Category: Stocks

Evaluating Stocks Part VIIIB: More Math Behind The Magic

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not how much you have at the end; it’s how much you could have made.

I was ready to move on to funds, but some people contacted me to give all of you some concrete hard numbers to look at it rather than all my usual argy-bargy ivory tower talk.

Sarcastic Reader: About damn time!

So, let’s talk real concrete numbers and make it simple as possible. Let’s say you and your friend both save up some money and have $10,000 to invest.

Your friend decides they will pile all their money at once into a S&P 500 index fund.

You, on the other hand, decide to spread your money out into ten good paying dividend stocks ($1,000/company) all at once and have all dividends reinvested into the stock that generated that dividend in the first place.

So, let’s state that the time you’re putting in your money is January 1998 and finish our calculations at the end of November 2018. I’m picking these dates on purpose. First of all, a twenty year time spread is to show how time is your friend when doing investing of any kind, especially dividend growth investing. Secondly, I purposefully included both the tech sector bubble being burst in 2001 and the financial crisis of 2008-2009 to demonstrate how this strategy of dividend growth investing performs when the market heads south on you (and majorly south in the case of 2008/9).Thirdly, since December 2018 is still in progress (Oh, is it ever), I can’t include in returns as of yet. For people who want to look at different years or longer or shorter time spreads, use these calculators to do your own calculating.

So having said all of that, here we go…  

Your friend puts in $10,000 in January 1998 into a S&P 500 index fund and checks where they are at on 12/1/18.

The total return for the S&P 500 (with the dividends reinvested) over the above time period is 313.007% which sounds staggering, but is actually only at a 7.045% annual average return over that time. Employing that ever so sweet Rule of 72, it would take your friend 10.22 years to double their money.  The Rule of 144 suggests that it would take your friend 16.18 years to triple their money.

To be clear in concrete numbers what all of that means, your friend would have put in $10,000 in a S&P 500 index fund (with any dividends reinvested) on January 2, 1998 and on December 1, 2018, your friend would have…drumroll please…$39,060.11.

You, on the other hand, have decided to put $1,000 in ten different dividend paying stocks since you’re a savvy investor and perhaps influenced by what you read on the Internet (ahem) which is totally fine because everyone knows that whatever you read on the Internet must be true.

So here’s a list of these ten money maker stocks of yours…

3M, Altria, AT&T, Cincinnati FInancial, Clorox, Coca-Cola, Colgate-Palmolive, Johnson & Johnson, McDonald’s, and Procter & Gamble

All of them are dividend champions and all pretty famous companies that have 40 or more years of increasing dividends. (I suspect that you have heard of all of them except for perhaps Cincinnati Financial.)

The conditions are the same: $1,000 into each company on 1/2/1998 and checking again on 12/12018 with all dividends reinvested.

Here we go…  

Company            Annual Return              Total Cash Value

3M (MMM)                11.59%                             $9,157.00

Altria (MO)                15.03%                             $16,886.49

AT&T (T)                     4.52%                              $2,349.22

Cincinnati Financial (CINF) 5.83%             $3,148.81

Clorox (CLX)             8.79%                               $5,474.44

Coca-Cola (KO)       3.65%                                $2,065.12

Colgate-Palmolive (CL)     8.89%                $5,610.83

Johnson & Johnson (JNJ)   9.51%                  $6,292.12

McDonald’s (MCD)             12.33%                 $10,522.98

Procter & Gamble (PG)       5.82%                 $3,142.38

Total Averages/Returns       8.616%              $64,649.39

So, head to head, the S&P 500 route gives your friend a 7.045% annual return and $39,060.11 versus an annual return of 8.616% and $64, 649.39 via your dividend growth investing strategy.

So some thoughts on all of this…

  1. A solid dividend growth investing portfolio will almost always outperform the S&P 500 provided all dividends are reinvested.
  2. None of the above figures have yet been taxed or subject to fees which only a mutual fund/ETF would be subject to and not the individual stocks themselves.
  3. A dividend growth investing strategy SHOULD NOT substitute for core holdings in index funds like the S&P 500.. This should be the second layering of investing on top of the foundation of your core holdings of index funds. As you can see, however, it can bring better returns than S&P 500 which is why it should be considered if it is within your risk tolerance to do so (and certainly why I employ this strategy).
  4. Note how varying your returns are over the years even within dividend champions. This demonstrates why you shouldn’t put all your eggs in one basket if you decide to go into individual stock picking, even if it is the dividend champions.
  5. Note how impressive Altria has been with 15% annual returns over the past two decades and comprising over 25% of the above returns. So much for the death of smoking…

On to evaluating funds next time!

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…

Evaluating Stocks Part VIII: The Math Behind the Magic of Dividend Growth Investing

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not how much you have at the end; it’s how much you could have made.

Let’s show the math behind dividend growth investing in real terms.

As stated before, the key to dividend growth investing is not only a steady growth of income, but the increase in shares generating more and more dividend income each quarter. The other variable in dividend growth investing is the price of the stock which can increase or decrease thus accordingly altering the number of shares purchased each time a dividend is generated (usually quarterly). Thus, the interrelationship between all of these three variables (dividend amount, increase in dividend, and stock price) is complex and virtually impossible to predict in terms of total value in the stock, the amount of dividend generated, and the number of shares owned at any given point in time.

The outcomes even in a positive sense (ie, increased value after investing your money) are myriad depending on what any of these variables do at any given time, especially with a fluctuating stock price.

However, we have to start somewhere and to give you an idea of how this mechanism of dividend growth investing would look...behold!

For those of you who like to see the math dividend payment by dividend payment…

Sarcastic Reader: Who are these freaks!?!  

…here you go.

To see the total returns dividend paying stocks have generated over the years, there are calculators that do all the heavy lifting for you and can give your total return for said stock derived from the exact date of initial purchase, amount initially purchased, and accounting for ongoing regular investments if that was ever done after the initial purchase.

People will argue that you cannot 100% predict that companies will continue increasing dividends until the day you retire…which is true….though this is as predictable as the market gets if you’re putting money into a company that has increased dividends for over half a century consecutively. Even with ongoing dividend growth with some companies which have not yet reached Dividend Champion status, the total returns can be staggering as noted here.

Of note, there is a psychological aspect to dividend growth investing that I use to help me keep the faith during the fallow times.

Perhaps, this is self rationalization amongst dividend growth investors, but the way to look at it to steady the course once you’ve moved forward and put your hard earned money at risk (and—don’t fool yourself—that is exactly what you’re doing any time you invest) is the following:

When your stock price is down, you’re buying shares of a great company at an even better price.

Who doesn’t like a sale?

When your stock price is up, you’re worth more.

Who doesn’t like to be richer?   

Who indeed…?

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…

Evaluating Stocks Part VIIB: Long Live The Aristocracy

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not how much you have at the end; it’s how much you could have made.

A good friend of mine (and a very savvy investor) pointed out that SDY is not the only Dividend Aristocrat fund available which is both true and false simultaneously.

Sarcastic Reader: Uh…what now?

PWT: It’s the Schrodinger’s Cat of the financial world.

Realize again what the Dividend Aristocrats are (companies who have increased their dividends for 25-49 consecutive years, but are only in the S&P 500 as opposed to Dividend Champions who have the same dividend history as Dividend Aristocrats, but are not necessarily in the S&P 500—so there are 50 Dividend Aristocrats and 115 DIvidend Champions for 2018) and then let’s take account of what funds are out there to help mimic their earnings potential.

  1. The first one is actually the only true Dividend aristocrat fund ProShares TR/S&P 500 Aristocrats ETF (NOBL) because it is the most strict in what it allows as an investment—only tur Dividend Aristocrats. The upsides are that these are equally weighted with each company making up 2% of the fund and the expense ratio is quite cheap at 0.35%. However, there are a few problems here—the fund has been around for 5 years (since late 2013), the dividend yield is only 1.6%, and thusly (it’s axiomatically true that you cannot sound stupid and win any argument when using the word ‘thusly’) has underperformed the market at times and certainly the Dividend Aristocrats themselves.  Of note, earlier this year, all of the stocks in the portfolio have an average PE ratio of approximately 21.
  2. The SPDR ETF (SDY) invests in any company that increases its dividend yearly for at least 20 consecutive years therefore it’s not quite Dividend Aristocrats only, but mostly. The dividend yield is 2.5% with a an expense ratio of 0.35%. It is the only Dividend Aristocrat fund that has been around for over a decade. And the returns over the last ten years has been over 10%.
  3. The Vanguard Dividend Appreciation ETF (VIG) has invested in a total of 182 stocks, but is comprised of only dividend Achievers (companies that increase their dividends yearly for 10-24 years). The expense ratio is only 0.08%, but the dividend yield is only 1.94%. This combination leads to a radically different rate of total return of 3.12% this year  which is below the average rate of inflation (3.3% remember?) (and that’s before you even subtract out the expense ratio).
  4. The iShares Select Dividend ETF (DVY) has 98 stocks in it, all of which are Dividend Challengers (ie, companies that increase their dividends yearly for 5-9 years consecutively). It has a dividend yield of 2.81% with an expense ratio of 0.39%. The 10 year total return (before fees/taxes) was 10.28% and was 8.43% since inception of the fund (2003).
  5. There are many other funds that are comprised of dividend payers, but realize virtually none of these are actually comprised of true Dividend Aristocrats as detailed above therefore your returns can be quite different than that of the Dividend Aristocrats. So do your research (even preliminary stuff  as above).

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…

Evaluating Stocks Part VII: Become An Aristocrat

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not how much you have at the end; it’s how much you could have made.

In response to the last post or two, people wanted to see the math behind “The Magic of Dividend Investing”, so let me talk to you in two parts about that.

The first is the one we will focus on for today.

Dividend Aristocrat Investing (remember what they are?—companies who have increased their dividends for 25-49 consecutive years, but are only in the S&P 500 as opposed to Dividend Champions who have the same dividend history as Dividend Aristocrats, but are not necessarily in the S&P 500—so there are 50 Dividend Aristocrats and 115 DIvidend Champions for 2018)     has two things of note from a total return standpoint.

The first is that the total return for Dividend Aristocrat investing is superior to the total returns for the S&P 500 (with all dividends reinvested into the companies that generated the dividends in the first place) in the past 5, 10, 15, and even 20 years.

Here are the average annual total returns as of September 2016:

Index Total return – 2016 through Sept. 2 Average total return – 3 years Average total return – 5 years Average total return – 10 years Average total return – 15 years Average total return – 20 years
S&P Dividend Aristocrats 14.1% 14.7% 17.9% 10.7% 10.1% 11.2%
S&P 500 8.3% 12.5% 15.6% 7.5% 6.6% 8.2%
Source: FactSet

If you don’t believe three percent better returns average over two decades isn’t terribly impressive, consider this article (which is a great read from 2016 which is also where the above chart was “borrowed”—pay attention to the graphs showing you the difference in the returns over time for $10,000 investment and imagine that that’s only for a one time $10,000 investment and not for yearly investment as any of you would be doing—right? Right?!?) as well as the following thought experiment.

Imagine getting 3% higher salary every year for twenty years than you usually would for DOING THE EXACT SAME WORK! Tell me that isn’t a significant return then. If you’re thinking that 3% a year more in your investments is a pittance, then you should gladly turn down the 3% bump up in pay because it won’t amount to anything. You can’t say the former and then argue against the latter.

One problem however…this leaves you with investing up to 50 different companies however. Several approaches can tackle this problem.

  1. Invest in each company with two percent of your total investment in stocks (not how much your total overall investment in all equities is) each year CON: It’s complex and requires many transactions with each one creating a fee each time thus reducing your total returns over time. Also, you have to keep paying attention to when a company drops off the list (pretty big news in the investing world) and when a new one gets added on. PRO: You get all the companies’ dividends and stock price appreciation the whole time you’re investing in them without fail.
  2. Invest in your favorite companies within the 50 Dividend Aristocrats by feel, by analysis, by lowest PE ratio, by the advice of your financial advisor, etc. CON: You don’t get all the benefits of dividends and stock price appreciation of all the companies, just the ones you’re invested in. Your total returns may be worse than the overall Dividend Aristocrats as your selections may underperform the others. This may cause you to drop these and pick up others…which can then underperform the following year. And so on and so forth… PRO: Your selections could outperform the overall Dividend Aristocrats. Even underperforming the overall Dividend Aristocrats, these selections may have total returns that still are greater than the S&P 500 which is, after all, the whole goal here. A small basket of stocks (ten perhaps) rather than 50 of them will be a lot less to manage, follow, and cost less in transactions.   
  3. There is an ETF that does all the work for you by investing in all of the Dividend Aristocrats (though it modifies the dividend aristocrat definition, reducing the minimum standard to 20 years), tracks them, pulls out of a company if it falls off the Dividend Aristocrat list, and invests in a new one if it joins the list. CON: There is an expense ratio connected to it and the returns are lower than doing all 50 stocks yourself though its total return may still exceed S&P 500. PRO: All the work is done for you for a small expense ratio (0.35%) with far less transaction costs than the DIY approach to Dividend Aristocrat investing. Since the ETF began in 2006, it has nearly tripled in value ( a return of over (5 a year if you remember the rule of 114—and if you don’t, you’re a jerk since I posted about this in the past) and then add in the dividends (2.48%) to really juice the returns.  
  4. You could do a hybrid of the above. 50 stocks is a lot to own, but not necessarily over 30-50 years of investing. Buy one a week and set up a DRIP and then you have all of them in a year and then add to them as you see fit/as your budget allows. The same could be done monthly thus allowing you to get all fifty within just over four years. Again, the beauty here is that once you’re in, the dividends start rolling in and increase your your stake in said companies increasing your next set of dividends in a glorious upward spiral of wealth.
  5. If you want no fuss no muss, then the ETF is the way to go. If you enjoy the challenge of owning a large panel of stocks for even a smaller basket, then go for it.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…

Evaluating Stocks Part VI: The Magic of Dividend Growth Investing

Never forget these two axioms:

Money frees us, but its pursuit may enslave us.

It’s not how much you have at the end; it’s how much you could have made.

 

Happy Thanksgiving to you and your family!!!

I’m thankful for many things, but as far as this blog…I’m thankful for all the subscribers, viewers, and support I’ve received over the past year. I’m truly blessed, honored, and incredibly grateful.

I’m no blind follower of popular will, but I do pay attention when multiple people ask the same question and others are critical of my investing strategy (which has certainly done well for me, but is always worth re-examining).

The question…uh…er…in question is the following:

Why is individual stock investing as desirable/more desirable as index fund investing?

Related to that question is if individual stock investing is worth the extra work (if you want to call it that) and even risk compared to index funds.

To answer that question, I need to clarify essentially what my investing strategy has been in a chronological sense.

  1. Index Funds
  2. Mutual Funds
  3. Dividend Growth Investing
  4. Growth Stocks Buttressed By Secular Trends
  5. Alternative Investments (eg, real estate, franchises, businesses, etc.)

I started investing early and often thanks to my parents (Thanks Mom and Dad!! Love you guys and can never thank you enough for the amazing life you’ve given me) and once I built up a critical mass (a subjective measure to be sure) of index funds and mutual funds, I then moved down that list one by one—only moving to the next one after reaching what I believed to be critical mass in terms of the amount of money invested in the current category. As you can see, each category carries with it more work and more risk as well. We can and will get into these categories one by one over the coming weeks and months.

So…after that brief interlude and window into my investing life, let’s get into individual stock investing. As you can see from above, the first grouping of individual stocks, I seek stocks with dividends where the company consistently increases the dividends year after year. This selects out many stocks—non-dividend payers, companies paying out dividends just recently (for me, that’s 25 years or less), companies with longer term dividends, but are ones that have neither increased the dividends or even worse dropped their dividends over time, etc.

So, in other words, the companies I am seeking are large companies with a good easily understood business model and a long history of strong profits with consistent dividends that are steadily increased year after year regardless of the broader economy or gyrations of the stock market.

These types of companies are relatively rare when considering that there are over 17,000 publicly traded companies and there are less than a few hundred companies that fit the bill. The good thing is that there are far more companies like this than any average Joe and Jill Investor would ever put their money into.

These are so valued, desired, and tracked enough that they have acquired names for themselves.

Dividend Challengers: companies who have increased their dividends for 5-9 consecutive years

Dividend Achievers: companies in the S&P 500 who have increased their dividends for 10-24   consecutive years

Dividend Contenders: Same as the above, but not only in the S&P 500

Dividend Champions: companies who have increased their dividends for 25-49 consecutive years

Dividend Aristocrats: Same as above, but all the companies are only in the S&P 500

Dividend Kings: companies who have increased their dividends for at least 50 consecutive years

Most people stick to one or other (S&P 500 or S&P 500+ all other stocks of any kind) classification system. Of note, the “dividend kings” is not a category that is universally accepted and only used by some (though everyone should recognize what its definition is when everyone it is thrown around).

So, these lists are not static obviously. The best companies move from one list up towards another once they have achieved ten, 25, or even 50 consecutive years of dividend increases. The less fortunate companies fall off the list after one year of not increasing their dividend. REMEMBER THIS: It’s not missing a dividend payout that gets you scratched off the list; it’s simply not increasing the dividend from the prior year that gets your company bumped off the list.

Take the example of Johnson Controls which paid out higher and higher dividends for 31 consecutive years from 1985-2016 until they could no longer increase it. They never stopped paying the dividend and even increased its dividend in subsequent years. However, just for missing one year out of the past 33 years, Johnson Controls went from being a Dividend Champion and eventually on its way to becoming a Dividend King to not even being a Dividend Achiever currently.

One missed dividend payment increase (even if you still pay out a dividend that year in question)…no matter for whatever reason…and you’re out.

Brutally unforgiving system…which is good for us as investors.

There are 25 Dividend Kings, 50 Dividend Aristocrats, 115 Dividend Champions, 220 Dividend Contenders, and 265 Dividend Achievers. Dividend Challengers are harder to nail down as there are approximately 150 companies, but more are being added before the end of this year assuming the dividend increase(s) occur.

Now that we have categorized the different dividend growth stocks, let’s delve into the whys of dividend growth investing versus index fund investing alone…next time.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Eat heartily and have a great holiday!

Until next time…

Evaluating Stocks Part V: An Explanation of the Heretofore and Whatnot…Especially The Whatnot

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

I’ll try to make this a shorter post after going extra long in the last post. I’ve been flooded with questions and some gentle criticisms (and some not-so-gentle yelling ALL CAPS INTERNET STYLE!!!!) about my financial chicanery at the end of my last post.

Essentially, all of it boiled down to the following question: Why pick Microsoft with a PE ratio of 51.01 with a dividend when you can get the same dividend yield at a PE ratio of 19.87 with Apple?

First, the disclaimers…

I am not advising anyone what to do for themselves, but rather what someone with my risk tolerance (high), debt burden (low), and critical mass of core holdings (my index funds and Dividend Champions) MIGHT DO. [In full disclosure, I bought Microsoft decades ago and have held it since even as “investment experts” bashed the company and said it should be dumped despite its steady rise in dividend and, of course, now it’s tripled its stock price over the past five years.Way to go, guys. Score another one for the “experts.”]

I’m not even advising for you to pick stocks if that is out of your comfort zone. (Though I firmly hold the position you should at least understand this process even if you don’t pick stocks yourself as either your financial advisor and/or mutual funds are doing it in your name.)

As Chuck Klosterman would often say, ANYWAY…

The rationale behind buying Microsoft at a higher PE ratio for the same dividend yield (after droning on about using the PE ratio as a leading metric of value) has to do with not its growth (its PEG ratio—remember what that is?—is 2.27 while Apple’s PEG ratio is 0.91 and Facebook has a PEG ratio of 0.93), but rather the other type of investing that has always intrigued me. If you enjoy investing in individual stocks (which I do immensely) in hopes to “beat the market”, it’s intriguing to take an educated guess on what secular trends will elevate which companies. For example, who will win the cloud computing wars? Well, I’m certainly smart enough to know, but I am smart enough know how to read the best paper in the world for investors, the Wall Street Journal.

A multibillion dollar company with over 30 years being publicly traded with dividends since 2003 and increasing that dividend since 2012 with a PE ratio no more than twice the sector average (and a PEG ratio no more than twice the sector average) PLUS massively increasing revenues in a whole new market space with only one other major competitor (Hello, Amazon!) so far.  

Sign me up for a (currently) well run company with a growing dividend and riding a secular trend with massive implications for the future any time.

Along with that, the money that was put in was not the most ($2,500 each for Microsoft and Facebook versus $5,000 for Apple) and would still allow to capture the advantages of Microsoft particularly since it will dollar cost average into more and more shares of a great company (provided you set up a DRIP from the start) with increasing shares leading to increasing dividend payouts leading to even a further increase in shares in a glorious upward spiral (I guess I am a bit of an investing evangelist).    

Again, that’s what I’d do with where I am at in my investing life and with my risk tolerance (and my love for stock picking and seeing if I got a good deal and a great investment years later). THIS DOES NOT MEAN YOU SHOULD DO THIS FOR YOURSELF AND/OR YOUR FAMILY.

That is all.   

I hope that helps…even and especially for your haters out there.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…

Evaluating Stocks, Part IV: MSFT vs AAPL vs FB: Showdown at the Hope Returns Are Better than OK Corral

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

 

Where we last left off, we discovered the range of PE ratios between some famous tech stocks (Microsoft/MSFT=51.01, Apple/AAPL=19.87, Facebook/FB=23.84) and will use that metric to determine which to purchase in a hypothetical $10,000 purchase. (Just like med school, let me set up a hypothetical that is unlike real life and make you stick to it. In this case, that means all $10,000 must go into only one stock rather than splitting it up into two or even all three companies.)

Before we dive into the comparison analysis, let’s review the PE ratio as a number and what it means. So, as you (hopefully) saw from last time, the PE ratio of the S&P 500 has essentially been between 15-25 for the past 15 years or so (with the major exception being in 2009 as noted last time). Thus, our evaluation has been pegged to PE ratios in this range.

***Note that in all future posts, if I refer to a low PE ratio company, it’s below this range (or at the lower end of this range) or a high PE ratio company would have one greater than 25.***

A low PE ratio company is considered “cheaper” regardless of its actual stock price and how much you have to pay for the same number of shares as a company with a higher PE ratio. This is part and parcel of the school of thought known as “value investing” (though they are other metrics used to determine what is a value purchase among stocks) which is what made this guy rich and famous.

A high PE ratio isn’t necessarily a bad company however. A high PE ratio for a company means that the stock price is high when earnings are relatively low.

Sarcastic Reader: Why in the world would that be? Wouldn’t the stock price be low if the earnings are low?

Dr. Scared: This is it! This is how they screw you!!

Dr. Unwise: Low earnings, but a high stock price? That makes no sense at all!  

A high PE ratio means that analysts/institutional investors (maybe even retail investors) expect earnings to take off in the near future (a totally and purposefully arbitrary and vague time period) based on…something…like a new product launch, a new division, a new acquisition, etc. How much that is worth may be subjective and it is up to you as in individual investor to make that call particularly if the PE ratio in question is multiples of that of the S&P 500.

Keeping all that in mind, let’s do some comparison shopping.

From purely a PE ratio, the “cheapest” company is good old Apple with Facebook as a close second and Microsoft a distant third.

Sarcastic Reader: So Apple is the best one to get right?

Dr. Unwise: I feel like there’s a catch here somewhere.

Dr. Scared: This is it! This is how…Aah, you guys know where I’m at with all of this…

PWT: Yes. Apple is the best company to buy into from a purely a PE ratio. There is no doubt about it. But, there’s something else—if not other things—to consider…

Sarcastic Reader: Oh boy, Here we go…

One other thing you need to consider when thinking of buying a stock is if it pays a dividend and what is the company’s dividend history if it does pay one. Facebook does not pay any dividend. Both Apple and Microsoft do pay dividends. Microsoft paid 0.42 per share of stock you own and will pay $0.46 per share starting in November which is a dividend yield of 1.7%. (Think of dividend yield as interest gained on the money you put into that particular company. That plus how much the stock price goes up [AKA capital appreciation] along with how much the company keeps increasing the dividend payout {if they do at all} will determine how well you do with that individual company.) Microsoft, for example, began paying out dividends in 20003 and has steadily increased its dividend every year since 2009 from 13 cents/share to 46 cents/share starting next month.

Apple, on the other hand, pays 73 cents/share with a dividend yield of 1.4%. Apple has increased its dividend every year since it re-started one in 2102. It had a dividend in 1988-1995 and none before that or since then until 2012.   

So, Apple has a more inconsistent dividend history in that it had one and suspended it previously. The counter argument here (by Apple fanboys) is that the company has a pile of cash that even Croesus would envy and will continue the dividend ad infinitum if not increase it occasionally.  Moreover, it has a far lower PE ratio (19.87) than Microsoft (51.01).

Sarcastic Reader: So…Apple…then?

Dr. Unwise: Please…please. I’m begging you in all the name of the holy, say Apple or nothing else makes any sense right now.

Dr. Scared: This is it! This is how you they screw you!!

PWT: In this contrived hypothetical, I’d pick Apple. This is where you get into investor biases and recognizing what your biases are.

Dr. Know-It-All: OK, smart guy. What are yours?

PWT: Hey, not welcome back, but long time no see. I had no idea where you went. My biases are clear: I am a value investor and always seek a good company with a long history whose business model I can understand and even more so if they have a good dividend history (ie, long history of paying out dividends consistently and best yet if the company keeps nudging the dividend up year after year without fail). The only other company types I look hard at are the ones that will be increasingly important given future needs/trends such as social media, cloud computing, 3D printing, technology, and—believe it or not—even water.

Apple checks all those boxes. In practice, however, you could easily split your money into $5,000 into Apple, $2,500 into Microsoft, and the remaining $2,500 into Facebook, betting on all three for the long term future and capturing the dividends of the former two while waiting patiently. And the dividends should then be set up to buy more shares of the stocks you already have evaluated as good buys which sets you up to keep buying more stock for no more money out of your pocket(s) ever again. This is the cheapest way in the world to dollar cost average and accumulate wealth over time.

Dr. Know-It-All: Um…thanks…

Dr. Spend-It-All: I’d just make the dividends come to me. So I can buy some jet skis for the lake.

Dr. Unwise: SOme? One isn’t enough.

Sarcastic Reader: Wait a damn second, Professor! We went through this whole exercise based on the fact that you could only pick one stock and not all three just like in medical school when they ask a question with all good options, but say there’s only one best choice. And then finally after a lot of flim flam you give the answer kind of and then tell us that “Oh, yeah, by the way, I’m changing all the rules now and would buy all three in real life.” What gives?

PWT: Welcome to medical school where students never win. Same with residents and fellows.

Dr. Unwise: Damn. So true…

Dr. Scared: This really is how they screw you!

OK.

Enough.

I’ve tortured everyone here long enough.

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…

Evaluating Stocks Part III: A Practical Example

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

Sorry for the delay recently, Once again, life got in the way, but back into it we shall go. We last left off talking about the PE ratio in its definition, how to interpret it, etc. Now that we did the theory work, let’s do the practical part (just like med school—Ugh).

Let’s keep using Microsoft (MSFT) as an example and then we can do some comparison shopping amongst the tech stocks.

Microsoft currently has a PE ratio of 51.01 with a stock price of 108.66. The current PE ratio of the S&P 500 is 22.60 (estimated as of 10/19/18) and was 24.97 on 1/1/18. (If you peruse the table at the other end of the link, you will see the PE ratio of the S&P 500 has steadily been rising since 2012—from 14.87 to over 20 today. This keeps cycling up and down as you can see in the table.

The highest PE ratio of late was the incredible 70.91 as of 1/1/09—as the market as a whole was sinking and wouldn’t find bottom for ten more weeks in mid-March. Everyone was focusing on how much stock prices were dropping, but earnings were plummeting even further thus making the PE ratio [remember that stock price is your numerator, but your denominator is the earnings—who know all that elementary school math would bubble back up in your adult life?] at the time spike up. You can then see as the market recovered the PE ratio fell back to normal human heights 20.7 by 1/1/10.)

So, what exactly does all this mean in terms of evaluating MSFT as a potential buy?

Comparing apples to apples (even if they are Red Delicious [a misnomer for sure] versus Gala—7,000!?! Wow. Who knew?), the MSFT PE ratio is 51.01 versus that of the S&P 500 (current estimation) of 22.60 meaning that MSFT is 2.257 times more “expensive” than the average stock in this market. Maybe that’s OK though. Purchasing is a matter of not only price, but value. You don’t get a 4,500 square foot house in the best neighborhood in town for the same price as a 1,200 square foot place in the sketchy part of the same town. We all buy the same things at very different prices and feel (are sure?) that we are getting a good value for the money we are parting with.

But, to compare with MSFT with the average stock in the market isn’t quite fair. If you’re car shopping and say that a Mercedes is far more expensive than a Kia, you’re absolutely correct and also stacking the deck in a ludicrous argument. You need to compare your Mercedes to other luxury vehicles (BMW, Audi, etc.—yeah, I like German cars). The same is true with stocks.

So, MSFT needs to be compared with the other well know multibillion technology stocks out there not the Proctor & Gambles  and Coca-Colas of the world.

So, in terms of PE ratio (rounding to the nearest whole number), MSFT is 51, Facebook is 24, Amazon is 140, Apple is 20, Netflix (a technology company of sorts) is 119, and Google (never Alphabet in my view) is 47. These are the famous so-called FAANG stocks.

Sarcastic Reader: Hey fella, Apple at 20 and Facebook at 24 is way cheaper in terms of this PE ratio thing. Why not just buy one or both of them instead of Microsoft?

Dr. Scared: This is it! This is how they screw you!!!

PWT: Great point. Let’s compare MSFT vs Facebook  vs Apple as far as if you have $10,000 and want to put it all on one stock all at once right now…next time.

Dr. Unwise: Damn it! This guy is getting good at the tease!

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…

Evaluating Stocks Part Two: The PE Ratio—Not Pulmonary Embolism For Once

Never forget these two axioms:

Money frees us, but its pursuit enslaves us.

It’s not how much you have at the end; it’s how much you could have made.

When evaluating individual stocks, much is made of the dreaded price earnings ratio (AKA PE ratio) which makes the eyes of many glaze over and nod in silent hopeless agreement. Defining what it is is far easier than how to interpret it.

PE Ratio=A company’s stock price/earnings per share

This is typically calculated by the four past quarters of earnings divided by the annual earnings per share. This is defined as the trailing P/E (or PE) ratio.

For example, if a publicly traded company has a stock price of $20 and the earnings per share is $2 over the past year, then the P/E ratio is 10. (I like simple math.) Note that the PE ratio is not in dollars or foot pounds or some such thing. It’s just a number and that’s it.

So what? What does this mean?

Who cares?

So what exactly does this number signify?

This number tells you how much you are willing to pay for a company’s stock. Think of it this way. In the above example, it means you would be willing/you will be buying a piece of a company at ten times what they earn for each of those shares you purchased. You can compare this PE ratio of company A to either other companies in the same sector (eg, pharmaceuticals, energy, utilities, etc) or even the whole stock market. If the company in question is way out of scale with either its sector or the market as a whole, it should give you pause and make you figure out why should you be paying so much more for this stock as opposed to others (whether in that sector or in another completely different one). If you cannot definitively prove (at least to yourself and your significant other) why this stock is worth so much more than many others, then don’t buy it. I completely agree with the Warren Buffet maxim of “Buying a great company at a good price is much better than buying a good company at a great price.” (I’m paraphrasing the Oracle of Omaha, but it captures the essence of what he was getting across.)

The caveat to this is ensuring you’re getting at least a good price, if not a great one. (More on that later.)

Due to the fact that company earnings only come out quarterly and the stock price changes daily, the trailing PE ratio keeps moving daily. Therefore, many investors pay heed to the “forward” or “leading” PE ratio which is calculated with the same methodology, but using projected future earnings (essentially always estimated over the next 12 months).

Now you have two PE ratios competing against one another for each stock that exists.  

Sarcastic Reader: OK. Here we go. This is how the flim flam starts.

Dr. Scared: This is it! This is it!! This is how they screw you!!

Dr. Unwise: Just once i’d like to finally find out who ‘they” is.

PWT: Umm…let’s just…keep moving…on…

If the leading (or forward) PE ratio is lower than the trailing PE ratio is, it means analysts are anticipating the company’s earnings to increase over the next 12 months.

However, if the leading (or forward) PE ratio is higher than the trailing PE ratio is, it means  analysts are anticipating the company’s earnings to decrease over the next 12 months.

To further confuse the issue, there is something called a PEG ratio (price to earnings growth ratio) which is the company’s trailing PE ratio divided by the growth rate of the company’s earnings for some specified time period (again, typically a year). PEG ratios themselves can be categorized as trailing or leading/forward depending on whether historic growth rates or estimated future growth rates respectively.

The instance where PEG ratios are often used is when you seem to have a “steal” in a low PE ratio (“cheap”) stock to see if that is truly the case as the PEG ratio accounts for the growth a company is undergoing as it is moving along which may indicate not where it is now, but what you want to know most—where it will be in the future. (More on this later.)

The companies that do not have any positive earnings have either a negative PE ratio (my preference), just arbitrarily assigned a PE ratio of zero, or even more ambiguously the PE ratio is unassigned and noted to be uninterpretable since some argue the PE ratio cannot be used to compare this company to any other. (More on this later…I hope we have time for all of this later stuff.)

Now that we have defined the PE ratio and its variants, let’s go thorough an example of a stock and run it through an analysis of how they should be viewed through the prism of PE ratios.

Good thing there’s always another week coming up…

I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.

Please spread the word about this blog to your friends (real and virtual), family, and colleagues. Talk to you soon.

Until next time…