The world is uncertain, and Crawford Investment Counsel, Inc. (CIC) believes that many investors underestimate the potential range of outcomes. This systemic overconfidence can lead to irrational decision making, securities mispricings, volatility, and, ultimately, larger than anticipated declines in both company fundamentals and stock prices. To help overcome some of the inherent uncertainty of investing in stocks, CIC prefers high-quality companies which bring enhanced visibility and predictability to the portfolio, thereby reducing the potential range of outcomes. It is for this reason that CIC focuses exclusively on high-quality securities and believes that quality is an important and often underappreciated factor in common stock risk and return.
CIC also believes that the success or failure of any common stock investment is primarily determined by both the fundamental progress of the business and the price/valuation paid. The focus on companies that have consistent businesses improves the likelihood that fundamental progress will be achieved year in and year out, continually enhancing intrinsic value in the process. CIC’s orientation to value and price sensitivity is a reflection of the belief that valuation is an important component of both the return and risk of any investment.
Dividends are an important part of CIC’s philosophy and process. Yield is an important component of total return over time, and income is a factor that gives value to stocks and improves predictability of return. Dividend-paying companies also tend to do relatively better in poor or lower returning market environments. But most importantly to CIC, dividends and quality are inexorably linked. A consistent and growing dividend often demonstrates a company’s ability to generate a sustainable and growing earnings and/or cash flow stream. Companies that can pay and grow dividends consistently over time tend to be businesses that are less cyclical, have less earnings variability, and lower fixed-cost structures that make them more profitable and financially sound. These types of companies also help reduce the range of potential outcomes, an attractive feature. For these reasons, the firm uses the dividend history as the initial indicator of quality.
CIC has found that investors are often overconfident and tend to accept more risk than they realize. This behavioral bias allows long-term investors to earn attractive, risk-adjusted returns by exploiting inefficiencies in the pricing of stocks, particularly later in the market cycle. As investors move further away from a market decline, risk aversion decreases, and there is a tendency to seek “high risk/high reward” outcomes and, subsequently, less attention is paid to higher quality, more consistent dividend-paying companies with predictable earnings. Crawford focuses specifically on this underappreciated segment of the stock market with the belief that high-quality, dividend-paying securities with less variability and predictable cash flows can lead to a more accurate estimation of a security’s value and a narrower range of outcomes.
The goal of CIC’s investment process is to identify high-quality companies with a more balanced risk/reward trade-off; invest in them when they are under-appreciated and undervalued by the marketplace; and let the fundamental progress, valuation improvement, and dividend all contribute to the total investment return. Constructing a portfolio of undervalued, high-quality securities enables CIC to participate in rising markets and protect capital in down markets. This is how CIC mitigates risk in down markets and offers the returns from the broad market over a full market cycle with an attractive risk-adjusted return profile.