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I am retired and live off my portfolio income and real estate rental income. I follow a simple investment strategy: (1) spend less than I earn; (2) use the savings to add more dividend paying stocks and rental properties to my portfolio. By doing this for many years, I've been able to grow my... More
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  • June 2015 Investments

    Every month, I collect my dividends, pay my bills, and reinvest whatever's leftover into more dividend paying stocks. I do this regardless of market conditions. While I prefer paying lower prices for the shares I buy, I'll pay up for a high quality, blue chip dividend champion, such as Dupont or Exxon. Up to a point, that is. I would rarely consider paying more than 20 times more than a company's average earnings over the last five years. And I'd rarely consider an investment that offers a yield of less than 2%.

    The most important thing to me is that I only want stable, proven businesses with unimpeachable records of dividend growth. This month, I bought IBM, DuPont and Valspar. These might not be the cheapest stocks out there, but I want to add positions because at the moment, distributions from these companies comprise only a tiny fraction of my portfolio income. My version of diversification is based on income sources, not share price, so I have a bias towards buying shares of companies which are currently underrepresented income sources for me.

    This month, the only interesting thing going on is the Greek financial crisis. Prices for stocks are down across the board, which is great news for anyone (like me) who reinvests regularly, or who otherwise has cash to invest. The reason why it is hard to picture why stocks across the Earth are "worth" 2% less today than last Friday is because stocks are NOT "worth" 2% less. I doubt company earnings are going to be affected by Greece - unless the company in question happens to be a Greek bank or is otherwise tied to the Greek economy. But will people eat less Smuckers' jam? I doubt it - but yet the stock is down on the Greek news regardless. To my way of thinking, this is an example of how the efficient markets hypothesis is just plain silly. Prices move for reasons having nothing to do with value, and everything to do with emotional factors such as irrational panic.

    Tags: DD, VAL, IBM
    Jun 30 12:48 PM | Link | Comment!
  • Redfine Your Investment Goals

    Most investors aim to retire. And most pundits and advisors counsel them to accumulate a portfolio with a price equal to some magical number. Perhaps a portfolio of $1m, or $5m, or some other number.

    There are a couple of problems with this approach. The first is that investors can neither control nor predict what their portfolios will be priced at on any given day or even any given year. A $1m portfolio can easily turn into a $500k portfolio, or a $2m portfolio, all for reasons that have nothing to do with the investor's spending or investment prowess, everything to do with market gyrations that nobody could see coming, and within a timeframe nobody would have expected.

    Intuitively, we all know that for you to aspire to a goal that you cannot control or predict is irrational at best, and counterproductive at worst. Suppose you aim to build a portfolio worth $1m. Ask yourself; what will you do when you actually accomplish that goal? What happens when the market tanks and your portfolio is suddenly trading at half the price it was at a few months before? Or the market pops and now your portfolio trades at twice the price?

    I won't keep you in suspense. Whichever direction the market takes won't matter, because either way you'll probably just end up doing the same thing. You will raise the bar. Maybe you will be scared as you correctly recognize that as the market giveth, so too doth the market taketh away (and usually much, much faster than the market giveth). Or it will go the other way - you'll chalk up your investment success to extraordinary prowess and intellect. Hey, if you're that good, it's pretty wimpy to stop with what you got. Whatever happens, I bet you will end up wanting more. And that wanting won't stop until you decide to take charge and make it stop.

    Some of you might relate to what I'm talking about. Maybe you've lived through similar experiences, or are living through an experience like this right now. You know what it is like to feel like a rat trapped in a maze - except unlike the rat, you're the one who put yourself into this maze of your own creation. Arguably, it feels even worse when you are directly responsible for your own feelings of being trapped.

    The bad news is that I can't help you. All I can tell you is what I did to get myself out of that maze. First, I got a really good handle on what my living expenses are. Second, I picked out and bought about 75 different companies and funds that pay regular dividends growing at a rate faster than inflation. Third, I reinvested my savings into more shares of these companies and funds until the dividends that my portfolio pays exceeded my regular living expenses by a comfortable margin. From that day forward, I never looked at the composite price of my portfolio. In fact, to this day, I have no idea what my net worth might be. I know how my businesses are doing, what sorts of new products and services they're selling, and what the earnings and dividends are. I read annual reports and shareholder presentations, and try to understand the opportunities and risks my companies face. But the most important piece of information I have is that I know exactly what I will spend this month, and whether I need to cut costs in order to ensure my income exceeds my expenses.

    Do I ever look at the stock price for any of the businesses that I own? Sure - but only when I am reinvesting my savings. And the only reason I do that is so I can buy more stock in whichever business is the cheapest. I suppose if you asked me what my magic number would be for an ideal retirement portfolio, I'd say $1, because as long as my portfolio income exceeds my living expenses and I can reinvest each month, I'd just assume buy more shares at the cheapest price possible. If my portfolio is down 10% this month, that's great news - it only means that my income on reinvested capital will go up 10%. Losing sleep over that is like losing sleep over the risk you might win the lottery or find a box of gold coins buried in your back yard.

    I've talked to enough people to know that 99% of investors and probably close to 100% of investment advisors out there will say that everything I just wrote is simply idiotic. Not only does that not bother me, but it's actually very good news. Investors like me thrive precisely because so few other investors want anything to do with the niche we occupy.

    What does concern me is the hope that maybe something I wrote will resonate for just one person out there, and help get him or her out of the rat maze. If so, then it was well worth my time to write this posting.

    Jun 11 6:05 PM | Link | 2 Comments
  • If Mr. Market Is Insane, It's Hard To Determine How Insane.

    Years and years ago, I stood in a crowd during a demonstration that devolved into a riot. I observed that normal people in a crowd will do things they would not ordinarily dream of doing. There's a form of mob insanity that seems to set in. Apparently, it doesn't even matter what the size of the mob is - as a species, humans are perfectly content to destroy the very environment we depend upon, whereas most rational individuals would say they'd prefer to NOT destroy the environment. "Collective wisdom" seems like an oxymoron at times.

    What about the stock market? If the stock market reflects the collective wisdom of investors across the globe, does that make it inherently rational? If so, we can comfortably conclude that whatever price we pay for a stock is precisely equal to it's value. We could buy stocks without doing any research, or just park savings into index funds and call it a day.

    But what if the stock market is NOT rational? If not, then whatever price we pay for stocks may have little to do with the value as much as it has to do with... "collective wisdom." And why wouldn't "collective wisdom" be at least as prone to destroying wealth as it is to destroying the environment, smashing car windows and tossing Molotov cocktails?

    In a recent interview, Warren Buffett claimed that the stock market is like a drunken sailor. What he means is that stock prices can vary wildly from stock values.

    But what is the value of a stock? To answer that question, suppose someone offered to sell you a business, with the stipulation that you can never sell it. How much would the business be worth to you? Simple, right? It would be worth all the company's earnings, discounted back to present value. Not a penny more, nor a penny less. So too is it with the stock market writ large. To any given investor, the value of stock is equal to whatever price the next investor will pay, but to the stock market as a whole (which can't sell a public company until it gets taken private), the value of the S&P500 is precisely equal to all the corporate earnings that all the companies in the S&P500 will ever generate, discounted back to present value by the cost of capital.

    So, getting back to drunken sailors, I wanted to see if Warren Buffett is correct, and so I pulled together a short study using data off Robert Shiller's homepage. For each year since 1900, the study takes the average of the previous five years of inflation-adjusted earnings for the S&P500. Next, for each year, I calculated the net present value of ten year's worth of payments equal to those average earnings, discounted back to present value by the average interest rate on a ten-year US Treasury over the past five years (I'll call this the NPV for short). Why did I pick ten years' worth of earnings? I picked it at random - you could use fifteen years, or twenty. Next, I multiplied the resulting NPV for each year by a multiplier of 7.84 - which is equal to the average historical multiple of stock prices divided by the ten-year earnings NPV. Had I picked fifteen years worth of earnings, or twenty years, the multiplier would have been different. Finally, I charted the inflation-adjusted price for the market for each year since 1900.

    To the stock market as a whole, the price of stocks should be closely correlated to some multiple of the value of some number of years worth of corporate earnings discounted back to present value by some cost of capital (I picked interest rates on a ten-year US Treasury for simplicity). I say "should" if the market is rational, and prices reflect the value of corporate earnings. If the market is not rational, price should be free to depart from the value of corporate earnings.

    Here is what I found:

    (click to enlarge)

    The chart shows that market prices tend to track earnings a lot of time, but that sometimes, the market throws hissy fits and tantrums (such as the 1930s, perhaps), and does, indeed, go on wild drunken spending sprees (I can't imagine how else to explain the 1990s). There may be other factors that influence the earnings multiple by which the stock market prices shares - factors such as forecast earnings growth rates, or extraneous factors like wars. The data used reflects average PAST earnings - investors care far more for ACTUAL earnings than rough guideposts. There may be technological factors at play increasing access too, demand for, and the intrinsic value of, stocks (the dawn of commission-free trades and limitless real-time information spring to mind). The value of stocks isn't necessarily any more constant than share prices are. For these, and other reasons I haven't thought of, I can't conclude whether the stock market is inherently nuts or not, just by looking at this one chart. I also can't rest comfortably assuming that investors get their money's worth each and every single time they click the buy or sell button.

    Tags: SPY
    Jun 03 5:29 PM | Link | Comment!
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