Podcast 160
21 March 2024
Greetings to listeners all around the world. Welcome to Safe Dividend Investing’s Podcast # 160, on March 21st of 2024.
My name is Ian Duncan MacDonald. In today’s podcast, I will be answering 5 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
HOW COULD A MUTUAL FUND MANIPULATE INVESTORS?
The mutual fund could establish 40 different “exploratory” mutual funds. Each one would trade in very specific but randomly generated stock portfolios. All 40 when taken together would match the market.
After five years some of the 40 token funds would turn out to be more successful than others. You would close the 39 unsuccessful ones and promote that most successful one as being your proof of how clever you were in picking stocks whose share prices had climbed. That super portfolio may have grown by 1,000 percent. No mention is ever made of the 39 losers that were discarded.
Investors looking at that 5-year track record would pour their money into the super portfolio naively expecting the same historical results. To protect themselves from the lawsuits of disgruntled investors mutual funds always add a disclaimer to their prospectuses that historical results are no guarantee of future results. They know no one can accurately predict future share prices.
QUESTION 2
WITH ITS RECENT GROWTH IN PRICE, AM I A FOOL FOR NOT INVESTING IN BITCOIN?
Your “profit” in bitcoin, if any, can only be realized if you sell the bitcoin. Where would you then invest this profit? Would it go back into a bitcoin, with the gamble that it would again move higher?
Bitcoin is a pure speculative play. It has no financial book value, no operating margin, no price-to-earning’s ratio, and no dividend payout. All it has is a perceived intangible value that rises and falls on the whim of speculators rather than on improvements and efficiencies in its operations. Bitcoin has no operations, it just “exists”.
Bitcoin holds zero attraction to someone who is investing in the skills of the executives to manage the revenue and expenses of a business. Companies who reward their share holders with regular growing dividend payments. These payments remove the necessity of selling the asset to generate money to live on, as you watch your share values in a well diversified, dividend paying, stock portfolio increase steadily year-after-year.
Before I invest, I know the financial strength of each share and why I invested in it. Its value is evident in the financial reports which are audited and monitored by the Securities Exchange Commission.
Perhaps the reason you have not invested in Bitcoin is that you too want to be able to analyze the recorded strength of an investment, rather than reduce your bit coin strength value analysis down to the logic of flipping a coin.
QUESTION 3
SINCE ITS INCEPTION THE S&P 500 HAS GROWN BY 3000%. WILL IT GROW BY 1000% IN THE NEXT 10 TO 50 YEARS?
What is the S&P 500? The Standard and Poor 500 Index is a compilation of stocks selected by a committee called the S&P Dow Jones Indices. It is managed by S&P Global Inc that sells financial information and analytics. This company is an evolution of the century old McGraw-Hill publishing company. The S&P 500 tracks the 500 largest American companies selected by their stock market capitalization, which is the value of all the shares held by investors in a company.
Fund management companies selling units in their S&P 500 mutual funds and ETFs, are quick to brag that just 9 of the 500 companies account for 31% of the market capitalization of all 500 companies. These nine are Apple, Microsoft, Amazon, Nvidia, Alphabet, Meta, Tesla, Berkshire Hathaway, and JP Morgan Chase. Their selling pitch for buying units in their S&P compiled funds is, “How can you lose with such well known, successful companies” .
However, most of the companies in the S&P 500 have low book values and low operating margins. Using “high capitalization” as a measuring stick is questionable. As an investor you are expected to put blind faith in the fund company who is supposedly investing your money in all the same stocks that make up the S&P 500 fund. It is a marketing ploy, which is all about making money from the management fee they will charge you for their involvement in handling your money They obviously do not need to spend money on fund managers to select stocks.
Thus, the growth ,of the S&P 500 is a manipulated index. The stocks of successful new growing companies are being added while the stocks of diminished, no longer successful stocks, are being removed. You as an investor have no say in this pruning.
Could the S&P 500 increase by more than 1,000 percent over the next 10 to 50 years? If economic conditions remained frozen the probability would be high. However, economic conditions will not remain frozen.
Predicting future share prices and stock capitalization has proven to be anything but accurate. So many things could change. For example, if the growing Chinese economy eclipses the US economy would the S&P become irrelevant? If the US ceases to be a cohesive, democratic nation will the S&P be irrelevant? If nuclear wars wipe out a large percentage of the world’s population what will be the economic consequences?
As an investor your future investment success would probably be more secure if you invested and monitored 20 diversified, financially strong companies with long histories of rising share prices and high dividend payouts. Such a portfolio could beat the mediocre results of a S&P 500 fund and save you thousands of dollars in management fees.
QUESTION 4
HOW LONG SHOULD YOU HOLD ONTO A STOCK WHOSE PRICE DOES NOT RISE?
My stock portfolio makes money consistently. I can go for a year and never buy or sell a stock. This is because I only invest in financially strong companies paying high dividends.
Stock scoring software measuring 11 factors is used to sort my stocks from the most to the least desirable. I limit my portfolio to the 20 best stocks I can find out of the 16,240 available on North American stock exchanges.
For safe diversity, I invest equally in each of those 20. They are rarely all up or down at the same time. It is more important to be concerned about the total performance of a portfolio, rather than each of the stocks individually.
The average annual dividend income for the portfolios is 6% and the portfolios, most years, grow, by about 12% despite. This is despite my taking out some of a generous dividend income to live on and investing some of it back into the 20 stocks.
Over 20 years, the portfolios have grown into the7 figures while generating that steady 6 figure income. Even during the 2008 and 2020 market crashes when share prices greatly declined, the portfolio paid its regular dividends and the stock scores remained steady.
Only 5 minutes is spent on 5 days each week to keeping an eye on the portfolio. While I have seen that no one can accurately predict future share prices, I have also seen it is possible to predict future dividend payouts.
My books provide many examples of companies whose executives have consistently raised dividend payouts for more than 20 years. Share prices do not have such consistency, because the whims of speculators control share prices. This is unlike the experienced executives who control the revenue and expense decisions which result in the profits from which dividends are paid.
If your objective is to preserve your wealth, grow it steadily, and live well off that portfolio, then buying stocks at a low price with the belief that such stocks, thanks to speculators, will soar and make you rich has a problem. Such speculation is reported to fail 90% of the time.
Why speculate? Successful investing does not require constant trading. Only if stock scores declined below 50 and dividend yields fell below 5% would I consider selling a stock. This occurs so rarely that I can go for years without needing to replace a stock in my portfolio.
At times a few stocks may fall below their purchase price. At other times a few stocks share prices may grow by many multiples over their purchase price. Investing, as I see it, is all about patience and recognizing that it is the strength of the total portfolio with its constantly fluctuating values that you are managing.
QUESTION 5
WHY DO YOU NEED TO CONSIDER MORE THAN STOCK PRICE WHEN BUYING SHARES?
Supply and demand set the price of a stock at any given moment. The stock market is an auction vehicle that manages the bids from potentially millions of stock buyers and sellers.
An ever-increasing share price for a stock reflects the desire of investors to own that stock whose price they believe has a great potential to increase. They must bid higher and higher amounts to motivate those who currently own the stock to sell that stock. The sellers are made to believe that the price being offered is now overpriced and due for a decline.
Price is only a fleeting perception created by buyers and sellers. Investors should be considering many more tangible factors in trying to determine whether they are getting something of value in their stock purchase.
Many years ago, I developed a stock scoring system based on the premise that an ideal stock score would be 100. If a stock scored 100 it would have scored 10 in 11 criteria.
Price was only one consideration in my stock scoring matrix. To earn 10 out of 10 a stock price would have to be greater than $100. Out of the 16,240 stocks traded in North America, I found only 799 could be purchased for $100 or more. The higher the price approaching, the higher the score.
The second criterion, that would earn an additional 10 out of 10, would be a stock price that was greater than $100 four years ago. Forcing an investor to look at a historical price confirms that the company existed four years. If it did not exist 4 years ago the score would be zero. If it did exist whether the amount was higher or lower you would be able to see a trend in the current price.
The added benefit is if you are going to look at the price 4 years ago, you are almost automatically going to look at the share price trend over many years. Looking at the price trend for the last 24 years gives an investor insight into how much prices dipped in the market crash years of 2000, 2008 and 2020, as well as how long it took them to recover to new record highs. Whether you like it or not you will eventually go through another market crash. A market crash is not a time to panic but a time to be patient and wait for your portfolio to recover.
The third sub scoring factor measures the share price trend. To achieve 10 out of 10 the current stock price would need to be 99.50% greater than it was 4 years ago. A current share price that was lower than it was 4 years ago would score a zero. Most new businesses have a hard time surviving one year.
The fourth factor earning a score of 10 out of 10, in the scoring system, would be a stock with a book value greater than $100. The company’s book value is calculated by accountants subtracting the company’s liabilities from its assets and dividing this amount by the number of shareholders. A book value greater than the current share price would indicate that you would be buying a stock (an asset) at a price below its liquidation value. This is a rare treasure.
The fifth factor compares the share price to the book value A current share price less than the book value by more than 49.49% would earn a score of 10. A current price to book that was 49.50% greater than the book value would score zero.
The sixth and seventh criteria are based on the buy and strong buy recommendations of stock analysts. While analyst recommendations are just opinions they do cause investors to buy stocks and cannot be ignored.
The eighth factor is a stock’s dividend yield percent. A dividend yield percents of 10.50 would score only 2 because stocks paying very high dividend yield percents often had serious financial problems or were one hit wonders. A stock paying no dividend scores zero. Stocks paying dividends up to 10.49% would Score between 1 and 10. Dividends can be the easiest way to identify strong stocks.
The ninth scoring factor is the stock’s operating margin percent. It is what is left after all the expenses to generate the company’s revenue has been deducted. It is from the operating margin that dividends are paid. Stock that can not generate profits do not survive.
The tenth factor is how many shares of the stock are being traded daily. Low volumes make it difficult to acquire and to sell such shares. The higher the volume of shares traded the higher the score. Several stocks trade millions of shares in a day.
The eleventh, is a stock’s price-to-earnings ratio. The lower the ratio number, the stronger the stock. High-flying stocks with virtual monopolies can attract thousand of speculative investors. This causes very high ratios. Monopolies can be short lived.
After scoring thousands of stocks for my books, I have learned that a prefect dividend stock score of 100 can never exist. The highest score, out of the thousands that I have calculated has been a 78. The lowest score was an 8. I avoid stocks scoring under 50.
All the eleven information items used in my scoring matrix are easily available on the internet and often supplied by whatever financial service you are using as a self-directed investor.
The very last thing I do in selecting a stock has nothing to with price or scoring. It is a Google search. I key in the name of the company being considered and the following words, “complaints and legals”. The information disclosed can sometimes be enough to rule out my investing in a stock.
THE END