There’s a certain amount of luck involved in investing. Nobody can accurately predict the future all the time, yet every single solitary cent of any company’s stock price is based on some sort of prediction of what that company will do in that unknown future.
You could get lucky in a good way, and a stock you buy could skyrocket shortly after you hand over your cash to pick up some of its shares. Or you could get lucky in a bad way, and discover that what you thought was a well-informed investment turns out to be the next Chinese scam on its way to bankruptcy.
While luck can’t be completely eliminated, you can follow a time-tested approach to reduce its impact and increase the chance that the money you earn from investing, you earn on purpose. This approach traces its roots to the heels of the Great Depression and Benjamin Graham, the father of Value Investing and the man who taught Warren Buffett how to invest.
The three parts to this Graham-inspired strategy are straightforward on their own, but they really gain their power when all three are used together. Those keys to investing success are:
- Dividends
- Valuation
- Diversification
Here’s why each matters, and how they work together.
Dividends
Dividends are cash payments made to investors to directly compensate them for the financial risks they’re taking for owning stock. Not every company pays a dividend, but once a company starts paying a regular dividend, it represents not only cash in investors’ pockets, but also an incredibly clear signal of the company’s prospects.
Take General Electric Company (NYSE:GE) as a prime example. The company was once incredibly protective of the dividend that it had maintained for decades and increased annually for over 30 years. When its overexposure to subprime debts during the financial crisis tripped up its own operations, one of the earliest public signals of just how bad the damage was came from the company’s dividend. After decades of clockwork annual raises, it held the dividend steady for six quarters, before finally cutting it.
Similarly, electric generating company Exelon Corporation (NYSE:EXC) tried to protect its at-risk dividend before finally succumbing to a cut. The saga unfolded in public over several months, as investor speculation and company statements hashed out whether the payment could be maintained, and under what circumstances.
Dividends may not be guaranteed payments, but in both of these cases, company management made it clear that they know investors watch their dividends and carefully analyze changes to policy. That both companies somewhat telegraphed their difficulties via their dividends shows how those payments can provide not only direct financial rewards but also powerful signals of what’s really happening.
