This is part 5 of the 5 episode “Back to the Basics” series from The Investing for Beginners Podcast. Each episode covers the fundamentals of the stock market and investing to provide a solid foundation for those who are looking to compound their wealth over time.
Here are the links to each of the episodes:
Back to the Basics Pt 1: The Anatomy of Stocks and Shares
–Defining what a stock is
–Talk about the big 3: the cash flow statement, balance sheet, and income statement
Back to the Basics Pt 2: Share Dilution on Wall Street
–What is a stock
–What are stock buybacks and how they affect us
–What are share dilutions
–What happens when we buy or sell a stock
Back to the Basics Pt 3: Stocks vs Other Investments
–Peer to peer lending
–Gold and other precious metals
–Bitcoin and other cryptocurrencies
Back to the Basics Pt 4: Investing 101 and Compound Interest
–The importance of buy and hold
–Compound interest and how it can make you wealthy
–Using a compound interest calculator
–The power of dollar cost averaging
Back to the Basics Pt 5: Dividend Stocks and Value Investing
–The advantages of buying low and selling high
–Dividends and the power of compounding
Welcome to Investing for Beginners podcast this is episode 46. Andrew and I are going to continue talking about back to the basics. Today we’re going to follow up on we’ve finished last week talking about compound interest, dollar cost averaging and we’re going to talk a little bit more about dividends today.
Of course, that’s Andrews favorite thing to talk about, and we’ll also talk a little bit about buying low and sell high. Without any further ado, I’m going to turn it over to Andrew to get our chat started, and we’ll just go from there.
- The advantages of buying low and selling high
- Dividends and the power of compounding
Andrew: cool so dividends yes let me get started because we were looking at the backbones of it. We’re looking at you know we talked about the anatomy of stocks and what shares represent. Whether dividends and how do they relate and why are they powerful for us. Dividends are pieces of earnings that companies are going to pay out to shareholders.
It’s in my opinion which is it’s debatable because of a lot of people kind of look past this. But I see investments as the whole point of having an investment is to receive an income. When you buy an investment you are taking on a certain amount of financial risk there’s a chance that you could lose all of your capital.
There’s a chance you could be given your money the Bernie Madoff, and he’s running off with it there’s a chance that you’re putting money into a business that decides to light it on fire and goes bankrupt after a couple of years.
It’s a lot of risks that are involved, but that’s where the reward comes in. Are you’re getting you’re going to get paid for those risks back to you, and in my opinion, the most reliable source of that would be interest and income. And so we see that with loans, and we talked about that a bit. We’re discussing all the different types of investments that are out there besides the stock market it gets lost on investors, and I think that they need to take a step back and consider why would you even hold a piece of a company.
Sure you can be a buy and hold type person who is going to buy low sell high or kind of like I don’t want to say like a Shark Tank investor. Because they don’t necessarily do that, but maybe angel investor would be the right word where you’re investing capital with the hopes of either the company going IPO or being acquired by a bigger company and essentially being able to cash out.
And that difference between what you invested at the start of the life of the company versus what the buyout is the profits. But if you’re not somebody who’s taking that sort of a path when it comes to owning a business or buying a business.
Then really what the whole point of having ownership of a business is to be getting those earnings and that profit and that cash flow paid back to you. I mean think about the everyday mom-and-pop guy the guy who owns a pizza store. He’s you can probably bet yourself that when he has a good year, he’s either putting some of that putting a good amount of money of that back into his company. Maybe trying to market and make the company grow like that. But I’m sure he’s also taking vacations and rewarding himself for all the hard work and everything that his business was able to provide for him with all this extra money.
As investors and part business owners ourselves we should expect that for yourself and that’s exactly what the company on Wall Street the public corporations that’s what they’re doing. They are taking their abundance of earnings and that overflow, and they’re giving it back to the owners, and obviously, that’s beneficial for everybody involved.
A lot of times the employees of big corporations will have ownership stakes themselves, so this is a nice way to get paid back for your hard work and a nice way to get bonuses and the nice way to create wealth over the long term. Obviously, that’s one reason why companies pay dividends it’s a great incentive structure it’s a great way to give employees that sense of ownership and motivate them to provide the kind of performance that will make the best financial results for the company.
As a whole, another reason why corporations will pay a dividend is that they want to attract shareholders and obviously when you attract shareholders. We talked about this on one of the previous back to the basics episodes when the demand exceeds the supply when more people want to buy the stock they want to sell it it’s going to push the stock price up.
And so when you pay an attractive dividend you’re going to attract a lot of investors who are looking for that yield. Looking for that return and that capital and it will inevitably drive the stock price up.
Unfortunately, you know like I always like to bemoan it’s there’s a lot more focus, and especially during a bull market and the bubble, there seems to be a lot of focus on trying to kind of flip your flip properties. They say or buy and sell and not so much focus on trying to get income, and there’s a stereotype that’s just for retirees.
But I always like to argue that the big thing that we can rely on then the best way to reliably and consistently grow your wealth is to receive these dividends receive this income reinvest it and that’s really how you’ll compound your wealth.
We touched on that briefly last week as well how buying a dividend buying a portfolio of dividend stocks having those dividend stocks pay you dividends and then reinvesting those. Do you receive it can branch out like a like a big oak tree or like a family tree or like a reverse pyramid-like Dave eloquently said. It just multiplies their money in a very fast way, and that’s the power dividend stocks.
And what’s fantastic about it is that in contrast to like maybe buying a mom-and-pop pizza store or you know some other sort of small business that may or may not be easy to analyze. All of these dividend stocks are required by the SEC to post their financial results post their financial metrics, and everybody can see in a very transparent way how is the business performing how is it performed over the last five 10 15 20 years.
What’s the trend look like how are they spending money how are they bringing in money how much money are they reinvesting in and spending on R&D; all these things are available for us and if we can just use some basic math and use some intuition. We can look at these stocks and make good decisions.
And like I said last week put ourselves in the right on the right side of the odds so they say you know get ourselves in situations where over the long term we are more likely to win rather than lose and over a long in the time period that’s going to happen and obviously the next step to that once you talk about having a long-term holding period and making sure that that’s a primary focus and then obviously on top of diversification dollar cost averaging and getting compound interest through your dividend stocks.
Well, then the next logical thing is also to let ‘s get the odds in our favor when it comes to picking the right stocks. Now we have all these different automatic systems working in a place and when you multiply that by enough positions over enough time with enough capital, and you’re tipping the scales in your favor.
Now you’re like you’re like that casino rather than the gambler, and so that’s everything we’re trying to do and in the big picture that’s what’s going to win it’s not going to be because you had special insight. You’re able to pick one stock it’s not going to be because you got the timing perfect it’s not going to be any of those things. It’s going to be because we’re going to tip the scales in our favor and we’re going to do what we’re going to believe in business we’re going to believe it’s going to continue to do what it’s always done.
And that’s why I say words like reliable consistent and you know it’s fundamental stuff and that’s why we can get excited, and that’s why it’s important to learn all of it so we can apply it and move forward.
A big step to doing that is getting the odds in your favor by being able to identify what numbers are good and what they mean and so that’s kind of what I want to talk about for today.
Dave: I like the way you talk about dividends and the passion and the excitement that you get from them, and it always gets me excited about them.
Dividends are such a great way to compound your wealth. I think that’s the best way to think about them and when a company pays out the dividends to us that’s their way of saying thank you for investing in our company and like Andrew was talking about there.
It’s an awesome way of the company using that tool to try to attract investors and when we’re looking at investing in a company. Dividend paybacks are a great way of us being rewarded for investing in that company and the percentage that they pay you over the years even if the company is not doing well in the stock market. Let’s say that the financials are still great but let’s say the price is taking a beating because maybe that sector is not doing well.
You’re still going to be earning that two to three to four percent on that investment during that period which you can’t always say with other investments and I think that is another aspect of dividends that are not talked a lot about. And I love the shirt that you brought that up because that’s the best time to be reinvesting your dividends.
Right, when the company is doing great they’re paying you a fat dividend, and the stock market’s hating the stock. Now you’re able to pick up even more shares so when that recovery turns around it just multiplies and returns even that much more.
Oh yeah exactly and one of the things that we talk a lot about the impact that compounding can have on your wealth. I want to use Warren Buffett a little bit here so the net worth of Warren Buffett right now I believe he’s worth about fifty-eight billion dollars give or take. Somewhere in that range so he’s obviously fabulously wealthy, and he’s the best investor of our generation arguably of all time, and the thing is though that when he was younger, he wasn’t this fabulously wealthy. And so just to kind of throw some numbers at you when he was 35 years old is worth seven million dollars which you know obviously is not chump change, there’s nothing to sneeze at. But compared to fifty-eight billion it’s chump change, so then we skip up the forty-three years, and he’s worth thirty-four million then we skip up to fifty-six now he’s worth one point four billion and now up to eighty-three, and he’s worth fifty-eight billion.
Will you look at a chart of that and I will put that in the show notes so you guys can see that this is what compounding can do and this is what dividends can do. Because the reason why I bring that up is Warren Buffett’s company Berkshire Hathaway does not pay a dividend and he has his reasons for that, and we’ve talked about this in the past. But the thing is that the majority of his portfolio that he’s investing in is companies that pay a dividend American Express Wells Fargo Walmart.
Those are the big three for him, and they all pay a dividend, and he compounds that dividend, and that’s where the power of dividends can start to take place, and this is the power of what Andrew and I are talking about.
By using the compounding of that additional money that you can be getting for the income that you’re going to be getting from that company, and I agree 100% with what Andrews is talking about when you buy a company you’re looking for income from that company. You’re only as wealthy as if you buy a company let’s say Fiat-Chrysler.
Which is a great company that makes cars it’s done well with the last three or four years. Let’s say you buy that company you’re only as wealthy as when you sell that company. So if the stock goes from six dollars to sixteen dollars you’re going to make a lot of money if you put a lot of money into it.
But you know what that’s not reinvesting it’s not compounding it’s not doing anything but sitting there and so you’re only as wealthy as when you sell that company. But with dividends you’re continually getting income that could be reinvested in the company and keep congruent at when you grow that income you’re going to get more dividends. And so it’s just like we talked a little bit about that last week.
To me it’s a little bit like an ethical pyramid scheme it’s something that’s going to continue just to keep giving you greater and greater wealth and there’s just so many great opportunities that you can get from dividends, and you know Andrew has a lot of great things to say about dividends and rightly so. They’re a fantastic way to grow your wealth.
Andrew: I love how you mentioned that how the compounding isn’t happening for price appreciation and you just take one look at the stock market. You can see I mean how the press seemed to like have four years of growth and then have a bear market come and see it all be wiped away, and it’s like the company the stock price needs to start compounding and then just start over.
Whereas yeah I mean dividends along the way like you said you’re getting more share you’re getting you’re picking up more share that’s partial shares or full shares you’re getting a bigger owners slice of that company and your capital base is growing.
And so, in the long run, the difference between that and not having the portfolio of dividend stocks can really be significant. Especially the farther and further out you go.
Dave: yeah totally. Let’s talk a little bit about investing in companies that like what kind of dividend companies you would be looking for?
Andrew: so what’s great about it is you know no discrimination here we’re going to look at dividend stocks in the same way we look at regular stocks the same way that Warren Buffett likes to pick stocks the same way guys like Peter Lynch and Benjamin Graham.
These investing legends who we’ve mentioned before on the podcast and the archives it’s the same way that we always want to look at a stock and it’s again because of the way that the stock market is constructed and the way that price moves and then the relation between price and value and that’s how we’re going to pick our stocks, and we’re going to put again tip the scales in our favor.
The best way to do that is to buy low and sell high basically other than being a catchy catchphrase that we always hear about, and everybody likes to say.
But the definitions of that are always so varied, but the most basic concept that I can think of and I’ll try to make it kind of simple. But let’s say again we’re business owners were going to buy a business right now. Let’s say we look down the street and around the corner is a Chipotle and across the street from McDonald’s. Yes I know that used to be the same companies now they’re two different companies. Let’s say that Chipotle is bringing in a thousand dollars; I’m going to make the number small.
Let’s say they’re bringing in a thousand dollars a year, and the McDonald’s is only bringing 250 dollars a year so you’re looking down the street and you’re seeing a line go all the way back for Chipotle people are this throwing their money in there, and McDonald’s is just slow and steady.
Not necessarily bringing in that much money you might think well we should buy the Chipotle and not buy the McDonald’s if we’re going to buy a business. But if the Chipotle if you can buy the Chipotle business for $50,000 but you only have to spend like twenty-five hundred dollars to buy the McDonald’s.
Well, then you’re going to want to buy the McDonald’s because you’re essentially buying low the price of that. The mature Paula is only making four times more money than the McDonald’s is. But it’s being priced if you want to buy that company outright your pain. I don’t know I guess it doesn’t make the math nice neat there but you’re paying like twenty times more or something like that.
Even though the McDonald’s is making less, it’s more of value because of the way that whoever’s selling it is pricing it in the same token. It doesn’t need to necessarily be the relation like just because there’s 2,500 versus 50,000 means that we should go for McDonald’s. McDonald’s could be making you know add a couple of zeros to them the McDonald’s could be making twenty-five hundred dollars and be selling that twenty-five thousand dollar where the Chipotle is.
Only making a hundred but selling about five thousand I’m just again I’m just we’re moving a zero and adding a zero, but even in that case McDonald’s is still cheaper because you’re getting more profits and more earnings about how much you’re paying. When we talk about buy low sell high, that’s essentially what we’re talking about, and the easiest way to use a ratio like that would be the price to earnings ratio.
We’ve done a whole episode on that so you can check that out in the archives. But when you talk about buy low sell high at the end of the day it’s not just one ratio you’re not looking at just earnings and just what the market’s pricing for that. You’re going to look at all the different aspects you want to look at the whole financial statement you want to see the heat the complete picture of how a business is performing.
How much cash they’re keeping you know is are they liquid are they able to have enough to be able to survive a downturn or do they have strong assets are they growing those assets are those assets productive and in the in the earnings and profiting sense.
Do they have enough revenue these are all things that you want to try to start to think about and start to analyze and when you master that. Then you’re giving yourself a tool to be able to pick stocks and do that for the rest of your life.
You could start out and maybe stumble around a little bit learn a couple of concepts here and there your first year of investing and then maybe your second or third year you start to see similarities, and you start to really understand what the numbers mean by the time you got your 5 or your 10 you could be picking stocks in your sleep.
Then this is something that you can take with you for the rest of your life. I mean like we’ve said it’s not about buying one stock it’s about creating a habit and consistently investing money and putting that into the market through something like dollar cost averaging.
If you can start to understand number one the different ways that people try to buy low and sell high number two like what are the best people who have historically buy low and sell high and then create a lot of wealth from the stock market. How do they define buy low and sell high and then number three how can you define buy low and sell high.
So that you understand it so that you feel confident in it and so that you can apply it and get results and stick it through and incorporate that system with all the other systems we’ve talked about. We tried to do that in a big way, and obviously, I’ve had the luxury of having more time to be able to research all the different things.
But what it boils down to is finding a margin of safety and figuring out what the company’s intrinsic value is what that means and buying a stock that’s cheaper than what it’s worth exactly that is right on the market.
Dave: That’s exactly what we’re trying to do and as a value investor that’s our job number one and you know when we’re talking about buying stocks you have to think about the company in question in front of you, and you can’t get excited about the market and how he did it may be or how down trotted it maybe.
You have to take each piece of the pie individually and look at it for what it is come in comparing it to itself you can’t you can’t necessarily look at seven different companies in the same sector and go this one’s lower than this one comparatively. You have to look at it on its own merits and when Andrew and I talked about the different metrics and the financials that’s really what we’re talking about.
We’re talking about dissecting each company and looking at it as its entity and thinking about it as it functions by itself. Now the price is going to be determined by the market, but that doesn’t necessarily mean that that’s what it’s worth and we talked a lot about this the value of what you pay is not worth what necessarily the price is.
When we’re talking about a margin of safety ‘re looking at intrinsic value what we’re really trying to do is we’re trying to peel away all the hype and all the glamour and all the glitz and glam that may be going on about a particular company and trying to decide if that’s what it’s actually worth. And when you look at Chipotle which Andrew was talking about earlier you know is it worth of the price that it’s being marked at right now in the market.
That’s without diving into the financials I can’t just say surface I don’t know you have to dig into and look at it you know it’s expensive per share.
Yep, you know comparatively to other things that you may be interested in, but that’s what you can’t fall into that trap you can’t look at Johnson & Johnson and compare that to Apple because they’re not the same company. You have to look at Johnson &Johnson as its entity and decide whether you think that’s overvalued or undervalued and then decide if that’s what you want to buy into at that time.
You can’t get too wrapped up in all the things that are going on around you, and the margin of safety is so critical, and the emphasis is on the safety because we make mistakes we’re human we get excited about things we fall in love with companies, and it’s imperative to the saving of our capital.
Because we work hard for our money we all do, and we don’t want to lose it based on making a decision based because of greed, and we want to buy it just because we want to buy it because we like the name of it or we use the product all the time. Just because the product is something that we use all the time doesn’t necessarily mean it would be a great investment and I’ll use Amazon as an example of that. Andrew and I both are fans of using the product. I love Amazon I bought a ton of stuff for Christmas with it works great but would I use it as an investment probably not and that’s because when I look at the intrinsic value of it to me it’s overpriced it just is.
There are people out there it will disagree with me, and that’s their opinion, and they’re entitled to it. But as a value investor, I’m looking to try to buy something at a discount. Think about buying a car thinking about buying a house think about buying socks. Warren Buffett likes to say all the time that he likes to buy his stocks the same way he likes to buy socks at a discount.
And that’s how you make money in the stock market is by buying things they’re cheaper than they’re worth and watching that grow and then having that dividend added to that bonus of what we’re doing is just icing on the top of the cake and that’s where it comes down to.
And like Andrew was talking about earlier with the different gurus or people that we admire and look up to a large majority of them they may not have companies that pay dividends but they invest in a company is to pay dividends.
I mentioned it earlier again, and I’ll say it again the big three with Warren Buffett they all pay a dividend and he bought them because of that Coca-Cola, Walmart and American Express and Wells Fargo they all pay a dividend and a big reason why he’s as wealthy as he is because of that simple fact. Those are some things I’d like you to take away from this.
Andrew: yeah and I if you want to see this visually I did a whole thing on this with graphs, and I compared to like the difference between buying a stock when you don’t reinvest when you do reinvest when you do reinvest with dividends and all of this stuff we’re talking about.
Obviously, a lot to process and we understand that and it’s not something though you can’t realistically expect to just listen to one podcast up, so they’re even listening to a bunch of them and to be able to understand it completely. Keeping that in mind and wanting to help people transition through that we made we’re in the process and about to release a course called Investing for Beginners Masterclass, and we broke it down into 23 modules with everything we’re talking about.
We start off with why you want to invest how to set up an IRA what’s the in-depth stock stuff from other bonds talk about interest rates diversification all that stuff and then, of course, we get into the nitty-gritty with the metrics and talk about breaking down the financial statements show you formulas and examples in this all video format.
So it’s a great way to dive in, and I have that huge quick I have a huge module on dividend stocks and have those graphs that I just talked about, and it’s just really I think it’s a great tool.
And one of the reviews I read one of the early iTunes reviews and someone that said you know Andrew and Dave should really make a course for this, and it really brought a smile to my face and I’m happy to say that we’re just wrapping up producing this and we’re going to be releasing this very shortly and it’s something alluded to several weeks or months ago and that’s it’s exciting to be able to be on this and be able to share it with the world.
We’re hoping that it’s the solution that can help you get from okay now I understand why how do I how do I take that next step and how can I find the right dividend stocks how can I buy low and sell high how can I be confident with that. How can I analyze financial statements all that kind of stuff that’s what we made the Investing for Beginners Masterclass for.
Dave: exactly and a big reason why we did this is just to continue the teaching that we’re trying to do with the podcast. A big reason why we started this was to try to help people, and we saw a need out there to help people learn how to invest for themselves. Our schools don’t do it you know the government doesn’t do it, and money is left up to each to learn, and it’s such an important factor of our life, and if we need help people need help, and that’s a big reason why we wanted to do this is.
We want to help people and Andrew, and I spent a lot of time on our learning all this, and we want to help you guys learn and make this easier for you, and hopefully, you can help your kids to someday with this.
This could be something that you could use to show your kids how this is how daddy or mommy got to where we are, and this is what I want to show you and there just aren’t a lot of tools out there to help people that are beginners.
Andrew and I thought this would be a great way to kind of pass along.
Andrew: yeah so I mean if you’re all at all interested it’s going to be on the product page when it’s released at einvestingforbeginners.com/products if you’re also on the email list mailing list. I’m going to be sending out emails once it’s released and obviously talked about it like I like to talk about everything Investing for Beginners on the mailing list.
If you’re not on there, that’s stockmarketpdf.com you can get on there and get my daily emails.
All right well I think that’s going to wrap it up for us tonight. I hope you enjoyed our discussion on the buy low and sold high as well as dividends our favorite subject. So without any further ado, you guys go out there and find some great intrinsic value invest with a margin of safety. I hope you had a Happy New Year and welcome to 2018 you guys have a great week, and we’ll talk to you next week