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IFB112: Small Dogs of the Dow, not DRIPing, and Intrinsic Value Books

Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave:                                    00:36                     All right folks, we’ll welcome to the Investing for Beginners podcast. This is episode 112 tonight. Andrew and I are going to dissect it listener question that we got from Clinton. It’s fantastic. He has a lot of great points in there, and Andrew and I wanted to just kind of walk through each section of those and take some time to answer those questions, and so I’m going to go ahead and start reading.

Dave:                                    00:58                     So first, a dear Andrew, two weeks ago, I started doing some serious research on investing in the stock market. I have next to no investment slash finance background. I’m 33 years old and married, working in health care with my first child. On the way, I came across your podcast with Dave on Spotify, and ever since I’ve been listening to two episodes a day from the beginning. I have a 40 minute each way commute to work. I am very intrigued by value investing. So I decided to purchase your e-letter letter to follow along with your $150 a month portfolio. So the first question, I am going to spend $1,000 a month in my invest in, in my invest in my account for the next 20 months to have around 20 positions and my wife and I will put $200 a month into the IRA account. I purchased the stocks of number and number blanket blank does Zack is a premium picks from the leather.

Dave:                                    01:58                     Okay, perfect. We’ll blank that out. So I researched and thinking about investing in the small dogs of the Dow plan also at the end of the year while following your eletter advice, what is your opinion on the small dogs of the Dow Investment Strategy? Andrew, what are your thoughts, your thoughts on that?

Andrew:                              02:13                     Okay, first awesome. Um, part of that question, Clinton mentioned how he’s going to take the next 20 months to build a diversified portfolio slowly. And so for anybody who’s starting now, I think that’s something that should be honed in on and pointed out that that’s a huge, huge, a great first step. He mentioned not having a background in investment or finance and coming into this fresh. And so either through, you know, beginner’s luck or the fact that I guess we’re making a difference, right? And people are learning the right things to do when you start. That’s, that’s a huge win just right off the bat, to have that patience, that, that longterm goal in mind and not trying to win it all at once. So first off, great start. Secondly, the dogs, small dogs of the Dow Investment Strategy. It is a pretty common one.

Andrew:                              03:13                     And so let’s kind of break down each of those components. First off, you know, you have the Dao. So what is the Dow? If you’re an absolute beginner in the stock market, you don’t know what the Dow is. That’s generally when you turn on the news, and you see they’re either talking about, um, the s and p 500 or the Dow. And so when somebody says, Oh man, the market was up three points, or the market was down a percentage point, sometimes they could be talking about the Dow. Sometimes they could be talking about the s and p 500. Um, the Dow Jones historically has been the index of choice. And the s and p 500 is relatively newer. Um, not like in the past several years or anything, but we’re talking about decades. And so the Dow is, it’s an older thin, and it’s, I think if you’re more sophisticated investors, somebody who’s learned a little bit more about investing. You understand that the dow is more like, Oh, to use a baseball analogy, it’s like, um, the, the hitters who didn’t use to bat flip.

Andrew:                              04:21                     It’s one of those traditions that is dumb. I don’t know what your opinion is on that, but, you know, it’s, it’s a, it’s like one of those old, old school things that, um, there are better ways to do it now. And so to give you context on how the Dow is constructed, um, basically it’s, it’s like the editors of the Wall Street Journal, they get together, and they comprise this list and this 30 stocks. And so they’ll add some stocks. They’ll; they’ll get rid of some stocks. When you think about that, it’s like, um, okay; these random guys are all going to decide which are the best stocks to their defense. They try to, um, they try to get a complete picture of the economy. So, they will try to make the Dow represent the different industries and, and, and try to include all the major ones.

Andrew:                              05:17                     And so the idea is to get an index that kind of tracks the economy and Kinda can give us a sense if the economy is doing good or bad based on how stock prices are going. Um, so, you know, that’s, that’s a good thing. It’s been around a long time, and it’s just kind of like old tradition. I guess that’s the best way to describe it. Um, problems with the data for one, the, so the way that these indexes are calculated, it can be different. Um, the s and p 500 is calculated through market capitalization. And so basically what that means is depending on how big stock is, it’s going to move the index more or less. So as an extreme example, a company like Apple, if they were to move 5% in one day, that’s going to move the s and p 500 a lot more than one of the very small stocks in the index.

Andrew:                              06:14                     Now the Dow is calculated through price. And so what that means is a stock with the share price being higher is going to affect the index more than a stock with the low share price. And so a couple of problems with that is stocks that have high share prices don’t get included in the Dow because they would skew the Dow. So much. So good examples of that right now as we recorded in 2019 are the Google shares. Those are not in the Dow because they are so high. And then also the Berkshire, um, what does it a or B shares, the one that’s like, and thousand is a-okay a and whatever ridiculous share price that is a 10,000 hundred thousand, whatever it is. So those are not included. And so what’s interesting about that is you have, you still have this wide range of stocks.

Andrew:                              07:12                     And this to me it’s like completely random as far as these random stocks can move the dial a lot. So I’ll give you an example. I took a list of the Dow, the 30 stocks right now in the Dow index recording this again 2019. I see the top five based on price, Boeing, United health, Home Depot, Goldman Sachs and McDonald’s. And then if you go on the lower side, you have, you know, to go down and move up. You have Pfizer at around for the, to Intel 49 and then Dow and incorporate the Coca-Cola and Walgreens. And so, I don’t know, I can’t remember if I mentioned, but like the Boeing United Health and home depot and that top bracket, those are like in the two, the 300 range. So it’s like if Boeing were to lose a lot in their share price tomorrow, that’s going to move the Dow a lot more than if, what was the other stock I said, like Pfizer.

Andrew:                              08:15                     So that’s, that’s weird. Right? And that, there’s no, there’s no logical sense behind that, but that’s just kind of the way it is. All right, so, so that’s the Dow, moving forward. Now there are the dogs of the Dow strategy, and this is something that, I don’t know how it was popularized. There might have been a book written about it that became a bestseller, or maybe it was an idea in the bestselling book. , but the idea of it is kind of like trying to buy low and sell high. And so if you’ve been following the market for some length of time, then you know that as a share price goes down the stock, their dividend yield will tend to go up. And so that’s simply because it’s, it’s, it’s math basically as, as a, as a share price goes lower, as long as the dividends not changing, then that yield is, is going to get higher and higher.

Andrew:                              09:12                     And so that can be a good strategy when you buy like we always like to say you’re buying with a margin of safety. You’re buying stocks that are temporarily undervalued in the market and, and temporarily hated for one reason or the other. But if it’s a good business, then you can be confident that this is probably temporary and that the business, the stock price will eventually recover. And as a bonus, you’re going to get a higher yield than if you were the bar stock that’s doing well. And so, you know, there can be a lot of compounding from that. So the idea of the dogs of the Dow is to take the ten highest yielding Dow stocks and then, um, invest in those. And I’m not 100% sure on how, you know, there might be different, sectors of the religion of the dogs, of the Dow.

Andrew:                              10:02                     There might be different ideas on, on when you sell kind of a thing that’s at least the accepted practice for the buying of an on this strategy. And so what the small dogs or the Dao are, is you’re taking the ten dogs of the Dow, and you’re buying the five smallest of that. And so that goes back to what we were talking about with the share price. So, the small dogs of the Dow, the five lowest in share price, those are going to be those. So I don’t know, in my mind that sounds like a completely random thing. If it had, you know, if, if it’s, if it’s a type of strategy that people are actively using this, probably seen some success in the past. The thing I would say about any, I think this, this, this kind of goes to any strategy and something that you need to consider, whether you’re a beginner, whether you’ve been in the market for a while and even as you make your strategy and it’s something you followed. You need to constantly be evaluating that and trying not to fall into the sort of, the bias or a sort of incomplete data or like this false sense of confidence.

Andrew:                              11:17                     So I think with any strategy, you can find periods where it’s done better than the market for one reason or the other. It can be completely random. It can be simply from the fact that value, I mean even value and growth, those cycle, just like the market cycles between the bear and a bull market. Um, sometimes growth stocks will do better, and sometimes value stocks will do better than gross stocks depending on the year. And Toby, talked about that a week ago, a week or two ago and did a good of talking about how value stocks have been underperforming gross stocks for a quite a while as far as recent history you guys. So just because there’s been some study on some period that you know, the small dogs of the Dow worked for some time or even the dogs of the Dow work for some time.

Andrew:                              12:13                     That alone should not be the con, the confirmation that yes, this is a strategy I’m going to pursue. Now obviously this is just my opinion, but I think it makes a lot of sense. What you want to do when you’re considering the performance of a strategy is you want to look not just at one period, but multiple periods. There are different metrics you can use, like rolling averages are great ways to evaluate that. But you, I guess the biggest thing is you want to look over the very, very long term and make sure that this is something that outperforms because it’s based on, on like a common-sense principle and not because it’s based on some luck or randomness. And then at the same time, to me, it’s important that it makes a lot of sense. So something like value investing, that makes a lot of sense to me, especially when you talk about value investing in good businesses. Because I completely understand that Mr. Market Metaphor speaks to me on a personal level. Like it just as soon as I heard that it just made so much sense. And, and you know, we’ve talked about Mr. Mark, I recommend going back in the archives for, for our in-depth discussion on that. I think it was, episode 20, or let me see; I have a list in front of me because I am a great cohost. Yeah, episode 20, that when we talk about chapter eight, Mr. Market, this is an idea.

Andrew:                              13:42                     I like how you caught that. This is a, you know, it’s not just my idea about Mr market. This is something from Benjamin Graham. He’s the father of value investing. He was Warren Buffett’s mentor, Somebody who had a library of ideas and a lot of great observations about the market. But the stock market’s a very irrational place at times. It can get very emotional. People are involved; there are so many moving parts. And so every once in awhile stock will be either undervalued or overvalued. It would be, there would be a lot of hate or irrational fear towards it. Or there’ll be just like clouds and rainbows that maybe necessarily shouldn’t be there and people turn a blind eye to what’s going on in the business. So that happens a lot. And so when you buy companies that are temporarily hated, then it makes sense that those prices should eventually revert.

Andrew:                              14:37                     And then when you compare that and not compare, but when you combine that with the idea that good businesses will continue the compound capital, they’re going to continue to make profits, they’re going to continue to reinvest those profits to grow and make more. And more and more profits and then we’ll kind of balloon up while then. That makes a lot of sense too. And now in my mind, you’re injecting a, a business kind of long-term mindset with value. You’re injecting it with this like gross serum where instead of starting from maybe even and just tracking the market the way a lot of people like to do with an index. Now you’re maybe taking advantage of some of them, the emotions of Mr market and then that because now you’re getting that great margin of safety than the compoundings only going to multiply as time goes on.

Andrew:                              15:31                     And as that business continues to thrive. So that’s the main idea of why I am a value investor, and then it makes sense to me logically. And it’s something simple. Hopefully my simple explanation I just gave you in this past 60 seconds or 60 minutes, however long it’s felt for you. Hopefully, that’s been simple enough where you’re like, wow, that makes a lot of sense. And so that’s why I invest as I do in addition to all the other studies. And I can pull a ton of them out of my cheekbone that kind of talk about by investing and why it works. So going back to the small dogs of the Dow, if we evaluate it on that mindset, we’ve already given the background in the context of how the Dow is calculated. And so since we know it’s a price thing, and it’s these random, there is on, on the Wall Street Journal, no offense to them.

Andrew:                              16:23                     I’m sure they’re great people. Um, then we know that, okay, this strategy first relies on the editors of the Wall Street Journal. I don’t know them, so I don’t know how they chose to pick these stocks. I don’t know of any books they’ve written. Right. So like the value investing people that, that has made this philosophy, they’ve written a lot of books, and so you can learn about where the mindset of how they pick these stocks comes from with the, with the Dow Jones. You don’t get that. And then with the dogs of the Dow, to me it just sounds, yeah, I like the idea of buying stocks that have higher yields. I think in principle that’s, that’s a great idea. And then you’re trying to get that buy low. But again, as the stock could be, beaten down because yeah, it’s temporarily hated or maybe it’s hated for a good reason and that stock may be eventually leaving the Dow because it does so poorly. So that part kind of makes sense, but then does it. And then you have this third aspect, which is the small dog, just because the price is lower, we’re going to buy those instead. And it’s like, okay, maybe that makes sense because those aren’t going to affect the Dow as much. Right. Because the dow moves based on price. That’s the only reason that I can think behind why they add that extra component to the dogs of the Dow. But in my mind, again, it’s such a, it’s just, it’s, it’s such an abstract thought that doesn’t make any sense from a business perspective. And so that’s why I don’t think it’s a valid strategy. Maybe I shouldn’t say it’s not, I don’t think it’s a valid strategy, but I think it’s not, it’s suboptimal in my mind because it has some of those obvious flaws

Dave:                                    18:12                     I would agree with that. And to kind of throw out, you know, to illustrate it a little bit, what Andrew was talking about, the five bottom companies, if you’re looking at this, would be Coca-Cola, the JP Morgan Chase, proctor and gamble, Cisco Systems and Merkin Company. So they all pay pretty good dividends, which is great. But I know right off the bat the Coca Cola is overvalued and JP Morgan is bordering on overvalued proctor and gamble. I know nothing about Cisco and nothing and Birkin Company, nothing. But I think to kind of tag off of what Andrew was saying; it’s just kind of beat into the strategy about a little bit is that if you’re basing it just based on taking the top companies and then taking the bottom of that or taking the bottom companies. And just basing it on that you’re, you’re ignoring all the principles of value investing.

Dave:                                    19:08                     You’re not looking for bargains. You’re not looking for something that is being sold at a discount to its intrinsic value. You’re not looking for a margin of safety, and you’re just basing it on what somebody else has determined is the top or the bottom of the Dow. And that is could, could be dangerous. , if you’re throwing a lot of money into something like Coca-Cola, which is a great company and it pays a nice dividend, but it’s overpriced and so realistically is a, can you expect it to continue to go up? No, you really can’t. And throw, you know, take take a look at the other companies. It might fall into the same category. And so you’re, you’re just setting yourself up for your, you’re putting your money where your opinion doesn’t really matter and based again on just what somebody else is deciding for you.

Dave:                                    20:04                     It’s Kinda like those articles that you see all the time on the Internet when you’re trying to learn how to invest. You know, here are the ten best dividends paying stocks for 2018 or here are five stocks that you should invest in for your kids for life. You know, those kinds of things because those are very short snippets about a company that gets tried to get you all excited about possibly investing in that company when you don’t know anything about it. And that’s always a dangerous place to be. And I guess any circumstance like that as is something that I always try to avoid. , just for the sheer fact of what I, everything that Andrew just illustrated about Mr. Market, a company being beaten down, the reason it’s being beaten down, it could be very valid. And there’s just so many unknowns about diving into something like that without actually knowing what you’re investing in. And that’s what Andrew and I have tried to preach about over the last 112 episodes is talking about investing with a margin of safety, emphasis on the safety. And when you ignore that, you ignore Warren Buffet’s prime directive number one, don’t lose money. Don’t forget rule number one, don’t lose money. So that’s, you put all that at danger when you follow these kinds of ideas.

Andrew:                              21:23                     Yeah, that’s, I didn’t even think of that. That’s, that’s brilliant too. You’re completely given control. Lay about anything about you becoming a better investor or making some decision. It’s like, well I’m just going to follow this until it sinks. Yup. So let’s move on to the next part of his question. Um, okay. He’s got a lot of good um, questions within this email he sent us. So he asks, I’m wondering, and this, this, this could be a fun discussion, but I’m wondering if it is more lucrative to sell a stock if the price rises significantly and will outpace dividend payments for a lengthy period of time and then reinvest it when the stock either falls, depending on timing. And the cyclical nature of the market and, or to reinvest them according to whether I’m choosing that month or should I hold onto the stock for the dividends no matter if it rises?

Dave:                                    22:19                     I think, um, so I guess I, my thought is right until you can’t write it anymore. Um, you know, when I’m looking for a company to invest in, I’m looking at something that I want to own forever, or at least as long as I can. And so I’m looking at trying to generate income from two places. One, the increase in the price versus what I paid as well as the dividend payouts over a long period. And we’ve talked before about that and the power of compounding and how great an ally it is for you. And the longer that you own the company and the more that you reinvest those dividends, the more stock you own of that particular company. And just on and on it goes. And when you sell out of the company, all of a sudden that all stops. And it depends on your comfort level. But if I had, if I bought a company that I believed in and I thought that the company still was doing a good job 15 or 20 years from now. And I guess why would I not continue to invest in the company if the whole thesis of why I bought the company, to begin with, is still valid five, 10, 15, 20 years down the road. Then I’m staying with a company, regardless of how much the stock is, you know, let’s say I bought it at 20 bucks, then all of a sudden it’s at 175. Well, I’m going to keep it. And I guess the other thing to kind of throw out there too is whenever you do sell it, you’re going to have to deal with Mr. Tax man. So those are all things you have to think about versus just the profits that you’re going to make from the company. What other impact is it going to have on my tax liability and or any investment philosophy that I have as well as, you know, the cutting off of that gift horse in the mouth? So to speak. So I guess for me I guess I would stick with the stock and continue to ride that baby as long as I can.

New Speaker:                   24:40                     Ah, yeah, I 100% agree. So those are great points and me, I do understand the argument against that. So first you can’t avoid the whole tax issue, so that could be a deciding factor on its own. But let’s take the hypothetical that this is in like a Roth for example, where you’re in this tax advantage account and so you can sell, and you’re not going to get tax because it’s a rough, even if that was the case, you have to consider that some stocks just won’t ever fall. So I guess first let’s, let’s, let’s think about, but in, let’s be fair with the discussion. The idea is you’re going to; you’re going to take advantage of the fact that maybe a stock is overvalued now. And so, you know, just as we talked about how the market can be irrational on the pessimistic side, it can also be irrational on the optimistic side. And so a lot of value investing strategies and good value investors, they will try the capture that.

Andrew:                              25:46                     And so not only are they going to capture on the buy side, they can capture on the, on the, on the sell-side too. And I, I think that that could be a fantastic strategy for you if it fits with your personality, your philosophy, and the way that you are buying and selling stocks. So it makes sense from, from the viewpoint that we are going to take advantage of something that’s overvalued. And then we still liked the company. We still like the fact that there are, you know, good dividends and we like everything about the company. We don’t like how the market is giving us this free cash. So we’re just going to take it, and then you’re, you’re going to go back in when once the market inevitably kind of goes turns the other way towards it. And I get that. And so you’re kind of like trying to maximize the compounding from it.

Andrew:                              26:33                     The problem with that is one you, you risk a, I just mentioned this, you risk the possibility of a stock that actually will never fall, and there have been plenty stocks too to kind of show that that’s happened. And I’m willing to bet, maybe I shouldn’t say I’m willing to bet, but I speculate that there’s that the missed reward from even just one stock that you sold it. Because it’s overvalued and they continue to get overvalued until you know, let’s say you missed out on all of those potential gains because you’re waiting for it to fall. But then let’s say you have like five other stocks where you, you sold, and then the stock fell, so then you bought it, and so you captured a profit doing that. Like you, you optimize your return in away. I’m willing to bet that that one’s huge winner would be, would more than offset all of the small wins that you picked up by, by selling and then waiting for a stock to fall.

Andrew:                              27:37                     Like that opportunity lost that, that money that you could have made that you did it with more than outpaced the extra kind of percentage points you’re taking by, by, um, by doing what we’re discussing here. Like, imagine if you just happened to pick like Walmart for example. Walmart is a great example of a, of a stock where even back in the late eighties and early nineties, it was for a time a good, you know, I had a great dividend, and I think there were periods in there where the value metrics were decent. And it would’ve been one of those stocks where if you had sold it when it was overvalued, you would’ve seen it keep rising. And that with a lot of hurts bad. One great quote that I’ve heard over and over again is the market can stay irrational longer than you can stay solvent.

Andrew:                              28:33                     So that’s kind of a quote to talk about short selling, but it can also apply to stocks that you own. And an overvalued stock can be overvalued for years and years and years. And so you’re just kind of never know. Well, when’s the exact overvaluation point that I want to sell and maximizes profit? It’s just really hard to say. So that’s, I guess the first part that’s tough about it. These, I guess second major component to this I wanted to discuss too is, so I get the idea that you don’t want to reinvest dividends into an overvalued stock. Like that makes sense. , and, and we’re going to touch briefly on this in the next section, but that’s another beast on its own. So the problem I have is, I don’t see, kind of, to Dave’s point earlier, I don’t like the idea of punishing the company because it’s doing well.

Andrew:                              29:31                     You know, it’s like you’re buying part ownership in the business and you’re going to get rid of the business because it’s creating so many profits that that’s driving the stock price higher. That doesn’t fundamentally make sense when you step back. And I’m not trying to say that I don’t make a mistake like I, I do kind of sell-out a position sometimes, which probably isn’t the best idea. But I think on a broader standpoint and trying to have a mindset in place; I think actively trying to optimize for these returns to can shoot yourself in the foot aggressively. So when, when I go bring it back to this idea, well I’m going to punish the stock for doing so well there. It’s just like the case studies that I’ve seen one stocks that all you had to do was buy it and then let the company compound and let it grow over time. There’s, there’s one that comes to mind that I like to use, but even like a lot of the investor relation websites, so like stocks that have done well historically. Coca-Cola is a great example of Procter, and Gamble’s are a great example. Many of the stocks in the Dow are great examples of, of stocks that are, that have gotten so successful, because of what they’ve done over the past 25 30 years, which ironically might make them not as great investments now because all those gains have been realized.

Andrew:                              31:32                     But if you go on one of those investor relation websites, and you click in there, and a lot of them will have this calculator, it says, if I had invested $1,000 into Coca-Cola’s stock back in. And then you can pick the year in 1990 1988 and 1987, and you can say, if I invested $1,000, if I invested $10,000 and then you just hit that button, then it calculates exactly how much those returns would have been. That gives you it the huge picture on why I get so excited about dividends and dividend reinvestment. You start to see that, wow, we’re talking about multiples, you know, factors, factors of five, six, seven, eight, nine, 10 or higher a of this money just absolutely exploding. And so that happens even with what would, what you would call suboptimal re-investment. Like, yeah, I get, I get the idea that man, um, um, I have however much money in these dividends, and I’m going to put them another stock that’s so much cheaper.

Andrew:                              32:41                     It has such a great, such, such as so much better margin of safety, the dividend yields higher on and on and on and on. But the reality of it is, is when you think about the business world, there’s no way for us to predict which business will take off. And so really by why, by having a great investment and trying to over-optimize it or trying to redirect the dividends may be, you run into the risk of killing your best money cow. And so I, want to encourage going on, on a tool like that and just seeing for yourself how big the numbers can be. I mean, there’s no guarantee that anyone of your investments will be that way. And I’m not trying to say that all of your investments will be that way, but if you think from that standpoint, then it doesn’t justify taking $1,000 and putting it into a super overvalued stock.

Andrew:                              33:41                   I’m not saying that at all. What I’m saying is that, um, as these dividends increase, you can be confident with your dividends, reinvesting in an overpriced stock because you know that like the vast majority of your capital was invested with a margin of safety. And so like you’re getting that, that part of it set up. But I think that trying to, you know, do things like selling when the price is too high and selling to reinvest. Like I would sell an on the stock that is overvalued if I did not feel great about the future of the business anymore. And that doesn’t even need to be like, okay; I’m, you know, the business-like, like, um, this is something I have on the spreadsheet to remind myself all the time. Like before you think about selling to, to over-optimize some gains like consider that if a stock, if you’re selling just because a stock is overvalued, that’s not a good reason to sell.

Andrew:                              34:42                   I would also want to sell because If there’s something there. There’s, there’s a huge fundamental reason that I don’t feel great about the longterm part of this business, whether that’s qualitative or quantitative, whatever that is. And I feel like that needs to be a second factor on top of selling on an overvaluation. And so if that were the case, then you wouldn’t, you would not buy into that stock when it fell because it’s not something you want to hold long term. And so that’s something that I would keep in mind. And I guess I’m getting a little bit of a tangent, but, really, if I can hammer in one point, it’s trying to look at somehow some of these huge a winners have been in the stock market and just how powerful those dividends have been. And it just feels so minuscule, right?

Andrew:                              35:32                     Just little dividends, 1%, even a one, and a half percent, but over time as, as your pile of shares and your ownership grows, um, those little dividends add up to a lot, especially when you talk about 10 to 20 years. And then if you factor in the fact that a company like Walmart goes from, I don’t know, 10 to 20 stores to like 400 stores across the country and now their profits are so much higher, and their dividends are so much higher than when you initially bought it. And you’ve just been silently collecting those dividends and, and watching your piles of shares grow over time, that’s going to make huge, huge impacts to your, to your total performance. And they could be one; they could, you could need one stock. So to be that like if I think of buff, I think coca-cola and then like Geico because I think that was something he bought when it was public and now they own the whole thing. But he could, he would probably say like Coca Cola, and maybe there’s one other company that I’m not aware of, but there, there can be these, this single company that drives the vast majority of your returns. And so by trying to optimize over, I think you’re really just nipping yourself in the bud, and that that huge pile of money, you’re just, you’re cutting it at the branches and not letting it grow into its full potential, and that could hurt in the longterm.

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Dave:                                    37:13                     Excellent. That was, those are great points. All right, let’s move on to the next one. This is for the drip king. So I heard Ben Reynolds on your podcast mentioned that sometimes he likes to adore drips on his accounts and reinvest them personally due to the possibility of his stocks being overpriced. I plan on doing this with my taxable investment account because the dividends will be taxed either way, but we’ll weave all of the IRA stocks with drip active because of them being nontaxable. Do you have any opinion on this matter? I’m sure he does.

Andrew:                              37:43                     Let’s, let’s, well I just talked about most of that and in this previous section, right? This whole idea of don’t nip it in the bud and let it grow. So that’s one problem with it. The second problem I see is, um, this would be good if you have a ton of money, right? Um, I guess it doesn’t need to be a ton of money, but enough money where you’re getting enough in dividends to be able to buy full shares with it. So I’m not going to do the math at the moment, but you know, maybe you’re getting like these quarterly dividends of like at least a hundred dollars. So I don’t know how much you’d have to invest in doing that. And so when you’re talking about people with, um, you know, I try to encourage people, even if you don’t have a lot of money to invest. And so that’s not even going to apply to people in that, but if you are in that situation, it can work yet I worry about that whole thing that I just puked about. And so that’s why, that’s why, yeah, I get it. It makes sense. It’s a very value investing type approach, but I’m not a hundred percent value mister, you know, I, I’m a huge dividend investor as well, so that’s why I guess you call me the drip king. It is why you got it. All right.

Andrew:                              39:07                     Okay. So moving on to the last part of the question. I have read your ebook, and I’ve just started reading what works on Wall Street. I have ambitions to read Peter Lynch’s one up on Wall Street and Beating the street as well as the intelligent investor by Graham and a random walk down Wall Street by [inaudible]. Also, do you know of any literature that would explain to me how to better determine the intrinsic value or how to value a company? I’m only googling it at the moment and getting mixed results by Andrew. What are your thoughts?

Andrew:                              39:38                     How about we rapid? Well, how about we go back and forth like a tennis match and give one book, and then you give the book. I’ll give him a book. Okay. Since it is around the time of Wimbolden, right. When they call Wimbledon, I’m so cultured then. Okay. The first one that pops into my mind. You laughed a little too hard there, buddy. All right. The first one that pops in my mind, um, the Warren Buffet Way by Robert Hagstrom I think is a great way to get insight on how Warren Buffett looks at the intrinsic value of a company. So Buffet has never said publicly how he exactly calculates the intrinsic value. He’s, he has said, it’s not like some algorithm, but he has given kind of hints and little droppings of kind of what type of equations he tends to favor. And so there’s like a, a DCF type of, um, Caucasian. He uses, uses the owner’s earnings and good timing.

Andrew:                              40:48                     Somebody I know just recently wrote a post about both of those things. Um, so that would be a good read, Dave. , yeah. Yeah. Um, and it’s just a great book. And he talks about some of the; I talk about how Buffet makes his discount rate, like what discount rate he uses for his DCF. Um, so it’s, it’s a general thing, but it’s, I think it’s good, it’s not, I don’t think anyone of these books we’re going to mention is going to be your way to determine intrinsic value. I think that’s something you should figure out for yourself. But I think that’s one of the tools that would be valuable to you and a good book to read. And it’s an easy book to read. It talks about a lot of the different stocks up of a has had success with. And I enjoy that.

Dave:                                    41:34                     Yeah, it’s a great book. , I guess my, my choice on this round would be, any of Buffet’s shareholder letters to the, um, or wetters to the shareholders. , you can start back with is, early ones in the 60s and work here up to current, present day. Ah, those are fantastic resources. He talks a lot about all his different viewpoints on investing and yeah as Andrew said, he doesn’t ever specifically say this is how you find the intrinsic value of a company. But he certainly hints at a lot of different ways of doing it. And he talks a lot about the margin of safety. He talks a lot about, just general investing principles and he’s it, they’re also easy to read. He’s got a great sense of humor, and he’s good at just explaining things in a way that we mere peasants can, can understand. And I am a strong believer in reading as much as you can about him, and what his viewpoints are because he’s, he’s a great teacher as well. So that would be, I guess my choice on that.

Andrew:                              42:45                   Yeah. All right. My turn, I like, um, I don’t know why I’m having trouble thinking of the exact name. Oh, the little book of sideways markets written by a Vitaly. , the little book series is awesome. There’s just a ton of great authors who’ve written different, really short little books. They’re super easy to read and consume. Um, all about different kinds of slivers of investing. I like, there’s one chapter in that book we had Vitaly on. So if you want to, um, go back in the archives, you can listen to our interview vitality’s super-intelligent as a fun conversation. He has a little chapter in there where it’s also keeping to that DCF, which is discounted cashflow — keeping to that theme. He has a chapter where he does like a super simple explanation, like a, say a farmer has a cow, and this is how he determines what the value of it is, the intrinsic value of it. And there’s a little aspect of Mr. Market in there. And for me, that was very helpful and learning DCF. I, I don’t use a DCF personally when it comes to intrinsic value. I know a lot of people do. Dave, I think you do a little bit, but I’m a super valuable to learn and another great tool to help you look at values of companies.

Dave:                                    44:09                     Yeah, that’s a that’s a fantastic book, and yeah, he’s a brilliant guy. , anything you can read by him is going to be well worth your time. , the book that I like and I think it would be a great recommendation for you would be the Dando investor by Monet’s provide. , he talks a lot about value investing margin and safety. , his, his big phrases head’s a win tail. I don’t lose that much. And he also talks a lot about intrinsic value, and he gives some examples in there and how he calculates it. And he again uses a modification of a discounted cash flow, but he also talks about ranges of values he’s looking for. A, one of the things that I’ll throw at you about intrinsic value is people sometimes get thick sated on finding the perfect price. And buffet talks about this a little bit as does Monish.

Dave:                                    45:03                     No one does pretty much anybody that has experience with working with this, you can’t ever find the exact perfect price. It’s more about finding a range of prices that you think are logical and possible with the company. Because after all, when we’re investing in a company or buying shares of that company, but we’re also dealing with Mr market and all the crazy people out there that are buying and selling the company based on their emotions and their whims as opposed to cold, hard facts. And so when you’re dealing with that, you’re never going to get the exact number of, hey, this stock is worth $72 and 51 cents. It doesn’t work that way. And that’s why we always try to invest with a margin of safety. The emphasis on the safety, because when we’re doing any math or any calculations, any intrinsic value that you calculate is always going to have guesstimates in there.

Dave:                                    46:00                     There’s never going to be precise. I know exactly how much growth this company’s going to have because none of us can see into the future. You know, I am never going to be able to determine exactly how much dividend yield this company is going to give off the next year because we don’t know. And so when you calculate these formulas that you’re going to learn from reading these books and these papers that we’re talking about, you’re going to look for estimates, and you’re going to have to learn too. You’ll learn as you do more and more of them. Just like anything else that you’ll learn that, hey, I came up with this price based on this growth number or this valuation came based on, you know, this dividend yield. And if those are wrong and you don’t have a margin of safety in there, it could burn you.

Dave:                                    46:48                     But when you’re looking for, um, a company to buy and you have that margin of safety, it’s going to help you give you comfort that, hey, if I’m off a little bit, it’s not that big of a deal. And even if you are off $2, it’s not that big of a deal. And people sometimes get also focused on; it has to be exact. It doesn’t have to be exact. As long as you’ve made good judgments and good assessments based on the principles that you believe in and understand, then you’re always going to be in a ballpark. And then you can decide from there, whether they want to investigate the company more or whether it’s something you’re like, no, that’s way overpriced. I’m not going to buy that right now. You, you don’t know. So, but these all things that you’ll learn with experience for sure.

Andrew:                              47:30                     That was perfect because while like the first two books we mentioned, first two or three, they give you like a, to your point, like a more definite but intrinsic value and needs to be a range and you have to be careful with that. So those are, that’s a good book to pair with one. One of the other ones we said, I, um, would say like, the Clinton talked about how he’s going to read, I’m going to point out beating the street by Peter Lynch and the intelligent investor by Benjamin Graham. Those both also have, I guess not like specific intrinsic value. But for me, that was helpful as somebody being like absolutely green to give some context on like a stock market metrics. So Peter Lynch, in particular, he talks about how he uses a low price to earnings PE ratio.

Andrew:                              48:35                     A the intelligent investor is where Ben Graham Kinda introduced a low price to book ratio in combination with a price-earnings, PE ratio. So for me starting, and I don’t know how’s how the case is for other people, but I can only imagine that maybe some of those books that we mentioned would be like a fire hose. Whereas particularly being the street and Peter Lynch from Peter Lynch and intelligent investor by Benjamin Graham, those were the ones that I started with. And those were like so perfect for me. They walk me through, um, and give me just enough without overwhelming me. So the fact that you’re going to read those I think is great, and I would very, very much so highlight those. , and I can’t pitch my book. I have the way I buy stocks, I don’t value a stock, to its an exact dollar amount, but I do have my formula for telling myself if a stock is overvalued or fairly valued or undervalued.

Andrew:                              49:40                     So that’s called sharp value indicator. And um, I’m sure you heard me talk about that multiple times too. But yeah, that’s, that’s, that’s the path I would hopefully push you towards. And then picking either of the books that Dave and I mentioned, it would be good to once, once you have a good grasp on some of the basics with the stock market.

Dave:                                    50:03, Yep. I would agree with that. Andrew’s book is a fantastic resource to help you understand kind of where he’s coming from and taking all the things that he’s absorbed and really kind of, um, adapting them into a great idea. And a great philosophy of how you can look at stocks and value them based on the different metrics that are available to all of, and it’s a great resource. I learned a ton for reading it as well. Another book that I would want to throw out there. It’s not necessarily a book, but more, I guess his old collected works would be anything from Professor Damodaran. He is a teacher at

[inaudible]

. He was a teacher at Columbia School for business and, I’m sorry, I know New York Stern, my bad, New York stern and he was, he is considered probably the foremost teacher on intrinsic value and value in companies. He has a fantastic blog that he writes on a pretty regular basis. He has a zillion different youtube videos on just about any sort of idea you might have about how do I invest in, how do I learn how to start calculating intrinsic value. I learned a ton from him, and I’m the kind of person that likes to look at a formula and reverse engineer it.

Dave:                                    51:29                     And by that I mean I see how it’s calculated, and then I start going back and picking up our apart the different parts and go, where did this come from? Where did this come from? Where did this come from? And that’s how I learned. And not everybody’s like that. You know, some people are way better at math than I am and they could sit down and go, oh yeah, that all makes sense. And you know, as somebody that is self-taught, I had to teach myself where some of these numbers were coming from, and that’s what I like about his stuff. As he explains all that and it, he goes in very, very much in-depth. He can be very technical, and if that’s something that’s up to your alley, man, you’ll hit a home run with him. , if it’s not that tactical is not your thing, then you can always, you know, look at some of the stuff that I’ve done.

Dave:                                    52:14                     I’ve, I’ve written a lot about intrinsic value, with the Ben Graham formula as well as just kind of cash flows as well as dividend discount models and using those different ways of trying to find the intrinsic value of companies. Hopefully, I’ve been able to dumb it down enough so that people that are newer and understand how to do some of these things, the math in and of themselves is not hard. It’s just adding, subtracting a little multiplication and division. The bigger challenge usually is trying to find where the numbers are, trying to fight, figure out what estimates do I use. And that’s one of the things that I try hard when I’m writing is to try to show you where those things come from so that you can kind of do your reverse engineering and figure this out for yourself. So I think, you know, all of those things would be things that I would recommend that would be hopefully helpful to you.

Andrew:                              53:06                     And I agree with all of that. Um, I’ve listened to them, and Damodaran, a couple of his lectures that he posts completely for free, on youtube and those have been fantastic, and he’s like probably the most popular professor on Youtube, like strictly his, literally his lecture, and the stern course is online. It was just a ton of views and then a, yeah, your, your stuff’s great too. Um, you’ve done several articles on my blog, and you also have your blog, that intrinsic value, intrinsic value formula.com which is a great resource too.

New Speaker:                   53:41                     All right folks, we’ll, that is going to wrap up our discussion for today. I want to thank Clinton for sending in this fantastic question. A, you had some great at different points for us to kind of talk about and dissect and I hope that he got a lot of good info out of that and as well as all of our other listeners and if you guys have any other great questions for us, any questions at all, please let us know. We’re here to help, so without any further ado, I’m going to go ahead and sign us off. You guys go out there and invest with the margin of safety, emphasis on safety. Have a great week, and we’ll talk to y’all later.

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