Keep It Simple

The stock market is already complicated enough, you don't need to buy businesses, you don't understand.  Sectors are sections of the market that group like minded business.  I stay away from certain sectors, because I have to admit I just don't fully understand their business.  The Banks, and Big Pharma are sectors for examples.

The Banks have complicated financials, and things on their balance sheet, called "Level 3 Assets".  All I really understand about those, is they assets that aren't accounted for.  They are invisible.  I have no idea why they exist.  There a lot of bonuses' being flung around in this sector, leverage being used, and I believe weird accounting is more prevalent.  That all adds up to I'm out on the Banks, for the most part.  There are certain foreign banks in which I would entertain the idea of investment but we can talk about that, a year down the road.  I don't own any currently.

Big Pharma, trades on medical breakthroughs, and patents.  This means that while a drug companies have a monopoly on it's drug, they are making lots of money selling it, because no one else has it, they are allowed to charge very high rates for it.

At some point, they will lose their exclusivity, and what they call "Generic" Drug Companies can make it, and sell it for cheaper.  This lowers a companies earnings, so they are forced to find new innovations to fund their companies future.  If they don't, they will get bought out, or drop big.  I can't guess when these breakthroughs will happen, so how am I to guess which stocks will have real longevity?  I don't understand the science happening on the ground level, so I'm out.  I'd just way rather own Altria, and sleep at night.

Understanding how a business is going to make money going forward is very important.  Established business' are expected to make money each year, and to slowing grow those earnings over time.  If they can do that, eventually they can afford dividends, and become long term winners.

Altria is simple.  They sell cigarettes, and chew tobacco (and also own at least a 30% stake in SABMiller.)  Each year less people are smoking overall, so the total market is shrinking by about 4% a year, but then they raise prices by 8% a year, to offset that, and grow earnings.

I have a high confidence level that people will continue to drink and smoke as they have been doing it for thousands of years.  Buying the biggest brand in the US, increases my confidence.  I can't see another company just coming out of nowhere and killing off the Marlboro Man.

I understand the business.  They sell a product people want, they have input costs, labor costs etc., At it's core, it's an easy to understand.  How much product are they selling, and at what price, and what is it costing them to make it all?

That's oversimplified, but you get the idea.  You need to understand what factors drive each business.  Watch the numbers closely.  A good company should be able to maintain fairly steady earnings growth, and a mostly stable stock, relative to the market.  When buying a new stock, dive right in.  Learn everything you can about the business.  If you think you understand how they are going to make money, and increase earnings going forward, take a look at the technicals, and buy the stock as it looks poised to pop.

There's a worry with foreign stocks, that trade on foreign markets.  It can be hard to get information about their earnings.  They can be held to different accounting standards.  For the most part I like to invest in North American companies, and get access to emerging markets through them.  If you live somewhere else int he world, make sure you trust the market, and the company you are buying.   "Emerging Markets" is just a term, for a certain part of the world, that is just starting to advance technologically.  Investing these markets can be lucrative, but most of the time, carries more risk.

I like an established business, with good visibility.  "Visibility" in this game, means how far you can see a companies earnings continue for.  You need to at least have the information accessible if you wish to understand the financials behind the company.  When starting out, stay away from any stocks that don't trade in North America.  We can always add the weird specs later.  Find companies with earnings, a chart you can look back on over 5 years, maybe even a dividend history.  Those companies will have conference call histories, which you can go back and listen to.  Without information, you are blind in this game.  Make sure your stocks give you everything you need to make an informed decision.

Time to open our ears, and check out "The Conference Call"...

Dividend Stocks and Money Management

Altria, or MO was about 75% of my portfolio to start the year in 2011.  This would not be considered a normal investment strategy, but it did allow me to make 18.5 percent on my total portfolio last year.  There is a time and place for all kinds of strategies, but MO made it easy, the whole year.  I love this stock for many reasons, and I'm going to try to explain, why this stock is so amazing.

Established companies payback shareholders in a couple different ways.  The stock can go higher, that is capital appreciation.  They can pay a dividend, most likely quarterly, so that you get money while you hold the stock.  They can also buy back shares in the market, essentially removing those shares, from the share float, making every share, slightly more valuable.  The float is how many share the company has released into the wild.  Essentially, how many pieces the company has been broken up into.  

Lets say you buy 100 shares of Altria tomorrow at $28, for a total investment of $2800.  Using round numbers Altria will pay you 6% a year on your investment, or $168 per year.  Doesn't sound like much?  Well keep listening...  Altria also increases their dividend about 1-2 times a year on average.  Meaning, instead of making 6%, next year, if the stock price is still at $28, you might make 7%.  As the years go on, the dividend yield you recieve on that original investment goes higher, so you dividend return on that money can be sky high, after many years of increases.

When you also have a company that buyback shares, they lower the share count, which increases the EPS automatically.  If the EPS (earnings per share) increases, they can also increase the dividend.

Basically if company A, has 100 shares outstanding, and makes $100 a year, then the EPS is $1/per share.  If that same company decides to buyback 5 shares that same year, and they have no increase in earnings throughout the year, next year, they will make $1.05 EPS because you can now divide $1 earnings per year, by 95 shares, rather than 100.

Basically the less shares outstanding the better for all investors.  If that float, is shrinking due to a buyback, that's a good thing overall.

Altria has a "pay out ratio" of 80%, meaning they will pay out 80% of all profits in the form of a dividend.  So they buyback shares, which decreases the float, and increases the EPS, which allows them to increase the dividend, that increased dividend increases the dividend yield, which likely increases the share price.  That is the virtuous circle I was talking about.

As always, feel free to ask me anything about this, in the comments section below.

Stocks that have safe, growing dividends are very resiliant in an up or down economy.  I use this stock to anchor my portfolio, and I would recommend you do the same.  By having 50% or more of your portfolio in a safe dividend earner, you will have a much easier time beating the market.  From there you can add the risky high fliers that really make this game exciting.

The reason I like one stock for my big dividend play, is because I just need to be right one time.  If that part of my portfolio works, then I can afford to lose, and take risks in other areas.  I can focus a lot of my energy just making sure this secure part of my portfolio really is secure.  I only have to listen to one conference call a quarter, instead of five.  Watch for one set of earnings reports.  This is not the type of investment you can afford to lose on.  Your high dividend yielder, should have money to pay that dividend for years.  It should be secure, and the business should have no real way to be undercut, or go broke.

From here all we need to do, is "Keep It Simple"...