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Understand The Flow Of Money In The Economy

|Includes: ED, GPC, KO, PEP, PG, RDS.B, SBUX, Exxon Mobil Corporation (XOM)

In this blog I try to focus on the underlying concepts of things. Concepts change the way your brain works, and therefore how you see the world. I find it really helpful and easy to understand when concepts are explained to me in plain English. There are plenty of good books out there (and some other blogs and articles here on SA) which will tell you how to do quantitative things such as read financial statements, evaluate P/E ratios, look at dividend growth percentages, etc. Taking a look at all those hard numbers ARE very important, but evaluating numbers doesn't take the place of thoroughly understanding the basic underlying concepts of how things work.

The concept I want to go over today is our mental construct of "the economy." When we talk about "the economy," what we are really talking about is the daily, weekly, monthly and yearly "flow" of money from one entity to another.

When I refer to "entity," I am generally either talking about a person or a company. In legal terms, a company is generally considered a "person" although many who lean to the left politically feel this is wrong in some way. Usually these same people feel that companies who are providing what the market wants, doing it in an efficient and cost effective manor, and earning a handsome profit for it, are somehow being unfair. They feel the money made by these companies should be "redistributed" (a nice word for stolen) and then given to others who have not provided any of the previously mentioned value to society. But enough of that.

What is most important here is to understand how this economy (or "money flow") works and how to take advantage of it. Everyday people all over the world live their lives. On an average day they might get up in the morning, take a shower, wash their hair, put on deodorant, throw on some clothes, etc, etc. Then they might have some coffee, go to the convenience store and buy some snacks and a drink. They might fill their car up with gas every so often on the way to work. Throughout the day they'll probably chat on their cell phone. Maybe after work sometimes they might go out to dinner, and/or have a drink. Maybe after that they'll go home and relax on the couch for a bit, watch some TV or a movie and finally hit the sack and call it a night.

The person above is a tiny, tiny "slice" of the huge economic pie out there. Multiply those daily activities times several hundred million or more, happening every day all over the western world.

Now here's the key.

Every time these activities happen, money changes hands.

There are two sides to every one of these transactions happening every day.

There is a name for those who are on each side of these transactions. The vast majority of those who consume generally trade their time and labor in exchange for their money, which they then exchange for goods and services they want. They can be called "workers." Many of the companies which provide these goods and services are owned by shareholders. These people who own the shares can be called "owners."

The main concept to understand here, which should hit you like a ton of bricks if you didn't already know it, is the DIRECTION in which the money is going in all these transactions. It's quite obvious, but for every product, service and commodity consumed, money is transferred FROM the person or entity who has received the benefit TO the person or entity who has provided the benefit.

This is why owning stocks will grow your wealth in a way nothing else can over time.

Owners look at the world differently.

Learn to see the world as an owner.

BE an owner.

Let's re-look at the above person's day as an owner. Let's say he's a male living in the US. Let's call him Bob.

Bob gets up in the morning and hops in the shower. First thing he does is flip on the lights and electric heater in the bathroom. It starts blowing warm air. Now utility companies such as Consolidated Edison (NYSE:ED), Pacific Gas and Electric (NYSE:PCG), and Southern Company (NYSE:SO) are all receiving money from the Bobs all over the country. Next he turns on the shower, which gets nice and steamy. Now the water companies such as Aqua America (WTR - the countries largest supplier) start getting paid. And don't forget that steam needs to come from the water being heated. Most people have natural gas water heaters, so maybe Southwest Gas (NYSE:SWX) or Sempra Energy (NYSE:SRE) start making some cash. And even they have to buy their gas from somewhere to re-sell, so don't forget companies that specialize in pipelines and transportation of energy, such as KinderMorgan (NYSE:KMI). And then there's the big boys (known as INTEGRATED oil and gas) such as Chevron (NYSE:CVX) and ExxonMobil (NYSE:XOM), the ones that actually drill for the gas, taking the supply chain all the way back to it's roots, deep down into the ground somewhere in some hostile and remote region of the globe, maybe even miles under the seabed of a deep dark ocean somewhere. All this water and energy doesn't cost Bob very much, probably under a buck or so. But there's millions and millions of Bobs.

Once he rinses off, he's probably going to reach for some shampoo. Maybe he uses Head and Shoulders. He squeezes some out into his hand. It's not much, maybe 10 or 20 cents worth. Times several million. Proctor and Gamble (NYSE:PG) just got paid. Maybe he shaves in the shower. I do. I like to save money by not buying shaving cream. But I still need razors. I've found Gillette to make the best razors on the market. And they only last about two weeks, even trying to get as much use out of them as possible, until they are uncomfortably dull.

So, BANG. More money to Proctor and Gamble, the parent company of Gillette.

Then Bob gets out of the shower and puts on some deodorant. Now personally, I use Old Spice brand deodorant, and have been for 20 years. Guess what's listed in tiny print on the bottom rear of the tube. "Proctor and Gamble Company." MORE money to Proctor and Gamble. As you may have guessed, Proctor and Gamble is one of my favorite stocks. I looked around my house and realized a huge percentage of the products I use around the house came from them and they had been getting a large chuck of my money for decades and I didn't even know who they were. Now I know.

So then Bob goes down stairs to make coffee. Maybe he uses Yuban (made by Kraft foods - KRFT) or Folgers. Folgers used to be owned by (ohmygawd...) PROCTOR and GAMBLE until 2008 when they sold it to JM Smucker Company (yes the same company that makes the Jam.) Oh, and don't forget that coffee maker uses a pretty good jolt of electric juice to get that coffee steaming hot, so lets throw a few more pennies over to the above electric companies.

And maybe there's some dirty dishes in the sink, so being the conscientious guy he is (why do you think Bob's wife married him anyway?) Bob throws the dishes in the dishwasher and pours in a bit of Cascade and hits the start button. Do we really need to go over who owns Cascade? You should know by now. Oh, and don't forget the dishwasher uses hot water and electricity, so the money starts transferring again, even as Bob kisses his family goodbye and heads out to work.

On the way to work, Bob stops off at the local Shell station (Royal Dutch Shell- RDS.B), fills up and grabs a Coke (obviously Coca-Cola- KO) and some chips, let's say Doritos. Or maybe he's not a Doritos kind of guy. Maybe he got Cheetos, Fritos, Cracker Jacks or Ruffles. Or maybe he's trying to be health conscious and picked up some Sun Chips. These are ALL brands of Frito-Lay, which is a division of Pepsi.

Almost regardless of what he buys, small amounts of money are being transferred from workers to owners.

Small amounts times hundreds of millions of transactions.

All day long.

Everyday.

Are you starting to see a pattern?

What about that car Bob is driving? It needs to be insured 100% of the time. Should we cover insurance companies? (Geico, Mercury General, etc, etc) Every few years it needs new tires (Goodyear, Bridgestone.) It needs constant maintenance. The brake pads wear down with normal use. Even if Bob is a frugal, do it yourself kind of guy and changes them himself, he still needs to buy the parts. Maybe he goes to the local Napa auto parts store. (a division of Genuine Parts Company- GPC).

All this, and Bob hasn't even gotten to work yet. In fact, he probably opened his eyes to his alarm clock going off less than two hours ago. I could continue throughout his whole day but this post would go on forever, and hopefully you get the idea by now.

When you become an owner, you get paid. By millions of people all over the world, every day. All day long. Every day these people wake up in the morning and think about how they are going to make their lives better. For most people, a "better" life means consuming more items of higher quality. They might be doing it on the level of "thinking big," such as driving a newer, fancier car or live in a larger, more upscale house, or "thinking small," such as having that morning $5 fancy latte at Starbucks. Whether big or small, when people achieve these goals, companies make money (known as earnings) and return a portion of it back to you (known as dividends.)

You have now discovered the goose that lays the golden eggs.

As long as you choose companies that make things that people need and use on a daily basis, and are well known quality brands that people have been buying for decades on end, you pretty much can't go wrong. You will enjoy workers money being transferred to you for decades, your family may even enjoy it for generations.

All because you learned one simple concept about how the economy works, and what is the best use of your money.

Become an owner.

AND, (as you should have learned in kindergarten,) don't EVER sell the goose.