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Fortune Favours The Brave

Consider these two investments.

The first, let’s call it Company A, has been extremely volatile. Over the past year alone, the value of its shares has ranged between a gain of over 37%, to a loss of more than 30%. From top to bottom — a move that has occurred in just the past 6 months — investors have suffered a near 50% loss.

Even if you take a broader perspective, the investment has proven a bumpy one. And, it would seem, a disappointing one. It’s been almost 5 years since the company listed — long enough to be considered a long term holding — but shares are today below what they were back in late 2010. Down about 30%, in fact, in a market that has gained roughly 5% over the same period.

Contrast that with Company B, which listed at the same time as Company A. This company has managed to deliver a wonderfully attractive income stream to investors; with the annual payment rising by more than three-fold since 2011.

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For those investors who purchased shares in the float, more than a quarter of the initial investment would have been repaid in dividends alone (more, if you include franking credits).

Importantly, those dividends have been well supported by company earnings. The nature of the business means that profits can be somewhat lumpy, but cash earnings have been improving, on average, since listing.

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The orange bar represents the midpoint of company guidance for the current year — down about 8% on last year’s result. That’s disappointing, but hardly a disaster. If realised, it will be the second highest profit on record.

At present, Company B is offering investors a yield of 8.9%. More than 10% if you include franking credits. And the company only recently reiterated its intention to maintain the dividend.

Since it listed Company B has been successfully winning market share, and is now one of the larger players in its industry. In terms of customer retention and satisfaction, it knocks its rivals out of the water.

So, if you had to choose, would you prefer to invest in Company A or B?

The truth is, they are the same company. And the latest Best Buy Now recommendation for Motley Fool Dividend Investor members.

Price is what you pay, value is what you get

The trouble for most people, is that they use share price as a guide to what the company is worth. In doing so they forget Warren Buffett’s maxim:

The market is there to serve, not to inform.

Another of the great man’s principles is:

Be greedy when others are fearful

The market had been expecting an improved earnings result from the company this year (I won’t disclose the name out of respect to paying members), and so it was shocked and disappointed when guidance was lowered. In reaction, shares have been sent to their lowest level in nearly 4 years.

Don’t get me wrong, shares deserved to fall on the reduced guidance — weaker earnings, albeit temporary, should lower the value of the company. But, to my mind, the fall has been completely disproportionate to the drop in the company’s true, or intrinsic value.

And therein lies the opportunity for long term, income focused investors. At least those that have the ability to not be swayed by the herd.

Been there, done that

We’ve seen it before. Another great company, with a history of reliable and growing dividend payments, was recently sent plummeting — about 40% from the recent high — on news that, although disappointing, was short term in nature. The company quickly became the target of short sellers and many long term holders lost their nerve and sold out for fear of suffering further declines.

Not us. At a point, shares simply became too attractive to ignore, and it was recommended to members. But, volatility being what it is, shares continued to fall after being recommended — dropping a rather hefty 13%.

I’d be lying if I said that such a fall didn’t test our faith. For three long months shares sat firmly in negative territory, and throughout the period the company actually had more disappointing news to share with the market.

But the underlying business, and it’s long term prospects, remained strong. So, rather than sell, we encouraged members to buy more — it was, in fact, our Best Buy Now last month.

That conviction, and patience, has been well rewarded; shares are today up 25% from their low and, with dividends, have returned over 13% based on the original buy price.

Of course, we’re not claiming victory just yet — shares could easily drop back into the red tomorrow. But my point is that true investing is not about trying to second guess market prices. Nor is it about treating short term price trends as useful indicators of underlying business health.

It’s about buying quality companies, at sensible prices, and giving them time to deliver on expectations. It means ignoring the herd, backing your convictions — even when most disagree with you — and staying the course.

Most people don’t have the temperament for it. That’s why most people fail.

Foolish Takeaway

There’s no guarantee our latest Best Buy Now recommendation will enjoy a quick recovery. In fact, in the fullness of time it may prove to be a poor investment. None of us can predict the future with certainty.

But for now, we have a company that shows all the signs of being in good health, with continuing bright prospects. One that is paying a yield that makes most look rather ordinary.

Most in the market don’t seem to agree. And it won’t be easy swimming against the current. But as history has taught us, fortune favours the brave.

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