An Investment to Buy With Confidence

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

After staying away from stocks for a long time, Americans are slowly coming back to the stock market. This recent column from the New York Times reads:

Millions of people all but abandoned the market after the 2008 financial crisis, but now individual investors are pouring more money than they have in years into stock mutual funds. The flood, prompted by fading economic threats and better news on housing and jobs, has helped propel the broad market to within striking distance of its highest nominal level ever.

The fearful investor

Sadly, most of these scared investors sold at market bottoms – after the crisis – and are getting back into stocks as the indexes make new all time highs, missing an enormous rally since 2009. Emotions of panic and greed can be an investor's worst enemy, and they are the main reason why most individual investors usually underperform the markets.

Still, better late than never, staying completely away from the stock market and relying exclusively on bonds, deposits and similar alternatives can be very detrimental to long term returns, especially in the current environment of ultra low interest rates.

This time, however, investors need to learn the lesson from the last crisis and understand that high quality stocks need to be bought, not sold, on market declines. Ben Graham said it with an outstanding clarity decades ago:

Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

The confidence factor

One critical factor to apply this strategy successfully is confidence; it's not so easy to buy the dips if we are not certain on the fact that the investment will maintain its long term fundamental value regardless of market conditions. Investors have seen it with the dot com bubble, and then again with the financial crisis: not every stock deserves to be bought when the markets go south.

That's why finding simple and high quality investment alternatives can be so important to many investors, it can generate enough confidence to stick with your positions through the ups and downs which will inevitably come over time. Even better, if you have confidence in the fundamental strength of the investment, buying the dips is much easier to implement.

Quality and diversification

Vanguard Dividend Appreciation (NYSEMKT: VIG) is a fantastic ETF to hold through good and bad times without losing sleep to market volatility.  The instrument replicates the Dividend Achievers Select Index, consisting of stocks which have increased their dividends in each of the last 10 years. The ETF charges a conveniently low 0.13% annual expense ratio.

Dividends are more transparent than other measures of value like earnings, since they are cash payments and less subject to accounting manipulation. If a company has been able to increase dividends for a long time, including the great recession of 2008-2009, that speaks wonders about the quality and resiliency of the business, and its ability to generate cash flows through good and bad times.

The ETF invests in a basket of more than 130 companies, holding mostly high quality names with indisputable competitive advantages: Wal-Mart, Coca-Cola, Chevron, Exxon, Procter and Gamble, McDonald's, Caterpillar, Pepsico, Nike and IBM are some of the highly recognizable names in the portfolio. These are mostly global companies with strong leadership positions in their respective industries, and this is the main reason why they have been able to successfully sail through all kinds of economic environments.

Not only quality, but also diversification reduce the risks for VIG investors, both in terms of company-specific factors and industry considerations. Coca-Cola (NYSE: KO) and Pepsi (NYSE: PEP) are both part of the portfolio, so investors don't need to worry too much about what happens with  the cola wars, as one company's losses are usually the other one's gains.

Coke and Pepsi own many of the most valuables brands in the world, combined with gigantic distribution networks which represents a serious limitation for smaller competitors trying to enter the industry and compete on a global scale. Both companies have raised their dividends consecutively for decades, 50 and 40 years for Coke and Pepsi respectively, so they are unquestioningly high quality businesses. By betting on these two cola titans at the same time, investors reduce the uncertainty coming from competition among the two rivals.

A similar example is the inclusion of both Exxon (NYSE: XOM) and Chevron (NYSE: CVX) in the portfolio of this ETF. The two biggest integrated energy producers in the planet actively compete to get access to big sized highly profitable projects, which are getting scarcer by the day. Also, while Exxon has gained more exposure to natural gas in the last years, Chevron is still more oriented towards oil.

Investing in the two energy giants means protection from the competitive risks coming from project sourcing, and it also guards investors from the very important aspect of oil versus gas competitiveness as an energy source. But energy is still energy after all, and that's when the industry diversification provided by this ETF becomes more important.

In a scenario of lackluster economic growth, companies like Coke and Pepsi, which stable demand and an extraordinary track record of growing dividends, can provide the safety and stability that energy players will not generate. On the other hand, Exxon and Chevron will almost certainly outperform consumer staples if the economy is growing strongly and energy demand is on the rise. Putting your eggs in different baskets has its advantages after all, especially in terms of risk reduction.

 
Bottom line

Vanguard Dividend Appreciation provides access to a portfolio of high quality companies which have proven their ability to survive and grow through all kind of economic conditions. Besides, the instrument diversifies among industries and between specific names in those industries. This is an investment you can trust, hold for the long term and buy more during market declines.

 


acardenal owns shares of VIG. The Motley Fool recommends Chevron, Coca-Cola, and PepsiCo. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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