Subscribe for free access: 7 Steps to Understanding the Stock Market
≡ Menu

4 Free Tools for Dividend Growth Investing

I’ve written many times about the benefits of dividend growth investing. When you look at a concept like compounding interest, there’s many different ways to achieve the same end goal. However, dividend growth investing gives you the best possible way.

dividend growth investing

For one, dividend payments provide compounding by increasing the number of shares held every year through reinvestment. So, a stock held for a long time will compound the interest received simply because there will be more shares from previous reinvestments.

As long as the company continues to pay the dividend, which most do, then the interest received from dividend payments will increase with an increased number of shares.

In addition to that, dividend growth stocks provide compounding interest through the growth of the dividend payments from year to year.

Not only do most dividend paying companies continue to pay their dividend every year, but many of the high performing dividend payers succeed in increasing their payouts every year, to a point where they reach consecutive years of dividend growth.

Dividend Growth Investing Success

10, 25, and even 50 years of consecutive dividend growth are markers of this achievement in a group candidly called dividend aristocrats. These businesses have been successful in achieving the ultimate goal of a corporation, which is to return money to shareholders.

They’ve also succeeded in doing so throughout many economic recessions, bear markets, and economic and global crises and panics. The dividend aristocrats epitomize the best vehicles for rapid compounding of wealth through a stock market investment.

It’s the dividend aristocrats like Coca Cola, Walmart, and Altria who’ve created the inspirational examples of what a small amount of money can become over a long period of time. I’ve written about this many times before, with simple examples showing how a small sum like $10,000 can compound into millions through the right dividend growth companies.

To be sure, not every stock will become a dividend growth investing success. Some of the weaker businesses face a stagnation, suspension, or outright removal of their dividend when hit with tough times.

That’s to be expected, which is why we must combine such an investing strategy with other prudent principles such as value investing and diversification. It’s completely fine to be wrong sometimes, and we don’t even have to be right most of the time. As the examples have shown, it could take just one superb investment to create decades of high-yield, consecutively growing dividend payments.

As dividend payments grow each year, the share price inevitably follows. This double upwards movement multiplies our returns and creates the exponential growth magic of compounding interest. It’s no doubt a much faster and efficient way to utilize compound interest.

The higher share price makes shares accumulated through reinvestment even more profitable, and will continue to do so as long as dividend payments increase. Hopefully you can see why I get so excited about this.

Now that we’ve prefaced the allure of dividend growth investing, I want to help you actually achieve it. [click to continue…]

Measuring Competitiveness in Maturing Industries

Industries tend to mature in similar ways. We can use this information when analyzing stocks to forecast a probable industry trend. Absent government intervention, we can predictably assume that the laws of economics will be shared across many industries.

industry analysis

If you can’t tell, I’m getting excited about this topic. My vocabulary tends to get stuffy and academic when I’m fleshing out complex topics. I understand this makes it harder to follow.

Just read the following post with the understanding that this is a relatively new phenomenon that I’ll likely pursue in the future. As such, with my own mastery will come an easier ability to simplify and teach. Like with many things in the stock market, the concept is simple but it’s application is quite complex.

There’s a couple of principles I want to share with you that reach across various schools of thought. Some of the most fascinating discoveries in the world have occurred from a proven hypothesis being tested in a new arena. The possible overlap of principles and ideas really creates more interesting thoughts and ideas.

In the world of internet search, there is a rule called the 40-20-10 rule. It’s not so much a rule as it is an observation. On any given Google search, 40% of the visitors will click on the 1st ranked website, 20% will click on the second, and 10% will click on the third.

Whether it’s because of human nature, or the psychology behind the innate desire to belong to a group, this internal choice mechanism seems to apply uniformly.

Marketing experts will tell you that humans prefer choices, but not too many choices. There was a study at Columbia University about two different jam displays, one with 6 choices and one with 24 choices. A whopping 30% of customers who were only exposed to 6 choices ended up buying a product, while only 3% of those presented with 24 choices purchased.

As you can see, the human brain tends to prefer less choices. In a limited choice selection environment such as a Google search, a presentation of 6-10 choices yields a “big three” of winners who follow the 40-20-10 rule.

If you graph the 40-20-10 results, what you’ll see is an exponential curve the decreases along the x-axis. Now, this graph gets interesting because it applies in many other fields of life. It’s also known as the long-tail curve.

long tail curve

Forbes did an article where they described the performance of workers in a business follows a long tail curve. The top 10%-15% of the population are considered hyper performers, while the majority of workers are just average. At the end of the long tail, you have the small number of workers who are performing very poorly.

Turns out this long-tail, or fat tail, methodology has been discovered a long time ago. An Italian economist and civil engineer Vilfredo Pareto created the Paretian (power law) distribution. In contrast to Gaussian’s law, which is the familiar bell curve that is employed to attempt and express mathematical averages. You’ll see this bell curve in economic contexts, predicting average returns among other things. [click to continue…]

What does Diluted EPS mean?

Take a look at any income statement, and you’ll see EPS (or earnings per share) divided into two categories: diluted EPS and basic EPS. Which EPS figure should you rely on, and what does those terms mean? Take a seat, grasshopper, and I’ll show you.

diluted eps

EPS is a standard metric for measuring how profitable a company is. While total net earnings indicate how much profit a company is bringing in, the direct effect on an individual shareholder is less clear. That’s where EPS, and consequently dilution, come in.

Basically, dilution refers to how many shares outstanding a company has. A company might have really high net earnings and a great P/E, P/B, and other such valuations… but if the company is too heavily diluted, then the “spoils” of war are reduced for shareholders. Too much dilution leads to a lower EPS, which in turn translates into a lower dividend payout.

As those who have been reading me for some time know, dividends are an extremely important aspect of my investing philosophy. Share appreciation is nice, but I’d prefer a steadily growing dividend payment that is consistent and reliable.

Remember that the total shares outstanding helps determine a company’s market capitalization, which in turn affects valuations and investing metrics.

The reason that earnings gets converted into EPS is so that investors focusing on the share price calculations can make comparisons. For example, a share price of $80.00 tells us nothing about P/E unless we also know that the EPS is $4.00. Of course, the same P/E calculation can be made with market capitalization divided by net earnings, but in both cases the metrics are multiplied by shares outstanding.

Share price * shares outstanding = market capitalization, and EPS * shares outstanding = net earnings. In effect we are making the same calculations, but notice that you can’t divide market cap by EPS, or share price by net earnings. It’s like trying to divide 6 inches by 4 cm.

My point is that problems with dilution aren’t apparent in other calculations, because the metrics are different, and so it’s something that can be easily overlooked. [click to continue…]

Liquidity Ratios: A Business Approach to Investing Pt. 2

The way to measure a good business is the same as measuring a good investment. As a result, many successful people with a background in business make an easy transition into growing their capital through investing.

In a previous post, I shared how to use profitability ratios utilized in accounting to find superior investments. This post will cover the second part of that, using liquidity ratios to measure the health of any business, which will in turn help you discover the best long term investments.

liquidity ratios

There’s a couple of things to consider when it comes to liquidity ratios. Firstly, liquidity is obviously a good characteristic for any type of business. While it’s chiefly important for financial banks, who depend on liquidity to cover any customer withdrawals and other expenses, it’s also crucial for every business.

Every business has a certain number of expenses that are required for the business to run. Some of them might be day-to-day, while others are longer term or sporadic. Regardless of the exact situation, every business must have a minimum amount of liquidity to keep the business running smoothly.

Understanding this concept will help you understand why liquidity ratios are so important. Take the example of a company who isn’t liquid. While running more liabilities than assets isn’t in any way sustainable, a company could continue to run for many months into the foreseeable future– by issuing more debt or increasing earnings in a short period, or making other tough but necessary decisions. This can go on for quite a while until something unexpected arises.

[click to continue…]

Negative PEG Ratio Implications

The implications for a negative PEG ratio might not be as bad as you think. It all depends on the reason behind the negative PEG ratio, which breaks into 2 possibilities. One spells trouble while the other might not.

negative peg ratio

I’m writing this post as a response to an email I received from a reader. He had seen the post I wrote last week about negative P/E ratio, and simply wondered, “what about negative peg ratio”?

If you haven’t read the post about negative P/E yet, I suggest doing that first. You’ll see that it potentially plays a factor into a negative PEG ratio, and you should understand all the reasons why I strongly warn against a negative P/E.

Before digging into the PEG scenarios we first must know how to calculate PEG ratio. It’s a simple division, dividing the P/E ratio by the earnings growth. Now in most general stock market websites, they use yearly earnings growth to calculate PEG. However, some may use Q/Q growth instead, so it’s important to check the numbers for yourself before trusting any website’s ratio.

PEG = (P/E ratio) / (Growth in Net Earnings)

I covered how to calculate P/E ratio in the previous blog post. The upfront calculation for growth, for those who are still unclear, would be this year’s earnings minus last year’s earnings divided by last year’s earnings. Or, if this year was 2015 and last year was 2014…

Growth in Net Earnings =
(2015 Net Earnings – 2014 Net Earnings) / (2014 Net Earnings)

The PEG ratio works like the P/E ratio, in the sense that a lower value is generally more desired. Whereas a P/E ratio is showing how much you are paying in relation to earnings, the PEG ratio expresses how much you are paying in relation to the growth. You can think of a PEG less than 1 as meaning that you are getting more growth than you are paying for, and a PEG greater than 1 as getting less growth than what you are paying for.

This assumption is loosely accurate and wildly based on Peter Lynch’s growth strategy where he wants a growth rate at least higher than the P/E ratio. A stock priced at 17 times earnings is expected to grow 17% next year, which is how this idea is derived. Of course, the way that things play out in the real world and how conventional wisdom tells you they should play out are rarely the same. But still, this is a mostly accurate calculation that I can endorse.

Looking back at the formula for PEG, we see there are only 2 possibilities. [click to continue…]

Profitability Ratios: A Business Approach to Investing

Business and investing go hand and hand. Often the best investors are also really great businessmen. Just look at the sharks on the famous TV show Shark Tank. They are all successful business people, and now putting their money to work as investors.

Even a great investor like Warren Buffett has said that intelligent investing is buying a stock as if you are purchasing the business. The same profitability ratios learned in business school can be invaluable in helping you to find great investments. Many of these formulas do crossover to both arenas, which is why learning them is so important.

profitability ratios

The problem with most of the profitability ratio information out there is that the application is not easily apparent. Information is just thrown at you, with the expectation that you will somehow absorb it. That’s not what I’m about, or what this website is about. No, I’m all about teaching you the information so you can not only learn from it, but profit from it too.

That’s why this post will give you actionable links with each of these metrics, so that you instantly have the power to sort between thousands of stocks and businesses to see how diverse the values can be. You might even find a solid investment in the process.

No matter if you’re just passing by as part of your schooling, or you’re an advanced investor hoping to bring a business aspect to your strategy, I aim to leave you with a life skill that while you might not profit from immediately– hopefully one day you’ll remember these concepts when you need them most. Or at least be able to remember how to refer back to this information, so that when the opportunity and the ability presents itself, you’ll take advantage.

If you ask any billionaire, be it Mark Cuban or Bill Gates, they’ll tell you that wealth is built over a lifetime. The skills you need to acquire along the way are also accumulated over a lifetime. The ability to discern between businesses through valuation analysis is one of those skills you must have to become really rich. This post is a small part in understanding that. So let’s dive in.

Net Profit Margin

The first profitability ratio to understand is the net profit margin. The word’s meaning is just as it sounds. When you think of high profit margin businesses, think of the expensive and luxurious brands. These kinds of business models are among the most lucrative and exciting to be a part of. Low profit margin businesses don’t make as much money and thus depend on high volume. Think of the Amazons and Walmarts of the world.

Calculating profit is really simple. Take the income and subtract the expenses. The calculation for net profit margin is just as simple. Just take the profit, also called the net income, and divide it by the total revenue. The resulting number will be a decimal place, and should be expressed in a percentage.

So, a company that converts 10% of its revenue into profits will have a 10% net profit margin, and on and on again.

Using profit margin to measure profitability makes the most sense in the plainest definition of the word. Generally speaking, a company with lower profit margins compared to its competitors will be less profitable. A company that grows its earnings over time often uses measures like cutting costs to raise its profit margin and thus raise its profits.

As is the case with many of these profitability ratios, the best way to utilize these ratios is to compare them within their own industry. A company may have favorable ratios just because of the type of business model or industry the company is in. It’s important for the investor to discern between when this is the case and actively utilize multiple ratios in order to minimize this effect. [click to continue…]

NEGATIVE PE RATIO – What to Do?

I recently received an email from a concerned reader about negative PE ratio. The question looked something like this:

“When P/E is negative then what to do?

Suppose Stock A was:
P/E = -17.65
P/B = 0.35

Suppose Stock B was:
P/E = 9.25
P/B = 4.25

In this circumstance what should I do? Should I buy more shares, sell these shares, or hold these shares?”

First of all, this is a great question because your head is in the right place. You’re starting to get a grip on the importance of valuations, and you’re using multiple valuations to compare stocks with analysis. This is a great stepping stone into solid fundamental analysis.

NEGATIVE PE RATIO

Before I answer your question, I have to provide the caveat that I can’t give you personal advice on your investing decisions. It’s against the law. So if these are actual stocks that you may own, I can’t tell you what to do and you’ll have to use your own judgment. However, I can tell you what I would do in that kind of a situation and hopefully through this process you’ll glean some helpful information.

Now, when it comes to buying stocks I hold firm with 3 unbreakable rules, as found in 7 Steps to Understanding the Stock Market. Those 3 rules are the following: [click to continue…]

Taxable Brokerage Account: Full Implications

“Hey Andrew, I read your recent article on why people should consider Roth IRAs for investments. Regarding taxes, when would an independent brokerage account (taxable brokerage account) be taxed?”

The tax implications on taxable brokerage accounts aren’t very clear. I’ll explain it to you, but let me preface by insisting that I am not a tax professional and am just sharing my interpretation of the tax law. You should seek tax assistance or an accountant, as these laws change every year.

taxable brokerage account

Taxes get triggered on your capital gains. Capital gains are achieved each time you sell a stock for a profit. The nice thing about taxes on gains is that you can offset them with losses. For example, if in one fiscal year you sold a stock for a $1,000 gain and also sold a stock for a -$750 loss, you’ll only get taxed for capital gains of $250. Keep in mind that tax events become triggered every single year in which you have capital gains.

Now you should also know that taxes will NOT be triggered if you are just holding a stock. Let’s say you hold a stock that has appreciated from $20 to $40 a share. As long as you haven’t sold that stock, you don’t have to pay taxes on it for that year.

Long and Short Term Capital Gains

When you do get taxed on your taxable brokerage account, there are two possibilities. One is that you get taxed for a short term capital gain and one is that you get taxed for long term capital gains. The short term capital gains are taxed much higher than long term. A short term capital gain is triggered on any stock that you sell and hold for less than one year. A long term capital gain can only be recorded if you’ve held the stock for more than a year.

As of 2014, short term capital gains were taxed at your ordinary tax bracket. Ouch. Long term capital gains were taxed at 0%, 15%, or 20%, depending on your tax bracket. Honestly I feel like I’ve seen these laws change so suddenly that it probably won’t stay exactly like this for long. You’ll have to constantly check every year. But this principle seems to hold firm: long term investors are favored over short term speculators.

Also keep in mind that the brokerage who serves you will not withhold taxes for you. IT IS YOUR COMPLETE RESPONSIBILITY TO TRACK YOUR CAPITAL GAINS AND PAY THEM DURING TAX SEASON. Sorry for the caps, but tax evasion is no funny business. Just ask the Giudices. You record any capital gains on your tax return along with the rest of your tax information, similar to deductible mortgage interest, your yearly annual salary or any other figure.

So if you are playing with stock market money in a taxable brokerage account, make sure you are sacking some of your gains away in anticipation of your tax bill. Just like paying taxes when running a small business, these numbers need to be organized, separated, and accounted for.

You can see how this can impede your progress towards wealth. Compounding slows down quite considerably when gains are taken right off the top and given to sweet old Uncle Sam. This is why you hear personal finance people always harping about IRAs and tax advantaged retirement accounts. [click to continue…]

Q&A about Transaction Fee and $200/month IRA Contribution

“I’ve often read and thought about this but how does one exactly do this? Lets say I put $200/month into my IRA. Do I think buy $200 worth of stock that I already own, new stock, or both? Also how do you feel about the transaction fee? Sometimes I feel as if it’s better to save until I have more and then buy a larger amount of shares.

I’d love your insight! Thanks!”

First of all thanks for the great question. I feel like I can give you some helpful perspective on this.

transaction fee

For the Sather Research eLetter portfolio, I put $150 a month into a Roth IRA. Each month contains a new stock pick for the $150. The way that this money works in the portfolio is to create a new position every month.

The reason for this is because I just started this automated system last October. With it being close to the end of January now, the portfolio only holds 4 positions, one for each month. Obviously this is much lower than the recommended diversification of 10 – 20 stocks, and so it makes sense to add a new position every month.

Your situation might be different depending on what your portfolio looks like. Once optimal diversification is met, at that point I will probably evaluate every stock in my portfolio and either add more, or invest in a better opportunity. Basically what I am saying is to automatically add new positions until diversified, and then invest based on best opportunity.

As far as the transaction fee, you are right to be concerned. This is a big reason why I advocate TradeKing. The difference between a transaction fee of $4.95 vs. $6.95 might not be that much, but consider how much it could eat into your return. With a $200 investment, the higher $6.95 fee gives you a 3.5% loss right off the bat. The lower $4.95 transaction fee with TradeKing is a full percentage point less at 2.5%.

The difference between even 1% in a long term and compounding return can become very significant. So it’s good to minimize this as much as we can. Over a 12 month period using your example contribution, we’ve already saved ourselves 12% by going with TradeKing over a different broker. [click to continue…]

200th Post: Who’s the Next Wolf of Wall Street?

Yacht parties. Huge mansions. Flashy cars. Drugs. Girls. Debauchery.

This is the lifestyle depicted by the movie The Wolf of Wall Street. In the film, Leonardo DiCaprio plays Jordan Belfort, the true story about a guy who peddled penny stocks and made a fortune off it.

next wolf of wall street

The question that everyone wants to know… is it possible to be like the Wolf of Wall Street? If some average guy was able to make all that money on Wall Street, well then can I? Are penny stocks the answer?

Well if you want to know my take about penny stocks, you can read my piece about it here. I want to be clear with you first and foremost.

Jordan Belfort did NOT make his fortune off Wall Street in the traditional way that you think about the stock market. He never owned any stocks, and the business he was involved in was not holding investments.

No, the Wolf of Wall Street was an investment broker. He was the middleman between the individual investor and Wall Street.

As a consequence, there was no incentive for Belfort to help his clients succeed. As a broker, think of the online brokers we see today like eTrade and Tradeking, he only got paid when a transaction was made. Interestingly, this reflects on most of Wall Street today. Many of them don’t get paid based on your success, they only get paid on your action (buys and sells).

So Belfort did what every greedy man without morals would do in his situation. He grabbed the horse by the throat and would say whatever he could to get his client to buy. **SPOILER ALERT** You see, Belfort quickly recognized that the commission on penny stocks was much higher than regular stocks.

All he had to do was to convince his prospect of a hot story, and get them to buy a stock. It didn’t matter what stock it was really, and it didn’t matter to him what the stock did tomorrow. As long as he got the prospect to buy some penny stocks, he would make a fortune. [click to continue…]