Investopedia explains volatility pretty well:
In other words, volatility refers to the amount of uncertainty or risk about the size of changes in a security’s value. A higher volatility means that a security’s value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security’s value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.
Volatility is generally something a lot of investors fear.
That’s because people get emotionally attached to their investments.
When a stock drops in value, especially precipitously, this can and often does cause a significant (negative) emotional response. This emotional response can then prompt an investor to make bad decisions – like selling off a great business that is more or less still humming along.
I personally love volatility. I also hate it.
I Love Volatility
Volatility is often wonderful.
I see short-term volatility as a long-term opportunity.
And I’ve put my money where my mouth is time and again over the years.
I can recall many instances in which I just loved to see volatility, because I knew it was an opportunity to buy shares in a high-quality business for less money.
After all, if you like a stock at $X, you should like it even more when it’s less than $X. If it becomes priced significantly less than $X, assuming the valuation hasn’t dropped in kind, you should probably love the stock.
Moreover, when talking about high-quality dividend growth stocks, this volatility can dramatically improve the yield that one is able to “lock in” at the time of purchase.
I remember when shares in Aflac Incorporated (AFL) dropped from ~$60 to $30 in 2011, over a rather short period of time.
The stock was cut in half.
Was the business cut in half?
Not really.
Aflac earned almost $5.00 per share in FY 2010. They earned closer to $4 in 2011.
So there was a drop in the company’s earnings, but this is an insurance company that can regularly report numbers that vary from year to year. In addition, GAAP EPS can be affected by numerous one-time events, making exact secular, upward growth very difficult.
This is something investors (should) know, yet the stock was absolutely hammered anyway. Of course, there were other concerns popping up at the time (like cancer risks), but to think a major company like Aflac – a company that has demonstrated proper risk management for decades – is suddenly worth ~50% of what it was just a few months prior is pretty silly (unless it was twice as expensive as it should have been prior to the 50% drop, which it wasn’t).
In addition, the company’s dividend wasn’t under threat at all. Quite the contrary, Aflac continued to pay and increase its dividend.
But I simply saw this short-term volatility as a long-term opportunity, buying up shares in the company when volatility took hold. I scooped up shares in the $30s in late 2011.
When the stock moved from roughly $60 to $30, its yield moved from 2% to 4% in the process. Price and yield are inversely correlated; all else equal, a drop in price will result in a higher yield. When the stock’s price drops in half, the yield doubles. If you like a stock with a 2% yield, you should absolutely love it when it yields 4%.
I can say that the investment in Aflac has turned out fantastic thus far.
I’ve been collecting growing dividends ever since I initiated my position. And the stock is now priced a bit above $80.
Indeed, it’s a major holding in my personal portfolio.
While short-term volatility isn’t always a long-term opportunity, it often is when you’re dealing with high-quality dividend growth stocks.
One will naturally want to make sure that a company isn’t somehow permanently impaired, rendering a valuation compression reasonable. If the dividend is under threat, this is another warning sign to stay away. And an overvalued stock can present significant short-term volatility, although the correction of a previously incorrect valuation isn’t necessarily an opportunity.
I Hate Volatility
Volatility is often wonderful when dealing with the day-to-day pricing of high-quality dividend growth stocks.
However, operational volatility, especially as it relates to the dividend, is something I actually strongly dislike. In fact, I’d go so far as to say I hate this kind of volatility.
I invest in high-quality businesses that reward their shareholders with growing dividends precisely because these businesses tend to generate fairly secular growth over long periods of time, limiting major drops in operational performance that can negatively affect a company’s ability to pay a growing dividend.
A lengthy track record of growing dividends is in and of itself a pretty strong litmus test of secular growth and business quality, as it’s not practical to pay out a growing dividend for decades on end while simultaneously running a poor business that can’t regularly generate increasing profit.
Using Aflac as an example once more, the company’s EPS has doubled over the last decade. It hasn’t been a totally smooth and secular run from FY 2007 to FY 2016, but the profit growth was largely up from year to year as the time frame moves to the right.
Most importantly, however, the company continued to pump out an ever-larger dividend annually, increasing the dividend as regularly as can be straight through that period.
In fact, if you didn’t pay any attention to the business and its operational performance at all, you essentially would not know that the company experienced any volatility in its bottom line whatsoever. All you would know is that your dividend every December was larger than the one that Aflac paid you the prior December.
If that’s not easy peasy, I don’t know what is.
But if Aflac would have reduced its dividend or cut it completely, you can bet I’d be very upset.
Any volatility when it comes to my dividend, and the annual growth of it, is something I don’t enjoy at all.
Furthermore, significant volatility in operational performance, is also something I’m not a big fan of.
But this is exactly why I try to stick with the best businesses in the world – I want to largely avoid these issues.
Conclusion
I thought it was important to share this perspective, because the word “volatility” gets thrown around a lot.
I love volatility in the traditional sense, whereby the price on a high-quality dividend growth stock can drop far below what’s reasonable in the short term. I also love this kind of volatility on stocks I already own, even when I’m not actively acquiring shares, as it often presents an incredible opportunity for a company that’s buying back its own stock.
But I hate volatility when it comes to my dividend payments and dividend growth. The only percentage of volatility that’s acceptable for me when it comes to my dividends is 0%. And I also don’t like to see major disruptions or volatility in operational performance, especially if it’s more systemic in nature, because this can then affect the secular dividend growth I enjoy and rely on.
However, this dynamic between loving and hating volatility is exactly why I try to invest in wonderful businesses: I’ve usually been able to take advantage of the right kind of volatility when the market has presented it, while simultaneously largely avoiding the wrong kind of volatility.
Full disclosure: I’m long AFL.
What do you think? Do you love and hate volatility?
Thanks for reading.
Image courtesy of: digitalart at FreeDigitalPhotos.net.
Mr. Market sure loves to overreact to any negative news, however slight. A company can be growing at double digits and run into a rough patch and lower their growth guidance by 2.2% and get hammered on their stock price by 1/3rd.
Because they hit a bit of turbulance and don’t expect $276 million in revenue next qtr, but $270m instead the whole company is worth $800 million less? Not to mention the growth was up 14.9% YoY.
Pretty crazy IMO, but that’s how you grab a bargain. As you have quoted Warren Buffet before: “Price is what you pay, value is what you get.”
MDD,
Yep. I hear that. I’ll see this happen all the time. The company has some issue that ends up costing it $200 million, yet the stock will drop the market cap by $1 billion or something. Happens frequently, which is just one more reason I don’t believe in the EMH.
In the end, it’s usually just an opportunity. Very glad it works the way it does.
I think Munger recently quipped about how if other people weren’t so dumb, they wouldn’t be so rich. Good ol’ Charlie! 🙂
Best regards.
Hi Jason,
I fully agree with that. I hate operational volatility and concerns with the continuity of the dividend. Otherwise price volatility is just wonderful.
I hope that you’ve got back power and all is well with you over there.
-Mike
Mike,
Just recently had power restored. Feel like a new man! 🙂
I’m with you, though. Price volatility is great. Operational volatility (especially in terms of the flowing and growing of the dividend), not so much.
Thanks for dropping by!
Cheers.
Glad to see major hurricanes aren’t stopping you!
Investors always use “volatility” and “risk” interchangeably, and I believe this is what allows the former to exist in the first place. People see the price swings and assume that there is a possibility of losing money (which there TECHNICALLY is, not being FDIC insured), so they make more trades hoping to avoid the big loss that just isn’t coming. That creates the big swings, causing people to perceive ev MORE risk. And on and on.
Let people see monsters in the shadows. More opportunities for those of us who see the light.
Sincerely
ARB–Angry Retail Banker
ARB,
Agree 100%. I actually wrote an article about this a while back, about how people conflate volatility and risk. Buffett wrote a few paragraphs about this in one of the BRK letters from a few years ago. Perception is reality, though. So if those price swings are perceived to be risky, then they’re risky (for those who perceive it that way).
But short-term volatility is often just a long-term opportunity. I’m happy to take advantage. 🙂
Thanks for dropping by!
Best wishes.
Hi Jason,
I noticed you don’t have any Fedex shares in your portfolio. I was wondering if you see FDX as a potential long-term buy and dividend growth beast.
Mike,
It’s a great business. The problem is that the stock yields almost nothing. Really depends on how much room you have in your portfolio for something like that (which obviously depends on your income needs and split between income and growth). I make room for a few stocks here and there with low yields (V, ALB, etc.), but I’m pretty limited with how many slots I can fill. As such, my play in that arena is UPS. Similar returns over the last 10 years, but UPS pumps out a much larger dividend.
Cheers!
I totally agree with your assessment. I see it as a good growth play with e-commerce growth and general macroeconomic growth but wouldn’t fault you whatsoever for owning UPS instead since you are more in the “live on investment income” phase of the investment process.
I must have purchased Aflac around the same time as you. My cost basis is $33. For now, it is positioned as a long term holding for us.
TPM,
Nice!
My cost basis is a bit higher because I added to it even after it rebounded a bit, but it’s very much a long-term holding here. 🙂
Best regards.