Conservative Stock Investing


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Conservative Stock Investing

  1. 1. Insights Conservative Stock Volume 1, Number 208 From the T. Rowe Price Investing Information Library S tocks are often viewed as high risk. those that are trading below the intrinsic value That is true in general, but there of the underlying companies. are areas of the stock market that n  The fundamentals of the underlying company are comparatively less volatile, are conservative, emphasizing regular revenues where market fluctuations are and, possibly, modest but sustainable long- dampened by certain character- term growth. These investments are often istics of the stocks or companies. As a stock referred to as “defensive growth” stocks. investor, it may help you to know whether the Of these three characteristics, dividends tend stocks you own are higher risk or more con- to do the most to protect equity investors. servative. You might also benefit by knowing how they can be incorporated into a diversi- Why emphasize dividends? fied portfolio designed to help you meet your There are only two sources of total return in financial goals. an equity investment—price gains and divi- dends. Dividends are attractive because they Elements of the conservative approach are the one source of return that will always The goal of conservative stock investing is to be positive, and they offer several important achieve long-term growth of capital without investing advantages: experiencing the extreme fluctuations that n Dividends reinvested in additional shares of sometimes cause investors to cash out at the a stock or mutual fund instead of being taken wrong time. Conservative stocks tend to have one in cash can play a powerful role in helping or more of the following characteristics, which to build capital. During the last 20 years, for can contribute to a steadier ride for investors: example, a hypothetical $1,000 initial invest- n The underlying companies provide a ment in the stocks composing the Standard & substantial dividend, which can cushion the Poor’s 500 Stock Index would have grown to impact of price declines in a falling market. $5,031.89 if all dividends were reinvested (see Many such companies also look to increase Chart I). their dividends on a regular basis; over time, n Dividends can be a good indicator of corpo- compounding those dividends can gener- rate health. Corporations are not obligated to ate significant returns. These stocks tend to share their earnings with stockholders, so cash fall into the “equity income” or “dividend dividends and consistent dividend increases growth” categories. are the most obvious signs of a company’s n “Value” stocks tend to have inexpensive profitability as well as management’s assess- valuations compared with the underlying ment of the future. To the extent that rising company’s earnings, their competition, or dividends reflect rising profits, companies that their own price history. When stock values consistently increase their dividends should are relatively low, their potential for steep enjoy rising share prices over time. declines is muted. “Deep value” stocks are
  2. 2. Insights n If you remain invested in a dividend-paying a stock, a stock may be inexpensive for any stock for a number of years, you will see your number of reasons—some of which may not dividend yield gradually rise. The absolute be beneficial for investors. Low valuations can value of company dividends tends to rise, but indicate structural weaknesses in a company, an the price of your original investment doesn’t emerging competitive disadvantage, or a turn change. So your yield—that is, income as for the worse in a company’s market environ- a percentage of your original investment— ment. The challenge for investors is deciding grows over time. if the circumstances causing a low price are temporary or more permanent. Price declines Chart I: Source of Stock Returns: S&P 500 Stock Index associated with economic cycles, corporate 20 Years Ended 12/31/08 restructuring, or shifts in investor preferences $ Thousands 1988 – 2008 12 Total Value of Investment may be relatively short-lived, whereas those Principal Growth 10 Total Value of Investment $5,031.89 due to weak management or declining business 100% Total Value of prospects may be more intractable. Reinvested Dividends 8 $1,779.49 Finally, defensive growth stocks (which 35% typically include certain health care, consumer, 6 and utility companies) often hold up better than 4 other kinds of stocks in down markets, espe- Initial Investment Total Principal cially ones that are related to weak economic 2 $1,000 Growth $3,252.40 environments (where earnings in general are 65% 0 slumping). But in better times for the market or ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 ’06 ’08 the economy, earnings potential in these stocks Source: Ibbotson Associates Past performance cannot guarantee future results. This chart is for doesn’t stack up to other types of growth illustrative purposes only and does not represent the performance of an companies, limiting potential price gains. investment in any specific security. It is not possible to invest directly in the index. Fitting conservative stocks into your portfolio 12000 Disadvantages Before making any investment decision, you Investing in conservative stocks is a good need to evaluate your overall financial picture 10000 strategy for generating growth over time while and long-term objectives. To build a portfolio managing risk. But conservative stocks are not that works for you, we suggest you identify DTP Operators please note 8000 risk free, and they have their own special risk for first graphgoals andfor the second your needs to move up 200 pts time horizon, and then deter- area and 400 pts 6000 characteristics. For example, dividend-paying mine an appropriate asset allocation. graph. Thanks, Meg companies typically are distributing a sizable Conservative stocks don’t have to take up an 4000 entire equity portfolio, since every long-term portion of their earnings to shareholders, 2000 rather than reinvesting them in the business or investor needs exposure to higher-growth developing new opportunities. For that reason, opportunities. However, they can be appropri- 0 ate as part of the large-cap segment of a typical dividend-paying stocks may offer less return ’88 ’89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 potential than stocks that do not pay dividends. equity portfolio (also considered the core Dividend yields can also provide clues into segment of a portfolio). As shown in Chart the health of the company. One clue might II, this large-cap/core segment could take up be the percentage of earnings paid out in approximately 60% of the equity portion of a 12000 dividends. Most industrial companies (exclud- well-diversified portfolio, to include a com- ing utilities) distribute only a portion of their bination of conservative stocks and large-cap 10000 growth investments. (The exact amount of earnings and reinvest the rest in the company. 8000 A high ratio might indicate earnings problems your portfolio that you should have in equi- or foreshadow a dividend cut. ties will vary depending on your time horizon; 6000 visit for more information.) Similarly, while a value approach to invest- 4000 ing helps reduce the risk of overpaying for 2000 0 ’88 ’89 '90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08
  3. 3. Insights Conservative stocks may be a good way to help you build capital for long-term goals. A lot of research and patience is needed for a conservative strategy to bear fruit, so the key is to choose investments you are comfortable with and stick with them.
  4. 4. Insights Insights reports provide background information on many aspects of investing. Call 1-800-638-5660 to request a prospectus, which includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. T. Rowe Price Investment Services, Inc., Distributor. 100 East Pratt St. Baltimore, MD 21202 1-800-638-5660 Z10-208 4/09 82430