The Prudent Investor

Letting Dividends Do Their Work

Most Recent Articles

The Dividend Discount Model for Dividend Investors – Part 1
The Dividend Discount Model is a means of valuing a stock price that is relevant to dividend investors because the theory is based on the sum of all of the stock’s future dividend payments. Part 1 of this article explains the formula and its shortcomings. The second part will speak to fixing those shortcomings and adding a margin of safety.
Future Dividend Champions - First of Long Island Corporation
With 24 consecutive years of dividend increases, First of Long Island Corporation is nearing the point where they will become a Dividend Champion.  It is time to examine it to see if it might be a good fit for your portfolio.
Future Dividend Champions - New Jersey Resources
With 24 consecutive years of dividend increases, New Jersey Resources is on the cusp of becoming a Dividend Champion.
 

Sensory Gating and Dividend Investing

by George L Smyth

Noise comes in many forms, and paying too close attention to it can alter the proper direction of the long term dividend investor. The key is to establish filters that ensure only relevant information is received.

Noise is an interesting thing. There are nights I spend in hotel rooms where the inhabitants of an adjoining room are not as mindful as I would wish during times when most people sleep. We have all encountered these annoying situations and the only way to handle them is to ignore the noise. Easier said than done.

One way I have successfully dealt with this has been to grab my tablet and open White Noise Lite (one of the thousands of similar apps). I select Heavy Rain Pouring and turn the volume to its second-highest level. It drowns out the external noise from the other room.

Initially one may think that this is just trading one noise for another, but these are two different qualities of noise. There is a big difference between a sound that is short and intermittent and a sound that is continuous and fills the auditory spectrum.

Listening to Heavy Rain Pouring at a loud volume is initially distracting, but after a while the brain realizes that it is hearing white noise. Once this happens, it no longer pays attention to the noise and discards the input. This is called auditory sensory gating.

Those who focus on dividend-paying stocks have a great advantage when it comes to noise. Many important things concern active investors, which are inconsequential to the investor who is dollar-cost averaging over a long time. Some of these find their way into publications that properly apply to the investor concentrating on share price but have little to do with the dividend investor.

The key is to figure out which parts of the noise are relevant to the dividend investor’s situation, which parts apply to other investors, and which parts are simply noise to draw our attention. With the 24/7 news cycle there is a need for the media to regularly shout “ALERT” and “BREAKING NEWS” to get us to turn our heads - after all their existence depends upon it.

The idea is to create filters that only allow the passage of information we need concerning the companies we own or are considering and the strategies we have employed. When children learn to walk they look down at their feet to see where they are going, and eventually this becomes automatic – they have tuned out unnecessary visual noise.  We need to find a means of doing the same with the financial information coming our way.

Filtering the People Noise

We should place the primary filter on other people's opinions, as this will remove the vast majority of the barrage of information coming in our direction. So much is relevant to others, and so little affects the dividend investor.

When I began seriously investing in the 1990s I read Usenet posts to try to learn from others. Later Yahoo provided newsgroups and I did my share of reading and discussing there. I soon came to realize that there were numerous people offering information that was less than helpful. Beyond the people who were offering opinions without reasoning were those whose interests did not align with mine.

In my article Stock Tips Are Bunk I talk about knowing yourself and why a stock that is good for one person might be wrong for another. For instance, the person who wrote a message you read may not have the same risk tolerance as you. The person talking on the television almost certainly is not using your strategy. If reader and writer are not in alignment then how relevant is the information offered to the specific situation at hand?

This is an example of filtering noise – not bothering to listen to extraneous information. Perhaps someday there will be a cable channel directed toward those who employ a dividend growth strategy by dollar-cost averaging their purchases over a long time. Or not.  After all, it is a topic that would probably only fill half an hour a day.

There are others doing the same things as you, and they are the ones you should listen to, question, evaluate, and decide whether to agree or disagree. I should note here that just because one disagrees that should not necessarily end the relationship.

For instance, I completely disagree with the number of stocks Dividend Growth Investor holds. I strongly feel that the number of companies he holds is way too many, but that number is simply too many for me, not him. He and I have different ways of doing things, so each should go with what works for them.  The fact that he offers interesting and well thought out information has me returning to his blog regularly, despite disagreements.

Filtering the Market Noise

Another place to filter noise is information about the constant movements of the markets. Keeping a focus on long term investments requires ignoring the daily gyrations of the market.

John Bogle, father of the index fund, said that your investments will certainly go up and down in value. After all, that is what they do. For him, the real question was whether or not volatility will bother one to the point that they over-react and do “something dumb.” We see this time and again, not just with individual investors, but with the market as a whole.

We oftentimes read that the markets are correcting. This is because people – individual and institutional investors – go to extremes and then decide to return to sanity. This would not be the case if markets were truly efficient, but the fact is that once emotion is involved unpredictable things can happen.

Exacerbating the problem is the fact that automated trading systems can at times take over and produce wild results. They comprise 75% of trading activity and can overwhelm what we consider rational. It has caused events such as the 2010 flash crash, where the DOW fell about 1,000 points only to completely recover within the hour.

How do the daily ups and downs of the market affect the long term investor? The obvious answer is that they have no consequence outside of being interesting data points. Fluctuations over a week also pale in comparison to the beginning and ending points throughout the holding of stock for years. The small ups and downs over time work within the noise of the market and are meaningless.

Sometimes we should pay attention to little things – I enjoy evaluating every pitch in a Baseball game, as opposed to simply finding out how bad my Orioles lost.  For others, each pitch is in the noise, whereas for me it is relevant information. We need to understand where the noise level resides for whatever we are doing.

For me, Baseball is not something that may make me do “something dumb.” However, watching stock prices to this degree of granularity can place one into a panic-like situation where action – any action – is required to relieve the tension.  I have literally watched this happen.

It does not help that television advertisements offer “trading platforms” that are superior to their competitors and will “give you the edge.” This is an inducement for action whether it is needed or not. After all, it is more exciting to think of ourselves actively dodging and weaving our way through our trading activity than it is to simply hold great companies.

The filter I employ is affiliated with knowing why I buy. I have expectations for my companies and when one is not meeting them it is time to take note of the fact. That fact may or may not move me to action. 

Four times a year it is a good idea to be aware of the information within the quarterly report for each company you own. Does the company have the proper cash flow to offer dividends? Is the company growing? Is the dividend growing? You should fill in the questions for each company that you consider to be of importance, and make sure that they are answered to your satisfaction.

A company failing to match your expectations for a quarter does not necessarily qualify to be sold, but the fact is something to notice. Is this failing a one-time occurrence or is it a trend? Is the company hiding the problem or are they overtly dealing with it? There are so many questions, but you should be the one to ask them as well as find the answers, at least, to the best of your ability.

Finally

The point of owning stocks is to make money. The point of making money is to have a more pleasurable life, however you wish to define that. If noise is reducing the pleasure in your life then it is time to consider that that noise may not be beneficial. The way to deal with do this is to establish filters that allow you to consume only relevant information.

After all, some people have sensory gating failures and are unable to deal with this overload of stimuli. These are people who suffer from schizophrenia. Fortunately, we have the choice to limit noise ourselves, and establishing filters is a key to investing prudently.

Other Articles of Interest

Stock Tips Are Bunk

Ensuring Dividend Survivability

Lessons Learned

 



This website is maintained by George L Smyth