I'm married and have a newborn son. I have a full-time job that has nothing to do with investing, I attend school part time, and I volunteer at the local Red Cross. Believe it or not, I have a life outside of The Motley Fool. As a result, I cannot spend all day, every day, poring over financial reports, nagging investor relations departments, and otherwise researching, building, and maintaining my portfolio. Yet the best path to building wealth that I know is through owning portions of successful companies. I want to provide for my family, both now and in the future, yet I still need to sleep at night. In order to allow me to meet my family's financial goals, without interfering with the rest of my life, I needed a plan that would let me invest without excessive vigilance in following my selections. In essence, I needed a strategy that lent itself to what fellow Fool Bill Mann calls benign neglect.
Through reading The Intelligent Investor by value master Benjamin Graham and studying under the guidance of Motley Fool Inside Value advisor Philip Durell, I've put together a strategy that lets me effectively invest for my family's future without waking up in a cold sweat, worrying about the companies I own. I owe a debt of gratitude to those who have helped me get where I am. As partial repayment, I would like to take this opportunity to pay forward the favor and share some of the lessons I've learned and the guidance that steers my investing philosophy.
Lesson One: Show me the money
As a shareholder, my money is at risk, invested as a partial owner in the businesses behind the stocks. When companies prosper, their owners deserve to prosper as well, and the most direct way that a company can reward its owners for the risks taken with the owners' money is through the payment of dividends. As well as satisfying the old maxim that "A bird in the hand is worth two in the bush," dividends say a lot about the companies that pay them. Dividends:
- Signal the fact that the companies have sufficient financial strength to make the payments.
- Provide a tangible reminder to management that it works for the shareholders.
- Give some consolation to investors suffering through downturns in share prices.
I may have missed out on Google (NASDAQ:GOOG), the hottest IPO of 2004, but I sleep well at night knowing that, at current prices, I get more distributions back to me per dollar invested in Kinder Morgan Management (NYSE:KMR) than Google takes in as revenue per dollar invested.
Lesson Two: Spread the risk
My crystal ball is still broken. No matter what method I use to evaluate a company and its prospects, the best I can do is make educated guesses about its future. I could be wrong, and I often am, both on the upside and the downside. When I first invested in home improvement giant Lowes (NYSE:LOW), for instance, I had no idea that the 2004 hurricane season would cause such a boom in its business. Conversely, as a partial owner of Merck (NYSE:MRK), I was shocked when the pharmaceutical giant needed to pull its blockbuster drug Vioxx from the market following a study linking the compound to heart troubles.
By owning shares in both companies, the good news surprise from Lowes largely offset the bad news surprise from Merck. As a result, my overall portfolio held up quite well, even as one company within it stumbled. I've been burned several times by companies failing to perform, but keeping diversified has helped protect my overall portfolio as individual companies struggle. It's easier to sleep at night when I can rest assured that a meltdown in one company I own will have little effect on unrelated companies elsewhere.
Lesson Three: Go bargain hunting
In the November issue of Inside Value, Philip profiled Omnicare (NYSE:OCR), a pharmaceutical distribution service provider. At the time of publication, the company traded at $29.51 a share, a significant discount to Philip's conservative fair value estimate of $41. Wall Street is a place where free cash is occasionally handed out to value investors, and in Omnicare's case, there was a golden opportunity shortly after Philip's recommendation. Already facing continued bad publicity because of the difficulty of its takeover bid of rival NeighborCare (NASDAQ:NCRX), the company disappointed Wall Street with news that its per-share earnings for that quarter had grown by a mere 15%. As a result, the company's stock had dropped as low as $26.93, giving bargain-hunting subscribers the rare opportunity to buy the company at a discount to the discount that Philip had determined already existed.
Deep bargains are often short-lived, and at a recent price of $34.39, investors who got in immediately after Philip's recommendation and those who were able to take advantage of the later discount have seen positive results. While Philip's Inside Value recommendation did not catch the exact bottom for the stock, the company did not fall much below the price when the newsletter was published. By bargain hunting, investors found a low price for a solid company and were able to sleep at night, comforted by the fact that the company was worth more than what they had paid and had merely become a better value.
Lesson Four: Do your homework even after you buy
What keeps a healthy dose of benign neglect in investing from turning malignant is a regular review cycle. Taking the time to read the quarterly Securities and Exchange Commission filings is how I keep abreast of the companies I already own. In a recent 10-Q filing, for example, Presidential Life (NASDAQ:PLFE) indicated some troubling information. Among other things, it reported that Moody's had lowered its Financial Strength rating of the insurance firm to grade Ba2, "Questionable Financial Security." That's a giant flashing alert signal, warning investors that choppy times may lie ahead for the company.
Because I do my homework and review my portfolio regularly, I caught the warning signal and investigated further. After reviewing the information, I came to the conclusion that the margin of safety in my original purchase price still appeared sufficient to protect my initial investment but that I certainly would not buy more shares in the company unless things improved. As I mentioned previously, if the company does not soon signal renewed fundamental strength by raising its dividends, it is a candidate for me to sell. By noting the bad news in the financial statements, before it became critical, I've been able to make a rational plan on how to proceed -- giving me ample opportunity to sleep at night without excessive worry about an unexpected meltdown.
Final Exam: Why bother?
Investing is a means to an end, and not an end unto itself. Over time, investing intelligently is a great way to build wealth and provide financial security for one's family. By looking for companies that directly compensate me for my risks, diversifying appropriately to spread out those risks, bargain hunting with Inside Value, and doing my homework by checking up on companies even after I own them, I've come up with an investing strategy that lets me sleep at night while still providing for my family's future.
Fool contributor Chuck Saletta owns shares of Kinder Morgan Management, Lowes, Merck, Omnicare, and Presidential Life. The Motley Fool is investors writing for investors.
