IFB169: Stock Splits, Ex-Dividend Drops, and Intrinsic Value

Announcer (00:02):

I love this podcast because it crushes your dreams of getting rich quick. They actually got me into reading stats for anything you’re tuned in to the Investing for Beginners podcast led by Andrew Sather and Dave Ahern. To share Step-by-step premium investing guidance for beginners. Your path to financial freedom starts now.

Dave (00:33):

All right, Folks. Welcome to Investing for Beginners podcast. Tonight is episode 169, and Andrew and I are going to answer some listener questions. We got four great ones that we’re going to answer for you guys. So we’ll go ahead and start. So I have the first question here. Andrew, do you have a pod episode that talks about stock splits, or have you guys talked about the upcoming Apple and Tesla splits on recent pods? I may have missed it. Thanks, Joe. Andrew, what are your thoughts on that?

Andrew (01:03):

So we haven’t talked about the splits; by the time this goes live, the splits will have already happened for Apple and Tesla. It’s I, that’s a good time to talk about them, basically what a stock split is when. So if you go back to the basics of why the stock is and what the stock market’s like and what that represents with businesses, you could literally go back to the basics with our series.

Andrew (01:29):

We did on episode four, the two I believe. And we did four episodes, all covering that very, very in-depth. So I highly recommend that for beginners who are just tuning in, but essentially ownership of a business is split into all of these different shares. And so, you know, you have a certain number of shares, and then you have the price per share and that price per share, what you’re going to see on CNBC or Yahoo finance. And, you know, in the case of, you know, let’s say Apple today, they’re at 120 something to share something, something like that, right? So you have that number. You have several shares. So when a company does a stock split, what they’re doing is they’re going to split they’re splitting the price. And so what that’s doing is it’s doubling the shares. So, you know, you can do different types of stock splits.

Andrew (02:29):

Tesla’s was kind of interesting because they did a weird ratio, but for something like Apple, you could, if you own the ones, one share, they’re going to split that into two shares. Let’s say you’re going to own two shares now. And then the price of Apple went from 200 something to a hundred and something. And what that does as a shareholder, if your current shareholder that doesn’t change anything. And if you look at it on a big picture, you’re not changing the ownership percentages any differently. And so one description I saw recently kind of summed it up perfectly, where if you have a pie and you split it into tiny slivers, that that doesn’t change. What part of the pie you’re getting. If you’re taking like half the pie, you know, so if you split half the pie into like four slices, or if you’ve split half the pie into 16, 20, 25 different slices, but if you still are going to get half the pie, you’re still getting half of the pie.

Andrew (03:39):

So that’s basically how it works with these stock splits. And it makes for an interesting kind of news event, and they can bring attention to the stock. So sometimes that can push the stock and bring some momentum. We saw that happen with Apple and Tesla, and then we saw that momentum also pop and then move the other way.

Dave (04:01):

So, you know, there, there’s no fundamental difference with what’s going on with the business when you talk about a stock split. And so over the very longterm, it doesn’t make a difference to investors. No, it doesn’t. And I wonder, what do you think is the reason for companies doing that? Do you think they’re doing it to make it the Sheriff’s air quote, more affordable to small retail investors like us? Or is it more just a marketing ploy to get people to talk more about it? I know that Apple and Tesla both have their share prices bid up quite a bit before the splits; I believe TESL was like 80 to 100% from when they announced that they did the stock splits. And I think Apple was probably in the same realm.

Andrew (04:54):

I don’t know if Apple went that extreme, but it was pretty ridiculous. You know, there could be different reasons. I’m sure there’s plenty of CEOs who would jump at that idea. Maybe, maybe not, there’s something to do with, you know, how the dividend payment gets paid. Maybe it’s easier to pay a dividend in a certain way or track these things. I, I, it’s, it’s an interesting part of wall street and the stock exchange because we all kind of know that there’s no fundamental value on lock. And I think I saw professor Damodaran talk about this. We all know that there’s no, no change in the business. And so out of all these transactions we see on wall street, like an IPO or a merger and an acquisition or a spinoff, you know, these are all value-creating events for either shareholders or companies, a stock split doesn’t categorize into any of that, but it creates a bunch of buzzes and I’m sure creates a lot of paperwork out of that. It’s interesting. Yeah, it is. I would agree. So, you know, good question. I hope that answered it, and I’m sure in six months it will spring up again with some other new company.

Andrew (06:20):

So we’ll move on to the next question. This says Sean from Ireland writes in, he says, dear Andrew and Dave, thank you both for that great work you are doing in educating your listeners On investing. I have two here’s two questions we’re going to answer. One of them says I’ve recently read about how a company’s share price will open down by the dividend amount on the X dividend date. Do you think this has lasting effects on its overall share price performance, particularly a higher-yielding stock? So, for example, 8% yielding a hundred dollars stock paying $2 quarterly dividend would take an $8 hit over a year. Dave. does that question make sense? And what is the answer?

Dave (07:06):

Yes, the question makes sense. And, And it does there is, I’ve seen if I could formulate my thought, yes, I’ve read That there are times where the stock price will take a dip right before the next dividend date. A lot of times, that doesn’t have anything to do necessarily with the performance of the company. It’s more about what investors are trying to get into the share price before it goes ex-dividend to take advantage of the dividend. And then, in some cases, there is an investment strategy that is right about where people will buy right before the X dividend date. And then once they receive the dividend, they’ll sell the shares. I don’t know why they would want to do that,

Dave (07:53):

But apparently, they think that that’s a great way to generate income. I don’t know that that necessarily would have a long-lasting effect on the company. Generally, I would think that it would be more along the lines of more having to do with the buying and selling of the shares, right before something an ex-dividend data is a bigger, a bigger event in a company—these [Inaudible], as well as it’s just overall market presence. And I would; I guess I would think that it just really wouldn’t make much difference. What are your thoughts?

Andrew (08:29):

How many over the long run it doesn’t, but you indeed see this pretty often. So if you think about like how, what happens when a company pays a dividend, there you have a company that’s trading in the stock market, right. It has a certain amount of cash and has a certain amount of equity. When they pay that dividend off, they lose that amount of cash, and they lose that amount of equity. So sometimes the price will dip to kind of reflect that. And so that’s why you’ll see weird things around the X dividend date. I’ve also seen people claim that they’ve tried to trade short term around that, and other people have said they’ve tried, and they failed. I’ve looked at it just kind of like for fun, but never saw anything that was exactly definitive. So over it, it would be as much of a factor as anything else in the sense that like, you know, you going to buy on Mondays and sell on Fridays, or there’s just a lot of different movements throughout any stock throughout any given period.

Andrew (09:48):

And so what’s going on between the X dividend date and the share price. Yes. There’s going to be movement. Yes. There’s going to be people who are taking advantage of that movement, but with so many people trying to take advantage of that, you know, between hedge funds or algorithms, or even, you know, market makers, like the brokers who are trying to make money with, with no commissions, right. Between all of that. It’s very hard to say how somebody could profit from the effect of the stock price moving from the X dividend date. And then when you zoom that out and try to answer Sean’s picture about how does that affect the longterm. Yeah. Like if you look at it fundamentally, yes, you are taking cash out of business. So that does take, that does take some value out of the business.

Andrew (10:41):

But as an owner, you know, you’re a part-owner you’re entitled to, as part of those profits through a dividend. And so you’re, you’re exchanging that value from the business to yourself. And so would the company have stayed more valuable if it didn’t pay the dividend? Yes, probably. You know, would that have been reflected in the share price? Maybe, you know, the market’s a little too crazy to say that definitively, but at the end of the day, over the, over a very long period, does that make it so that your investment is doing a lot worse than if they didn’t pay the dividend? And I would say probably not. So, you know, yeah. Then, the dividends over the longterm do affect the underlying business, but there’s that good for the investor? I also say yes.

Dave (11:32):

Yes, And I would agree with that. And I think thinking through that a little bit farther while you were talking, think about a company like Johnson and Johnson, for example, a dividend or a scrap, that’s been paying a dividend for over 25 years. If they permanently lost a value, every single time they paid a dividend, nobody would ever invest in the company. So

Andrew (11:54):

There may be a short term hit to the value of the company. But I think over the longterm, I don’t think it affects it as much. I guess thinking along those lines as well, the best way to take advantage of some of those dips is to find out when Dave’s going to buy a stock because it’s guaranteed to take a short term dip as soon as I buy it. So if you, if you want to go that route, that would work for you too. And maybe I’ll have to put you on my speed dial.

Andrew (12:24):

Let’s see what I can do to help everybody out. Right. All right.

Dave (12:29):

Let’s move on to the next question. So I have a hello, Mr. I have been bingeing your podcast while working and trying to catch up. I have also read both of your books and found extremely informative, especially with the VTI calculation. I do have two questions for you, and I was hoping you would answer them. The first is pretty straightforward, and that is how I should figure the intrinsic value of a company. I’ve been trying to figure out which method to use, and all seem to have upsides and downsides.

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Andrew (13:08):

Yeah, that’s the million-dollar question. There is a ton of different things that you can do as I’ve gotten more experience. I’ve realized there’s a lot of different tools you can use to try to estimate intrinsic value, and there’s no one answer for everything. And, you know, Warren Buffet will tell you that more than anybody else will. And so what you have to do is you have to take the tools that you have and try to collect a lot of them, try to understand a lot of them and apply them as best you can for a company. And you have to consider more than just intrinsic value on its own. Do you have to consider how much I am paying for this intrinsic value? Am I getting the margin of safety for that? Am I paying the fair price for this intrinsic value? Am I overpaying for this intrinsic value?

Andrew (14:01):

Those are huge factors, and that’s maybe even a whole other discussion. Still, it is important when you’re thinking about intrinsic value because you know, there’s no, there there’s nothing that’s solid concrete that says this is the intrinsic value of something. They say the quote is like beauty is in the eye of the beholder. And the value of something is, is the price that somebody would pay to buy. And the price of some of the else would sell at, right. But when you’re talking about the stock market, that changes every second that the market’s open. So, you know, that, that doesn’t sound like a great definition of intrinsic value. So, you know, you want to look at where it’s trading that what’s, what’s the relation hire, estimating that. And then you want to look at things Like what makes the business valuable? What does the business owner that makes it valuable? So, you know, you can find a lot of that in the financials. A lot of times How much Cash do they have, how much property plant equipment do they have, what’s their earnings power. And then some intangible things can go into that too. So a business could own something like a brand that generates a lot of earnings or generates a lot of free cash flow, contributing to intrinsic value. And then you also want to think about there’s intrinsic value in the sense that A company could have opportunities to grow.

Andrew (15:36):

And some businesses might have that more than others. And so does that make their intrinsic value greater than one with less growth potential? And so it’s, it’s all relative, and it all depends on the situation. But those are some of the things that you need to think about when you’re trying to look at intrinsic value.

Dave (15:56):

Those are all fantastic ideas and great points to consider. I agree with all the things that Andrew was saying; those are all very important points to think about and relate to as you’re working through this. The biggest thing that I think about when I think about intrinsic value is so many people gets caught up in figuring out the exact number. For example, if you’re trying to value a company like Apple, you will; some people will spend a lot of time trying to find the exact number that they think it’s worth right now. And they get so focused on the actual number that they forget about the reason why they’re doing that. And the reason why they’re doing that as they’re trying to evaluate whether it’s a good investment for them at that time or not. And it’s more important to try to find an approximate value Than the exact value, and Buffet talks about this a lot. He would rather be approximately wrong than precisely, right? Or wait a minute, sorry, sorry about that. He would be, he would rather be approximately correct than precisely wrong.

Dave (17:10):

And so what he means by that is don’t get so focused on the method of figuring out intrinsic value, rather assessing the whole company as a whole, using the numbers, to analyze the company as obviously a great way to start. And those are very important things to consider. And there are lots of different tools that you can use to calculate intrinsic value whether you want to go down the rabbit hole of figuring out the different models that you can use. I E a discounted cash flow, a dividend discount model, excess return models you can on and on. There are, there are a million of them. You can also look at relative value, where you use things to compare different companies to the company you’re trying to value.

Dave (18:00):

So you can use the PE ratio and use that to compare it to other ones. And then, based on the comparisons, you can find out whether you think your company is over undervalued. And again, it’s not necessarily focusing on how much it’s over undervalued, rather more the quality of the undervaluation and the margin of safety and how logical you think that is. And it all comes back to how well do you understand the business and how well do you understand the prospects of the business, as well as the numbers that are involved in all those different models, as well as the ideas of how those companies function. And when you’re trying to calculate the intrinsic value, there are lots of tools online that you can find to use. One that I like is it this kind of cash flow model that guru focus has now; they also have a reverse DCF that you can use.

Dave (18:56):

And those are simply tools that you can use. You can plug in a few numbers, and it’ll do all the calculations for you, and it’s not super precise, but that’s kind of the point. It’s just trying to get you in a ballpark to see if this company is under or overvalued and never, ever, ever, ever, ever buy a company, just because you see this cheaper than what you think it should be because it could be a value trap. There could be a possibility that there’s a reason why it’s so cheap because it’s a pilot, a pilot dog do-do, and there’s a reason why it’s so cheap, but it could also be because the market is ignoring that particular sector. So there’s a lot of different things that you can consider when you’re thinking about intrinsic value. Still, I would try to find several different tools that you are comfortable with, and we know it inside and out and use those and think about all the things that Andrew was talking about because of all those ideas, all interplay with each other. It’s not just simply taking a spreadsheet and plug it in some numbers. And off you go there, there’s a little more thinking involved in it, but it doesn’t, it doesn’t have to be complicated. I remember a quote that Albert Einstein said he said, make everything as complicated as it needs to be. In other words, make everything as simple as it needs to be. And that is as simple as you need it to be. So I thought that was kind of fascinating. So anyway, that’s my thought.

Andrew (20:25):

Yeah, I like it. I think, you know, people who want to learn more about DCF, those are both the DCF and the reverse DCF. Those are good ways of getting a grasp on intrinsic value. And it’s something that A lot of traditional law, traditional finance courses will teach, and Davis wrote two great posts about those topics.

Andrew (20:48):

So if you just go on the website, you search DCF, Dave’s great. Posts will pop up, and that gives you a really good in-depth lesson that you can apply. Some of those things, a lot of different, great tools, and a lot, a lot of the things you can apply to, to find great stocks at the end of the day, it’ll come to a balance between the science and the R the valuation, and there’s going to be numbers involved. There’s going to be, you know, some common sense things too, and you need to focus on both and not rely on one or the other. So let’s, let’s finish this off with this second question.

Dave (21:27):

He says since This is about current economic issues since the business has slowed down drastically, that means that revenue will be going down. Businesses will be having to dip into their reserves or take out loans to cover operations costs. He says,

Andrew (21:42):

So what I’ve been doing is looking at the current cash on hand and current liabilities and creating a ratio between the two, my thought being that the greater this ratio, the last money the company will have to leverage. This will have two advantages. The first is that the company will be less likely to become over-leveraged in the current environment. The second event I see when they occur, when the economy recovers, those with fewer liabilities will be able to recover faster because they will be able to put a large portion of their revenue into growth and dividends instead of paying off loans; he says, Or am I too cute about this? And overthinking that have an excellent day, Ben,

Dave (22:25):

Oh, that’s a great question. And I think that’s a; it’s an interesting viewpoint. I had not thought of creating my ratio per se, but it’s a, it’s a good idea. And it’s along the same lines as thinking about a quick ratio or a current ratio. Those are, in essence, what Ben is trying to was creating and looking at the difference between the current liabilities and the current assets that a company has. And for those of you who are not familiar with what I’m talking about, current assets and current liabilities are, in essence, things that you own and things that you owe that are due within a year. So current assets are going to be things like the cash on hand that Ben mentioned. They’re also going to be things like accounts receivable, or accounts payable, inventories, other assets. There are lots of different things that could fall under their marketable securities there, depending on the companies, there are, they’re going to be different line items that will line up with that.

Dave (23:31):

In essence, on the balance sheet, there’s going to be a section that’s called current assets, and then there’ll be an asset, total assets, and then there’ll be current liabilities and then longterm liabilities. So when you break those down and look at the current assets and the current liabilities, those are liquid as much as they can be. And generally, as you work down the balance sheet, the more the top items will be the more liquid ones. And as you move down the assets, there’ll be less liquid as you go down the line. So the current asset and, or I’m sorry, the quick ratio and a current ratio were created to help show that indicate that kind of liquidity that Ben is looking for. And as we have gone through the crisis now since March, there have been companies that have stretched their current ratios, and our current quarry shows because they haven’t generated cash.

Dave (24:30):

Now, I haven’t looked at a company like, let’s say AMC, for example, that had their business shuttered for three or four months. It would be interesting to look and see how much their ratios changed from before COVID hitting two today. I bet you would probably see a big change in those because they had to use a lot of money to try to stay afloat during this time. But I like his idea, and I think it’s an I think it’s a great idea, and he’s not necessarily, I don’t think you’re too cute, but I think there’s already been a ratio created for that. That can help you fairly quickly figure out the liquidity of the company.

Andrew (25:14):

Yeah, I agree. I like, I like where the thought is. I would just caution that you just have to put it in context. So I’ll give two examples. One of them was I have a stock that I recommended in the leather, and then I added to it after the pandemic. So what I saw with this business was not only was it not negatively impacted, but it was positively impacted for a variety of reasons. And so I felt very good about the tailwinds that were pushing this business forward. I felt very good about how the business had grown up to now, and now they had these things that would make things even better. And then what I liked about them a lot as compared to their competitors.

Andrew (26:04):

They had a lot more cash flow available in the future. So companies will have to disclose what kind of liabilities they have in the future. You’ll see that on the balance sheet, there’s also an obligation the, in the footnotes. And so you can see other things like purchase obligations for CapEx and things of that nature. So I was looking at them versus somebody else. And I, so I saw a company that was still pretty reasonably valued. They had a lot of real assets. They had a lot of real growth, and they had many things going for them, even though the pandemic. And then you add the cherry on top where a lot of their future cash flows are just going to be able to reinvest that. Or, as Ben said, pay that off in a dividend. So that made me excited about it and gave me the edge over another one of their competitors in an industry where the brand name might have a little to do with it.

Andrew (27:03):

But a lot, a lot more of it comes down to size, scale, resources, marketing, things like that. And so, you know, you’re looking for an edge between competitors. This could be a big one in this particular situation. Now, if we take that, if you take that and try to apply it to a different industry, and let’s say, I don’t know, let’s say you’re talking about like shoe companies, right? And so if you have a company that’s competing with Nike as an example where everybody’s buying Nike, no matter, you know, whether you’re a runner, a basketball player, a soccer player, everybody’s buying Nike. Then you have a, I don’t want to like throw a brand name under the bus, but you know, you have this, this small little, little shoe let’s say like Reebok’s, I think Reebok’s used to be a lot more popular than they are now.

Andrew (28:12):

So if Reebok’s was in a situation where they didn’t have much in the way of liabilities and loans, just because they’ve, they were that way against Nike doesn’t mean I would want to buy Reeboks over Nike, because if you go the ten people around and give them a pair of Reeboks or pair Nike, they’re going to pick Nike. Right? So in that situation, using a racial, like this one, be that helpful, particularly if you’re just taking it and it’s at its face and not trying to apply it amid other factors. So I think that’s, that’s something, it can be helpful. It can be useful. Maybe another tool kind of like what we were talking about before you have a lot of different tools that you use to figure out different parts of these businesses, but it’s not something that is like an automatic guarantee that these businesses will do better just because of it.

Andrew (29:10):

All right, folks, we’ll that is going to wrap up our conversation for this evening. I wanted to thank Joe, Shawn, and Ben for taking the time to write us those great questions. We appreciate it very much. And we hope you guys got some answers that satisfied your questions. And if you guys have anything else you guys would like to know, please don’t hesitate to send us some questions. We love doing this for you guys. So without any further ado, I’m going to go ahead and sign us off. You guys go out there and invest with a margin of safety. And if this was on safety, have a great week, and we’ll talk to you all next week.

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