC list, or whatever screening method you use, quite a bit. Yet, many of the above are widely held and people often mention they'd like to add to them during a correction.

Some will say "well, I'll buy them for the upswing and then get out before they drop". That presents several problems for me; 1.) Now you're timing the market. Not many people can do that consistently. I know I can't., 2.) You're adding more trading of your holdings with each trip incurring transaction costs., and 3.) You're missing out on some of the compounding if you're in and out of a security at the wrong times.

Additionally, many say that total return is the only thing that matters. In that case, wouldn't something that goes up faster than the S&P be a good thing? What about the downside trip? See my comments above. Wouldn't you just be better off buying an index fund and letting the market determine your returns?

Personally, I really don't care. What I'm looking for is companies that are performing well, or maybe better worded as well as I am expecting, and that can continue to increase their dividend stream over the years. To me, the portfolio value is not as important as the steady income stream just keeps inching upward better than inflation so I can pay my bills in the future. Sure, no one likes to watch the market value of their portfolio value going down when Mr. Market is not cooperating. Yet we all feel like geniuses or smile inside watching our portfolio participate in a good upswing -- especially if we're ahead of the S&P.

However, I can see some benefits.

During that time when AFL or WAG have dropped back down to the 30's or 40's during a market break, my reinvested dividends are buying more shares and a bigger piece of the earnings and dividends going forward. Hopefully, management can navigate the short-term challenges so they can benefit when the market comes back and at a faster rate than the overall market. That's why we look to the earnings reports, management's projections and see if it matches their results, etc. In other words -- due diligence or analysis.

My thought is, don't base your investing decisions only on statistics and "look backs".

This wasn't meant to disparage anyone's investing methods. I'm just musing on something I read. What I do is different than what others do. You need to find what works for you and your comfort zone. That's my opinion, what's yours?

P.S. This will be posted on my SA blog once I clean it up a little. Don't think it would qualify as a paid article from past experience. Just wanted to share it here first while it was fresh in my mind.

[hendi_alex]

Sounds like someone talking out of both sides of his/her face to me. On the one hand they would say, [I'm not interested in share price fluctuations, I'm only interested in the dividend stream and whether or not the company continues to execute.] But the quote above, says the they do care about market fluctuations of share price. I'm with you, all that really matters is how a company continues to execute. Just because the market overly punishes the shares price, when a company gets lumped in with an entire sector or investment class that is out of favor, that means nothing about the company and may in fact present a tremendous buying opportunity. So for me, it is hard to generalize simply based upon beta. Regardless of beta, the stock of a company that continues to execute and out perform, will generally give the share holder out performance as well.

[TomK]

I agree completely with both of you. Beta doesn't really factor into my decision-making. Generally, I am dealing with the largest and most well-established companies in the world, and I am going to hold most of them for decades. If they happen to fluctuate in price a bit more than the index, well, then that is just going to help me buy more shares at lower prices and fewer shares at higher prices. No worries there.

[cannew]

As mentioned before, I have narrowed down my list of core stocks and would certainly buy any of these stocks if the fell way below the market. The problem facing the company would really have to be serious before I wouldn't buy and even then I would probably not consider selling.

I normally don't buy other than the stocks I already own, but if I was interested in another than I would be hesitant to buy on a real drop. As I didn't have a history with the company I'd hate to rely just on price. If it appeared to be a good company with a long history of paying and growing div's (min 10 years), I'd probably watch and buy at a certain entry price and watch the company closely.

[EricL]

Can't say that I've ever considered beta when buying or selling a stock. Not even on my radar.

[Dividend Watcher]

Good point, Eric. I never have either but I guess I wasn't clear enough in my post.

The thing that irked me was the idea of ruling out companies that would "tend to fall further than the broad market index". Unfortunately, the statistic that best shows this tendency for both a rising and falling market is beta hence using it interchangeably with "tend to fall further than the broad market index". That was the lazy man's way out of all that typing.

The gist of the article was that if you're going to rule out stocks that "tend to fall further than the broad market index", you may be missing out on some very good long-term holdings. Perhaps a better title may have avoided some misunderstanding.