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The Part-time Investor
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I am a medical professional, but I have been studying investing for many years so that I can control my own portfolio. DGI seems to be the best way for me to invest for my retirement while being able to sleep at night.
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  • How To Buy Great Companies At Fair Prices

    "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." --- Warren Buffet

    I like to keep things simple, and I can't think of anything simpler (in the world of investing) then buying a great company with a stellar dividend growth record, and holding it forever, only selling it if it freezes or cuts its dividend. Of course the process of deciding which companies to invest in is not always simple, but once I've bought a company, I plan on holding it "forever", meaning well into my retirement. And as a dividend growth investor I often say that the stock price doesn't matter to me. I will claim that I don't watch the market because market changes don't matter to me. In fact I do check the market every day (I can't help myself), but I will not sell my stocks based on changes in their prices, whether up or down. I am investing for income, and as long as my stocks continue to pay me an ever increasing stream of dividends, and the rate of increase satisfies my requirements, I am happy.

    But my statement that the stock price doesn't matter to me is not completely accurate. What I should say is that ONCE I HAVE PURCHASED THE STOCK I'm not worried about the stock price. But the actual purchase price is very important. Even if I have identified a great company which I would love to own I still have to make sure not to pay too high a price for it.

    Warren Buffet was taught by Benjamin Graham to purchase stocks only if he could buy it for below intrinsic value. To look for a margin of safety. But later in his career, as he was influenced by Charlie Munger, he came to believe it is just as worthwhile to buy great companies at a fair price. Conversely, even a wonderful company should not be bought at a bad price. The key is buying the company for fair value (or, if you get lucky, below value). Even if you are buying a wonderful company with a great dividend, if you pay too much your returns will suffer.

    There are many ways to value a company, but, again, with my desire to keep it simple, I just go to FAST Graphs. One of my criteria for buying a stock is that it must not be over priced based on its FAST Graph. FAST Graphs shows you whether or not the stock price is above or below True Worth (Chuck's term). You can read the FAST GRAPH ARTICLES by Chuck Carnevale to learn more about FAST Graphs, but basically the orange line shows the True Worth of the company based on its earnings. And if you make sure you don't buy a stock that is trading over its True Worth line, and that stock continues to be a solid DGI stock, then your returns should be pretty good.

    To show what I'm talking about here are some examples of some great dividend growth companies, and the returns they gave if you had bought when they were over valued, or fairly valued, based on their FAST Graph. All of the values shown below are with all their dividends reinvested .

    Coca-cola (KO)

    (click to enlarge)

    Coke is one of the great dividend stocks of all time. And over the past 15 years Coke has increased its earnings at an annual rate of 8.80%, and it's dividend at a rate of 8.62% per year. But back in 1999 KO was trading well above its True Worth (TW) line (The orange line on the FAST Graph). If you had bought Coke at that time you would have had to pay about $34 for it (post-split), but the FAST Graph TW was only around $13. If you had held it through present time a $10,000 purchase would have turned into only about $16,300. Your annual return over that time period, including reinvested dividends, would only be 3.51%. So even though Coke's earnings and dividend grew at better then an 8% rate, your return would have been significantly less. Yes, your dividends would have increased at 8.62%, but your over all return would have suffered.

    Now compare that to Oct 2004. Although KO is still over its TW line it is at least much closer. It could have been bought for about $20, while the TW was about $15. A $10,000 purchase would have turned into about $24,500 by now, with an annual return of 11.08%.

    Date Purchased

    Stock price

    True Worth

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $34.00

    $13.00

    $16,320.66

    3.51%

    $2,986.55

    11/1/04

    $20.70

    $15.00

    $24,545.35

    11.08%

    $3,505.10

    For those interested strictly in dividend income, and not total return, it is interesting to note that you would have collected more in dividends if you had waited until KO was closer to TW in 2004, then if you had bought when it was over priced in 1999, even though you were collecting dividends for 5 less years.

    Some more examples

    Medtronic (MDT)

    (click to enlarge)

    Once again you can see that in 1999 MDT was selling for well over its TW of about $16. MDT has increased its earnings at a rate of 10.63%, and it's dividend at a rate of 14.29% over the past 15 years. And yet if you had bought MDT in 1999 a $10,000 purchase would have turned into only $17,300, with reinvested dividends, a total annual return of 3.85%.

    MDT did not return to, or even come close to, its TW until about Oct of 2008 when both the price and the TW were about $40. A $10,000 purchase at that time would have turned into about $14,500 now, a total annual return of about 8.4%. Much closer to the long term earnings and dividend growth rate.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $35.78

    $12.00

    $17,336.25

    3.85%

    $2,023.51

    11/3/08

    $39.81

    $40.00

    $14,677.18

    8.45%

    $814.59

    Walgreens (WAG)

    (click to enlarge)

    Another great dividend stock, but in 1999 WAG was selling for about $30 while TW was around $12. WAG has increased its earnings at a rate of 12.22%, and its dividend at a rate of 14.8% since then, and yet if you had bought WAG in 1999 a $10,000 investment would have turned into only $21,100, an annual rate of only 4.60%.

    However, by waiting until Sept 2008, when both the price and TW were around $31, you would have improve your annual return to about 17%, above WAG's historical earnings and dividend growth rates.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $27.00

    $10.00

    $21,118.76

    4.60%

    $2,028.60

    10/6/08

    $23.22

    $23.00

    $23,227.16

    17.16%

    $1,366.90

    Becton Dickson (BDX)

    (click to enlarge)

    Here is a stock that was selling for over TW in 1999, around $40, while TW was around $25, so it too was over priced. But it soon fell back down to its TW, and traded along its TW for quite a while. BDX has increased its earnings at a rate of 9.75%, and it's dividend at a rate of 12.63% over the past 15 years. Had you bought in 1999 $10,000 would have turned into about $29,200, an annual return of 7.93%. Not too bad, but this still would have trailed the earnings and dividend growth rate. But if you had waited until the end of 1999 and bought it when it was closer to the TW line your return would have increased to 11.49% and $10,000 would have turned into $42,700.

    And look at the dividends you would have collected. Had you bought early in 1999 you would have collected $3047 over the next 15 years. But had you waited for BDX to return to its TW you would have collected $4360. That is $1300 more, over a shorter period of time.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $40.97

    $25.00

    $29,235.10

    7.93%

    $3,047.92

    11/1/99

    $27.81

    $25.00

    $42,699.00

    11.49%

    $4,360.53

    McDonald's (MCD)

    (click to enlarge)

    MCD has increased its earnings at a rate of 10.26%, and it's dividend at a rate of 20.93% over the past 15 years. Just like BDX, MCD was trading for a premium to TW in 1999, but soon afterwards its price dropped back down to TW. In 1999 its price was about $40, compared to TW of about $20. A $10,000 purchase at that time would have turned into $32,780, an annual return of 8.69%. But by Sept of 2002 it had fallen to its TW price of about $18, and a $10,000 purchase would have turned into $74,000 today, an annual return of 20.70%! This is much closer to its DGR.

    You would have collected $4800 in dividends if you had bought in 1999, when it was over True Worth, but that would have increased to $10,500 if you bought it when it dropped to its TW.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $40.25

    $20.00

    $32,780.72

    8.69%

    $4,816.81

    9/30/02

    $17.50

    $20.00

    $74,044.45

    20.70%

    $10,535.41

    United Technology (UTX)

    (click to enlarge)

    Finally, we have UTX. UTX has been trading at, or below, TW almost continuously for the past fifteen years. During that time UTX has increased it's earnings at a rate of 10.88%, and it's dividend at a rate of 12.70%. Of the six stocks mentioned in this article only UTX was trading for about its TW at the start of 1999, and buying a fairly valued UTX, rather then any of the others over valued stocks, would have been a wise move. $10,000 worth of UTX bought in early 1999 would have turned into almost $42,000, with an annual return of 10.48%, consistent with its earnings and dividend growth rate. Just three months later UTX was over TW, and if you bought at that time your results would have been worse. $10,000 would have turned into $36,000, an annual return of 9.58%. But be patient and wait for UTX to fall back to TW in early 2000 and your annual return, if purchasing it then, would have improved back up to 12.19%.

    Date Purchased

    Stock price

    True Worth(est.)

    Final Value

    Annual Return

    dividends collected

    1/4/99

    $28.67

    $26.00

    $41,898.34

    10.48%

    $5,861.80

    4/5/99

    $32.94

    $24.00

    $36,015.90

    9.58%

    $5,011.89

    1/31/00

    $25.80

    $26.00

    $35,675.87

    12.19%

    $6,318.40

    Comparing the dividend income, out of the three scenarios, the one that was bought when UTX was above TW is the one with the worst income.

    Conclusion:

    As I said above I am an income investor, and I look to increase my dividend income year after year. But that doesn't preclude me from caring about total return. Capital gains still matter to me, and although I don't invest with the purpose of achieving capital gains, I know that over time it will make up a significant part of my return. Therefore poor total returns achieved due to buying stocks at too high a price is relevant, even to a DGIer like me.

    It is better to find stocks that are around, or below, their true worth, as shown on FAST Graphs, rather then reaching for the over priced ones. Although not over paying for a stock seems like an obvious idea, the actual effect it can have on returns can be striking, and these examples can help to really drive home the point. Some looking at my examples might say "All you're showing is that if you buy at a lower price you'll do better. DUH!" But that, of course, is not what I'm saying. It's not that simple. MDT, bought in 2008, would have given you a better annual return then MDT bought in 1999, even though the 2008 price was higher. What I'm trying to show is that all these stocks, stellar as they may be, can become over valued, and reach a price where they are too expensive. And if you over pay for these stocks, even if they continue to provide excellent earnings and dividend growth, your total return will suffer.

    But what I'm also showing is that you can still achieve excellent returns if you pay full but fair value. Every one of the stocks I mentioned, when bought at its True Worth, returned excellent results. You do not have to invest only in stocks trading at a discount their true worth.

    Thank you for reading my article. I welcome your comments and criticisms.

    Disclosure: I am long MCD, MDT, UTX, WAG, BDX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: I am not an investment advisor. Nothing I write should be considered to be a recommendation to buy any particular stock. I am simply discussing and explaining the methods I use and some studies I have done. Every investor should do their own due diligence.

    Jul 21 5:07 AM | Link | 4 Comments
  • It's Never Too Early To Invest For Retirement

    My daughter will be graduating from college in May. She is 22 years old, has her entire life before her, and is both scared and excited about what she will do after graduation. So what am I going to do in the next two weeks? I'm going to sit her down and talk to her about retirement. Yes, I think it is time for her to start thinking about retirement. I doubt that she has ever given a thought to saving and investing. But it is essential for her financial wellbeing, so it's time we sit down and discuss it.

    I don't think most college students have much of an idea about how to manage money effectively. Most have always relied on their parents to take care of them financially. But once they graduate they have to get their own jobs and have to start supporting themselves. Their spending habits have to change, their savings habits have to change, and their lifestyles have to change. This will not be easy for many of them to do because they have never had to worry about money before. And it can be a rude awakening. They have never had to worry about saving before. If they did have any money from a part time job it was usually considered spending money. All the essentials (tuition, rent, food) where paid for by their parents. So saving is an alien concept to them. And investing? Retirement?? Most have never even considered it! At such a young age it's not easy for kids (young adults?) to be thinking about saving for retirement. To them it is so far away it's almost non-existent. To get them to start thinking long term is very difficult. But for their own good they need to learn.

    Don't get me wrong, some college students work full time, are financially independent, and pay all their expenses themselves. But for those who have been dependent on their parents, like my daughter, this is meant for them. This is written for my daughter, but for any soon-to-be college graduate, this is for you as well.

    Saving - To be ready for retirement you must save for your whole life.

    1. Live within your means. This will be the most important lesson for you. You absolutely MUST NOT spend more money then you earn. If you are like many young adults, as soon as you get any money in your hands you spend it. Clothes, movies, nights out with friends….whatever. While in college your parents paid the rent, paid for groceries, paid utilities (especially the cell phone!), and most importantly they paid your tuition. So anything you made in a part time job was, by definition, spending money. But no more. After graduation you must realize that you will be responsible for all of these expenses, and that these essentials must be paid before you can think about buying new clothes, or another iPod, or going out to dinner for your friend's birthday. You will have to learn that all the fun things you are used to buying or paying for will have to take a back seat to paying for all the essential things you needs to live. And that brings is to the second lesson….

    2. Delay gratification. There is nothing wrong with wanting to buy something that you want. But with the change in your financial situation you are going to have to learn to put off that purchase. If it is something you really feel is worth having then you should start saving money, and when you have enough saved then you can go out and buy it. But under no circumstances should you put anything on your credit card that is not absolutely necessary. A credit card is for NEEDS, not wants. And that leads us to point number 3……

    3. Minimize debt. Getting into debt can lead to trouble. Some debt is good. A mortgage, a car loan, maybe even a business loan. All are responsible uses of debt. And having a credit card and using it responsibly is a great way to establish a good credit score. But piling debt on your credit card just to buy things you really don't need is a recipe for disaster. The late fees and interest charges will add up very quickly, and cost you far more then the original cost of the product you bought. If you can't afford to pay off your credit card at the end of each month, then you are taking on too much credit card debt.

    4. Keep your costs low. The best way to live within your means is to keep your costs low. Rent an affordable apartment. Buy a used car. Shop at the discount stores for your clothes, or at the more expensive stores only if the clothes are on sale (look at the clearance rack!). Buy groceries and household goods in bulk, and cook for yourself. Eating out is very expensive. And cut coupons! Save money any way you can. By following these tips you can still get all the things you need while also keeping your expenses as low as possible.

    5. Make a budget. This is essential. Every month calculate what your income is and then figure out what all your fixed costs are. Fixed costs include rent, utilities, car payment, student loan payments, etc. These are things that cost the same every month, and that you must pay for month after month. Once you have subtracted these fixed costs from your take home pay what you have left over can be used for your non-fixed costs. Non-fixed costs change month to month, but they are still things that must be paid every month. This would include things like groceries, gas money and clothes. Figure out how much you need to spend on these things and add it to your budget. Make sure you stick to that amount. Finally, after subtracting all these necessary expenses from your take home pay, what you have left over is what can be spent on the unnecessary things. By making a budget before hand, and knowing what you expect to spend on each category, you will have a better chance of not over spending, and of not having to use your credit card.

    6. Save receipts. This is a good habit to get into. When you first get out of college and get an entry level job you will most likely fill out the 1040-ez form when calculating your taxes. So you will take the standard deduction. Receipts won't help you. But when you start earning enough to begin itemizing your deductions, saving your receipts will be a big help. Get into the habit early.

    Investing - Now that you know how to save here is how to invest for retirement.

    A. Get an advisor and Make a plan. You probably don't know much about investing, even if you think you do, so find someone you trust who has a lot of experience, and read a lot of books. Educate yourself. And once you are ready to start, make a plan on exactly how you are going to invest. What will you invest in? How often? How much? What are your long-term goals? Decide all this before you start and set it up in such a way that you can easily follow the progress and determine if you are meeting your goals. As time goes on you can change the plan if it is not working or if your situation changes.

    b. Pay yourself first. You're probably going to have a relatively low paying job, and for the first time in your life you will be responsible for all your expenses. So how are you going to have any money to invest? You are going to pay yourself first, that's how. By this I mean you are going to set aside (SAVE!) at least 10% of every paycheck and put it into a bank account. This 10% has to be part of your budget so that it is just as much of a priority as any other of your expenses. Once you have enough saved to cover about 2 months worth of your expenses you can start putting money into a retirement account and begin investing.

    C. Open a Roth IRA. Use a discount broker and open a Roth IRA in which to put your investment funds. This will be funded with after tax money, so when you retire and withdraw the funds you will not have to pay any taxes on it. You can check with an accountant to see how much you can put into the Roth. Maximize this as much as possible.

    D. Invest regularly. Once your investing account is set up, and you have your investing plan set, you can start investing. Your plan should include regular purchases at a set time period. It's up to you what time period you pick, but monthly purchases would probably cost you too much in commissions. Quarterly or yearly is probably best. Don't skip any investments. Make sure your quarterly or yearly investment is in your budget and execute it.

    E. Diversify. You don't want all your eggs in one basket. If you own too much of one type of investment, one stock, one ETF, only owning technology stocks, etc. and it goes against you, your portfolio can take a big loss. When you first start, with the low amount of funds you will have, it's probably best to start with an index ETF. These are naturally diversified, have low fees, and pay a decent dividend. Once you have enough to start buying individual stocks, you can begin building a portfolio of 20-30 stocks, in different sectors, to make sure you maintain diversity.

    F. Buy dividend stocks and use the miracle of compounding. There are two reasons to buy stocks. One is for capital appreciation, which means that the stock rises in price and you sell it for more then you bought it. The other reason is to collect dividends, which is cash a company pays you just for owning it's stock. I suggest buying dividend stocks. No one knows what will happen in the future with stock prices. If the stock you own does not go up in price you gain nothing. But with a dividend paying stock you keep collecting cash, quarter after quarter, year after year. Even if the stock price doesn't go up, you still get a return. And don't just buy stocks that pay a dividend. Buy stocks that pay a dividend that rises YEAR AFTER YEAR! And once you have that dividend, reinvest it. This is how compounding will kick in. With compounding, when you reinvest your dividends, now those reinvested dividends will pay even MORE dividends next quarter. This causes your dividend returns to grow exponentially. A stock like Coke (KO) has been paying a higher dividend, year after year, for the past 50 years. Every year you get more money. Over a 50 year period, this can lead to great wealth.

    For example, lets say you put $1000 into a stock that pays a 3% yield. In the first year you will collect $30. But now lets assume that the dividend rises by 10% every year. After 40 years you will collect $1,357.80 every year! In cash! And over the whole 40 years you would have collected $14,636, on an investment of only $1000. And this, of course, doesn't even include any rise in the stock price. If you include an average rise in the stock price of 8% a year, the stock will be worth $23,462 after 40 years. Add in the dividends you were paid and that $1000 investment will have turned into over $38,000. And that is with a single, one time $1000 investment. That doesn't even take into account that you will be investing more and more each year. Over a 40 years period, if you continue to add new funds and reinvest the dividends, compounding will make you very wealthy.

    G. Stay 100% invested. The market will go up and the market will go down. But nobody can predict when that will happen. If you are going to use a dividend growth plan then you have to actually own the stocks to collect the dividends. If you are out of the market for any reason you cannot collect dividends. So it is my advice to stay 100% invested. You may reconsider this as you get closer to retirement, but while you're young you should stay fully invested. Every quarter take all the money you have deposited in your account (and collected from dividends) and use it to buy dividend paying stocks. This will maximize the amount of dividends you will collect, and over time, with compounding, your returns will skyrocket.

    H. Keep costs low. Every time you buy or sell a stock you pay a commission. Over time these commissions, if too high, can cost you quite a bit of money, and lower your over all returns. By keeping the commissions low, by using a discount online broker, and by keeping your number of transactions low, you will minimize these costs. If you buy a stock and hold it into retirement you will only pay a single commission. This will save you a lot of money as compared to trading in and out of stocks. There are no commissions when you collect a dividend.

    Summary If you follow these goals, although you may not live the high life in your twenties, you will be comfortable and financially secure, and as you get closer to your retirement you will find that you won't have to worry about money. You will have plenty. And who knows, you may even be able to retire early.

    While writing this it occurred to me that the lessons I want to teach my daughter are the same lessons people discuss on SA every day. And the lessons I want to teach her, I'm sure, are the same lessons other parents will be trying to teach their children. I hope by reading this article some people might get some ideas about how to approach this topic with their college age kids. And as I put this article together I came to realize that the lessons I will be trying to teach her are applicable to all of us. College students, young adults, Couples just starting a family, middle age people closer to retirement, and people already in retirement should all try to live by these principles. There is never a time in your life when you should not try to be financially responsible.

    I hope that if other people have other ideas for me and my daughter they can let me know in the comments section. I can teach my daughter a lot, but I know I don't know everything, and I'm happy to get whatever advice people can give me.

    Thank you for reading my article. I welcome your comments.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Tags: retirement
    Dec 24 5:41 PM | Link | 4 Comments
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