The Case Against Value Stocks as Drips

A longtime Fool named off2Japan began a discussion board thread entitled I'll show you mine... if you show me yours! Catchy title. The poster then displayed a list of his Drip holdings.

What surprised me was the enormous response that followed, with numerous people listing the companies they Drip, whether through the company plan or through a pseudo-Drip (such as BuyandHold.com or ShareBuilder). I have been compiling this information from the community in aggregate form, counting the number of people holding each company.

If you have not done so, we would love to hear from you. What companies do you hold in a Drip? Simply respond to the discussion board thread and I will add it to my count. If you do not wish to do this publicly, you can e-mail me directly via [email protected].

Are value stocks good Drip stocks?
As we continue examining the life of a Drip investment, we consider what companies will work well in our hypothetical portfolio. Numerous times it has been mentioned that we are seeking growth stocks, not value stocks, though I'm not certain if this has been adequately explained.

Before beginning, we should understand the terms. The Fool's School gives these explanations:

Growth investing is the idea that you should buy stock in companies whose potential for growth in sales and earnings is excellent. Growth investors tend to focus more on the company's value as an ongoing concern. Many plan to hold these stocks for long periods of time, although this is not always the case.

The goal of the value investor is to purchase companies at a large discount to their intrinsic value -- what the business would be worth if it were sold tomorrow.

So, on these measures, a growth stock's future growth is paramount to its selection. These companies tend to expand their tendrils outward, encompassing the competition.

Value investors, on the other hand, look at a company with a different set of metrics. They investigate a company with the stock's price in mind, looking for cases where the market thinks too little of the company. When this is done successfully, value investors get stronger returns when the rest of the market catches up with their analysis.

Of course, these two definitions are not mutually exclusive. Growth companies are undervalued at times. The investor finding these companies can be doubly rewarded.

Both strategies have their proponents, and both strategies have proven to be worthy of consideration. Growth companies understandably are generally the ones we tend to examine for a Drip. However, why do we generally tend not to consider "value stocks"?

One tenant of making any purchase is to understand why that purchase is being made. A frequent question on the Drip discussion board concerns when one should sell. My personal answer all along has been that when one knows why he made the purchase, he will know when to sell.

The best value stocks are companies that have been unfairly beaten down. As we all know, the market tends to overreact in some cases, and occasionally becomes downright schizophrenic. When one sees a quality company that is worth more than the market has decided, it may be proper to make the purchase. This idea has been shown time and again to make sense through the Foolish Four strategy.

However, if the company shows the market that its valuation is improper, and this is reflected in an upturn of the stock's price, the reason for making the purchase will no longer exist. Unless there is another reason to retain the stock, it would make sense to sell it.

Since we expect to make regular purchases of Drip companies for at least a decade, unless a company has the characteristics that I mentioned last week, we are operating with the wrong tools.

Does this mean that we should completely dismiss value stocks as Drip considerations? I would not go this far because if you can find a company with both growth and value characteristics, then you will benefit greatly. However, if one only looks at the value aspect when considering a Drip prospect, the lifespan of the possible investment should be kept in mind. Once your stock rises in value as the stock market recognizes it, will you want to sell it? And, by that time, will you have dollar cost averaged enough money into the stock to make your purchase worthwhile in the first place?

Your Turn: