Dr. Henssler approaches investing like David Dodd and Benjamin Graham. Bankruptcy risk, in our opinion, is the paramount risk when investing in the stock market. This is why we choose to only buy companies that are ranked “A” or better for Financial Strength by Value Line, “A-” or better for Earnings and Dividend Quality by Standards & Poor’s, or “2” or better for safety by Value Line. This ensures that we only buy top-tier companies that receive the most scrutiny from rating agencies. These companies are required to meet stringent financial metrics to maintain the highest ratings.
Risk is often confused with volatility. Volatility is inherent with common stocks. The markets dip about 5% three times during the year. The markets also see a 10% drop once a year, and a 20% drop once every three years. We believe an investor shouldn’t count on being able to get their money from the stock market in a short period of time. If you need your money in two years, you should invest that money in a fixed-income investment, with a maturity date of two years to preserve your principal.
Overall, volatility does not scare us, as it is part of investing. Some stocks are less volatile than others. Beta is a measure of volatility. A beta of 1, generally, indicates the security is just as volatile as the market as a whole. A beta of less than 1 indicates that the security should be less volatile than the market, while a beta greater than 1 indicates more volatility than the market. For example, if a stock’s beta is 1.2, in theory, the stock should move 20% more than the market.
Another measure of volatility is standard deviation, which gauges the degree of an investment’s up-and-down moves over a period of time. From a portfolio perspective, standard deviation shows how much a portfolio’s returns have deviated from its own average.
When you invest in the market, you accept the risk of the markets’ fluctuations, but you should try to minimize the risk of a company going out of business. To do this, you buy financially strong companies with high profitability.
We also combat risk by matching the investment style with a client’s time horizon. If you need the money in the near term, it should be parked in high quality bonds, which have a very low risk to principal. However, they are not riskless investments. They still carry inflation risk. If you put $1,000 in a bond today and inflation increases by 5%, that $1,000 will not have the same purchasing power in 10 years when the bond matures.
Another aspect we look at when evaluating investments, is its PEG, or the price-to-earnings-to growth ratio. A stock’s price-to-earnings ratio is then divided by the growth rate of its earnings for a specified time period. We also like to consider dividend. For example, if you have a stock that is growing by 8%, yields a 3% dividend, and it is selling at a price to earnings ratio (P/E) of 11, the stock would have a Price/Earnings to Growth and Dividend Yield Ratio (PEGY) of 1. We like to buy stocks with a PEGY of less than 1 or at least below the industry average. We see it as a price sustainability ratio. If a company is going to grow earnings at an expected pace, its price to earnings should sustain itself. We look at that as a measure of value. You cannot take a P/E ratio at face value. One might look at a stock with a P/E of 20 and consider it expensive if the industry average is 15. However, if the stock is growing at 20% and also pays a 4% dividend, the stock looks cheap to us.
At Henssler Financial we believe you should Live Ready, which includes understanding the different aspects to evaluating investments. If you have questions regarding your investment strategy, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
