Send us a Text Message.
Welcome to Safe Dividend Investing’s Podcast # 159 on March 14th of 2024.
Today, I will be answering 2 interesting investment question.
QUESTION (1)
IS A STOCK’S BOOK VALUE AN IMPORTANT INVESTMENT CONSIDERATION?
QUESTION (2)
IS A STOCK’S OPERATING MARGIN AN IMPORTANT INVESTMENT CONSIDERATION?
In Podcast #154, I announced a contest to select 20 stocks using $200,000 in “play money” that will generate the most capital gain and most dividend income over 12 months. While this contest was created as a learning exercise for those who have been hesitant about investing in the stock market, it is open to anyone who wants to test their investment skills. To make it a bit more captivating, the winner will receive $100 as an incentive.
SIX INVESTMENT BOOKS, BY IAN DUNCAN MACDONALD, ARE AVAILABLE FROM AMAZON.COM KINDLE BOOKS, THE FOLLOWING ARE THE 2 LATEST.
(1) CANADIAN HIGH DIVIDEND INVESTING -
In this 325-page book, learn how to select, purchase and build a portfolio of 20 Canadian strong dividend stocks. Summary records of 215 stocks are sorted in multiple ways, and each stock's unique page provides detailed scoring data and 24 years of price and dividend trend data. Released September 23.
(2) NEW YORK STOCK EXCHANGE'S 106 BEST HIGH DIVIDEND STOCKS -
In this 334-page book, there is a 2-page report for each company scoring 11 data elements. It also lists 23 years of historical share price and dividend payouts so that investors can judge the stock's reliability. Released December 2022.
A TRANSCRIPT OF THIS PODCAST IS AVAILABLE.
FOR MORE INFORMATION ON HIS 6 INVESTMENT BOOKS, HIS 3 NOVELS, PAINTINGS, PHOTOGRAPHS AND DIGITAL ART VISIT www.informus.ca and also www.artgalarian.com
Ian Duncan MacDonald
Author, Artist, Commercial Risk Consultant,
President of Informus Inc
2 Vista Humber Drive
Toronto, Ontario
Canada, M9P 3R7
Toronto Telephone - 416-245-4994
New York Telephone - 929-800-2397
imacd@informus.ca
PODCAST 159
SAFE DIVIDEND INVESTING
14 March 2024
Greetings to listeners all around the world. Welcome to Safe Dividend Investing’s Podcast # 159, on March 14th of 2024.
My name is Ian Duncan MacDonald. In today’s podcast, I will be answering 2 interesting investment questions about the importance of Book Values and Operating Margins in selecting strong, high dividend stocks.
In Podcast #154, I announced a contest to select 20 stocks using $200,000 in “play money” that will generate the most capital gain and most dividend income over 12 months. Seek out the transcript attached to Podcast #154 for more details.
While this contest was created as a learning experience for those who are hesitant about investing in the stock market, it is open to anyone who wants to test their stock picking skills. To make it bit more interesting the winner will receive $100 as an incentive at the end of 12 months.
Request the Excel entry file if you are interested in participating at ianduncanmacdonald@hotmail.com.
The objective of my books, my website and my podcasts are to show all those seeking financial independence how to become informed, confident, successful, self-directed investors.
QUESTION #1
IS A STOCK’S BOOK VALUE AN IMPORTANT INVESTMENT CONSIDERATION?
Is a common stock an asset or liability? It is neither. It is an equity.
What is corporate equity? Equity is the amount that remains after you subtract from all the assets in a company all its liabilities. The higher the resulting number is on the positive side of this mathematical calculation, the healthier it is. The greater the positive equity, the stronger the company.
If the company’s liabilities are higher than the assets negative amount of this mathematical calculation sees the corporation as being unhealthy and weak. Theoretically such a negative amount could be interpreted to mean the creditors now own this company. They are owed more money than what the company is theoretically worth or able to create enough revenue to offset the bleeding of cash.
The liabilities the creditors are owed may be bank loans owed by the company, account receivables owed to suppliers, wages to employees and others. What are supposed to be offsetting this debt are he company’s assets that could include real estate, vehicles, machinery, accounts receivable, cash and investments.
When the situation becomes so dire that the company is unable to pay their obligations as they come due, then they are technically bankrupt. Banks can then seize the assets that are securing their loans. Trade suppliers unable to get paid for what they have shipped to the company can now approach the courts and petition the company into bankruptcy. A court appointed trustee in bankruptcy then meets with the creditors and they agree on how to sell off enough of the company’s assets to help offset what they are owed.
Sometimes the creditors get the lucky. The company’s book value may have been valued accountants at a much lower amount than its market value. This is unlikely because long before the company reached insolvency, the company should have been doing all they could to lower expenses and pump more cash into the company to cover its debts.
If their customers were slow in paying them the company should have created more aggressive account receivable practices such as using collection agencies to quickly recover cash. If revenues had been declining, the number of employees should have been reduced. Property they owned should have been sold and perhaps be leased back from the buyer if it were critical to their operation. Slow moving, expendable inventories should have sold to discounters for whatever they could realize. Offices should have been reduced and consolidated. These are all moves that experienced skilled executives of the company should have been making to allow the company to survive.
Unfortunately, once the company officially goes bankrupt, it is highly unusual, after the orderly disposal of the company’s remaining assets at bargain basement prices, for significant equity to be left. The secured and unsecured creditors will not recover all they are owed. They will settle for cents on the dollars they are owed.
In the hierarchy of who gets to share in money realized from the sale of a bankrupt company, the company’sshareholders are at the bottom of the list. They are unlikely to regain anything of what they had invested in the common shares. In working with bankrupt companies, I can only remember one time when shareholders received a payout from a bankrupt estate.
This is why it important before you purchase the shares of any company that you look at the book value figure. You always want to see a positive healthy number. A negative number indicates that the company’s creditors could some day impact the value of your investment in the shares of that company. A book value close to or higher than the company’s share price is a sign of positive health.
Speculators intent on buying the next hot tech stock or lithium mining company stock ignore negative book values. If they even notice the book value figure, they will blow off its message by saying that most new companies, who have yet to start generating revenue can have negative or low book values. They see it as buying a cheap stock at a bargain price that will some day be worth much, much more. Often a stock buying frenzy by such speculators drives the share price up with little to justify the increase. They are convinced that speculating is the only way they become “rich” in the stock market. Unfortunately, I understand 95% of speculators lose money investing in financially weak shares. No one forced them to buy these stocks. They are pawns of media hype and stock promoters who would not invest in these shares themselves.
Thus, if you own a high-flying tech stock trading at $200 whose book value is $4 you should be concerned and take the time to thoroughly investigate the risk you are buying into. To own at stock trading at $3.90 whose book value is $4 should make you feel confident in the stock’s health and potential for capital gain. The management of such a company are controlling revenue and expenses.
Speculators who today pay $200 for that high flying stock that they could have bought for $4 twenty years ago will greatly suffer if the company’s debt payments ever exceed the resources of the company to pay their creditors. Going suddenly from interest rates of 1% in 2020 to interest rates of 6% in 2024 is going to trigger increase corporate bankruptcies and losses for speculators who were betting that the stock price would surely climb well past $200 and that interest rates could ever climb that fast. Inflation can cause prices for companies to increase faster than they can raise their own prices to keep revenue and expenses in balance. When you invest in a corporation, you are really investing in the experience and skills of company’s chief financial officer to protect the company from losing control of that balance. Companies are controlled by people not by random chance. It is important to look over 20 years of historical records to see the stability and adaptability of the companies whose shares are giving you partial ownership in them.
QUESTION 2
IS A STOCK’S OPERATING MARGIN AN IMPORTANT INVESTMENT CONSIDERATION?
A stock’s operating margin percent measures how much of a profit a company makes on every dollar of sales after the costs of production are subtracted from the total sales figure. The costs being deducted would include wages and raw materials used in producing the product or service being sold. This would be before the company paid any interest or taxes. To calculate the operating margin, you divided the operating income or earnings by its sales or revenue and show the result as a percent.
The operating margin is a good indicator of how efficient a company is in generating profits. It shows what percentage of revenues are available to cover the cost of operating the business. The higher the operating margin the less chance there will be that the stock you own in a public corporation will run into financial difficulties that are beyond its control. Often financial difficulties translate into lower share prices and reductions or even discontinuances of dividend payments. To protect a dividend income that you may be living on for the rest of your life it is important to select companies with high operating margins.
Speculators can run share prices up and down on a whim which means technically your stock investment losing and gaining value. However, until that stock is ever sold you have neither gained of lost anything.
However, many companies with a high operating margin often increase their dividend payouts even when speculators have driven down theirs share price. Looking at historical records of a company’s dividend payouts and their steadily improving operating margin can give you confidence that the management of the company is making constant improvements in controls, pricing and marketing. These are the kind of stocks you plan on never needing to sell.
Different industries have different normal operating margin percents. Operating margin comparisons can be very useful when trying to decide which company in the same line of business would be best to add to your portfolio. However, even if the companies you are considering are not in the same industry, it is still helps to see that a company has a high operating margin. This increases the probability that the share price and their dividend payouts will most likely increase.
Some stocks you encounter will have negative operating margins. This indicates that they are not profitable. Such stocks are unlikely to be paying dividends. If they were you would probably expect that they were borrowing the dividend money they were paying shareholders. This would have a significant negative impact upon the company’s book value.
Such companies may be surviving by borrowing against what they see as their glorious potential. For example, it can take as long as 15 years before a mine can start producing. Tech stocks can spend years developing software before it is marketed. These are speculative investments which investors like me do not invest in. Too many unexpected occurrences can wipe out such glorious futures.
There are industries who are so competitive in pricing that there operating margins are very low. Such companies can have massive sales volumes and quite high share prices. Even a minor negative incident can wipe out billions of dollars in shareholder value. For example, a few years ago the famous footballer Ronaldo, who was promoted a healthy diet, moved Coca-Cola bottles off the table in front of him and substituted bottles of water. Picking up one the bottles he said one word, “Water”.
Coca-Cola’s share price immediately dropped by 1.6% to $55.22. The market value of Coca-Cola shared went from $242 billion dollars to $238 billion dollars. One word caused a 4 billion dollar drop that no speculator could ever have anticipated.
Interestingly on March 8 Coca-Cola Consolidated was trading at $825 with a book value of $153.15 or about 20% of its share price and an operating margin of 8.45% or about 1% of its share price. Paying a dividend yield of only 0.24% or $2.00 a share, Coke is immediately rules it out as a prospect for my portfolio. By comparison, for $60.23 I can receive double that dividend payout or $4 .08 which is a 5.02% dividend yield. This company has a book value of $46.43 which is about 66% of share price and an operating margin more than three times greater at 27.23%. The company was TD Bank the second safest bank in North America. I do not own TD shares because the bank shares I own provide an even better return.
In building a financially strong, high dividend portfolio you can choose to not invest in companies like Coke which will often show up in mutual funds and ETFs. Without doubt, Coke is a market leader but with a little research it is not difficult to find stocks that will safely put more money in your pocket with less risk.
In calculating a company’s operating margin, you divide operating income (earnings) by sales (revenues).It is expressed as a percentage. For example, if a company had revenues of $2 million and had expended $1,200,000 to earn that $2,000,000, its operating margin would be the difference between the two figures. This would be $800,000. Which is expressed as an operating margin percent of 40%. You do not have to do this calculation. There are many free online data bases where the operating margin is always supplied for every stock in a stock exchanges.
Operating margins do change. They can improved with better management controls, by lowering costs with their suppliers, more efficient use of resources, improved pricing, and more effective marketing. Look for improvements by looking at Operating margins over many years.
THE END