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How to Invest
A friend of mine recently asked me if I could do a blog on what I’ve learned about the stock market and other types of investing, and I’m more than happy to oblige.
I first started learning about the financial industry in high school and I’ve kept a slight eye on things until mid-2008, which is when I ramped up the amount I paid attention to the financial industry and the stock markets. After a lot of scrutinizing, I’ve found that a lot of the ways I’d been going about trying to increase my investments were inefficient at best.
Banks Are Inefficient
For quite some time in my youth, I used savings accounts to sock away some money for a rainy day and earn a little interest on my investment. As I was growing up in the 1990s and 2000s, interest rates were perfectly acceptable and the average yearly increase was matched and passed, especially by CDs (Certificates of Deposit).
However, with the 2008 banking crisis, interest rates from banks dropped like a rock and have been negligible ever since. They still serve their purpose as a place to sock away money for a rainy day or a place to house an emergency fund, but if that money isn’t used in a timely fashion or put somewhere that beats the rate of inflation, it will slowly lose value.
For example, a lot of folks have ING Direct savings accounts – I do as well. When I first signed up for the account (which was shortly before the 2008 banking crisis hit), the interest rate was at a healthy 3% a year, which beat the 10-year average inflation increase of 2.4% a year (though not the 100-year of 3.4% a year). After said crisis, the interest rate dwindled down to a meager 1.1%, which isn’t quite half of the 10-year average inflation rate.
To break it down further – take $100. The $100 that is put in the savings account at 1.1% per year is now worth $101.10 after a year, but the price of something that was $100 at the time of the investment is now $102.40 a year later, thanks to yearly inflation. Now the 2.4% isn’t a steadfast number – last year, the US actually had deflation of 0.34% and this year inflation is about 1.48% through October, but it’s a good indicator to work from.
Beating Inflation Through Dividend Stocks
While it’s important to know the inflation rate, it’s more important to know how to surpass it with your investments. The best way I’ve found is through investing in stocks that pay out dividends to the shareholders. With dividend stocks, not only do you have potential growth through the stock price, you also receive a quarterly payout which you can use however you please. I’ve written before about how to get the most out of dividend stocks, though I’ve picked up a few new tricks of the trade over the past few months.
First, find an online broker. I use Sharebuilder, because they’re easy to start with and very efficient. While I like them for their service, I much prefer MSN Money for the way they list their financial information.
Next, go to MSN Money and enter the name of a company or the symbol where it asks you to and click on “Get Quote”. For an example, lets go with Johnson (formerly known as Johnson & Johnson) or JNJ.
That brings you to the next screen, which will have a bunch of information that could overwhelm you. The important pieces of information here are of course the price (which you can’t miss), but also on the right-hand side of the screen, there’s the Dividend & Yield amounts, as well as the Earnings/Share and the P/E.
The Dividend & Yield amounts show how much the stock pays back yearly per share owned, and the Yield is the percentage of the price that is payed back through the yearly dividends. Say you have a stock that costs $100 a share, and the dividend is $5. If the dividend stays constant over the next 20 years, you’ll make your money back. However, lots of companies grow their dividends – some of which do so every year. I’ll get to that in a bit.
The Earning/Share is the amount of a company’s earnings divided by how many shares they have on the market. As you can imagine, a higher number is better. The P/E is the Price to Earnings ratio, which divides the earnings from the price and is a handy indicator of how the stock is doing. MSN can be a little funky with this on certain stocks, so I plug the numbers into a calculator to be sure.
An example would be if a stock costs $100 and the Earning/Share is $5, the stock would have a P/E ratio of 20. Some folks use 20 as an upper limit when they buy, though for the most part, I use one of 15 as I’m trying to make good choices and be frugal at the same time.
Now, JNJ currently has a price of $63.83 per share with a $2.16 yearly dividend, which yields a 3.38% growth in one’s investment. That beats the 10-year average inflation and ties the 100-year average inflation rate. It’s also worth $4.87 a share and has a low P/E ratio of 13.11 (though the site says 12.52).
One thing to note about JNJ in particular is that the company has increased its dividends for the past 47 years with an average increase of 13.4% per year since 2000. It’s also one of the companies that makes up the 30 stocks in the Dow Jones Industrial Average, which means that it’s one of the largest and widely-held companies in the US. If it isn’t obvious by now, I do have some shares in JNJ and I’ve certainly been pleased with the results so far.
There are more factors to take a look at though, and I’ll walk you through them. On the left-hand column in the JNJ quote, go down to Financial Results under the Fundamentals header. There’s something very important to check on this page, and that’s the Payout Ratio – the percentage on the bottom right of the Financial Highlights chart. You can see that it’s at 42.00%, which means that JNJ pays out 42% of its profits to its investors.
A company that pays out less than 60% certainly has room to grow their business and grow their dividend, which makes them a great choice for long-term investment. A lot of the telecommunication stocks are usually closer to 80% and can be good choices as well, but they take on more risk, as they generally have higher yields.
Now click on the Key Ratios tab and go to the Financial Condition tab. The important one to look at is the Leverage Ratio. The Leverage Ratio is the division of the total assets of the company from the shareholder equity invested in the company. A ratio of 5 is the industry standard, and a ratio of 2 is ridiculously good. As you can see JNJ has a 1.7 leverage ratio, which makes them very strong financially.
There’s one last thing to check, so go to the Earnings Estimates tab under the Research header, then click on the Earnings Growth Rates. The one to pay attention to for long-term growth is the Next 5 Years figure, and you can see that it says 6.1% for JNJ. Anywhere between 5% and 14% is an indicator of a strong, stable company with positive growth. As you can see, JNJ passes all of these tests and would be a fine way to invest some of your money.
The reason I went through all of this is that you can plug any number of stocks into this equation and see how well they fare. You’ll want to invest in more than one stock, as having a diversified portfolio in a number of sectors will prevent you from losing much of your portfolio should something unfortunate happen to one of the companies that you own stock in. A good rule to go by is to not have more than 20% of your net worth invested in any one investment.
Highest Dividend Yielding Stocks
For those looking for the quickest return on their investment, REITs (Real Estate Investment Trusts) are the way to go. The best of the bunch right now are yielding between 15% and 20% a year. Of course, they’re highly volatile, but in the short-term, they can be great boosters to your net worth.
The main thing to watch with REITs are their payout ratio. REITs are required by law to pay out 90% of their profits to their investors, so seeing a REIT with a payout ratio of 90% is not an issue. The three best performers right now are AGNC (at 91%), HTS (at 105%), and NLY (at 208%). As you can see, AGNC is pretty much on-par with its payout ratio, HTS is a little high but has potential to recover, and NLY is way over the top and will likely have to cut their dividend in the near future.
It’s unfortunate, because two quarters ago, NLY was around 90%, but they jumped to about 155% last quarter and 208% this quarter. That means they are paying out over double their profits to their investors, which is completely unsustainable.
More Ways to Invest
There are certainly more ways to invest and grow your net worth than I have listed here, but the stock market has been rather good to me this year, so I haven’t really dug into investing in precious metals or commodities or any of the other types of investing.
Dividends are definitely the safest and likely the surest bet (depending on the company they’re paid by) in the short and long-term, and if the banks ever get their act together, their ways of offering interest may return to being valid choices. As it is, I can definitely recommend starting a portfolio comprised of stocks that pay dividends.
I’ve added a few links below that could help you to figure out what stocks might be worth your while to investigate, as they all have some serious positives to them in one way or another. I hope this blog has been helpful!
Discuss this post at the For the Love of Creativity Forum!
Posted on November 20th, 2010.
External Links
• 25-Year Dividend Increasing Stocks – 25-Year Dividend Increasing Stocks | Dividend.com
• Dow 30 Dividend Stocks – Dow 30 Dividend Stocks | Dividend.com
• Fastswings – FastSwings: Stock Carnival Ecstasy – November 25, 2010
• MSN Money – Personal Finance and Investing – MSN Money
• My Wealth Builder – My Wealth Builder: The Wealth Builder Carnival #16
• Personal Dividends – Carnival of Wealth #14 – Nov 28 2010 Edition – Personal Dividends – Money+Lifestyle
• Sharebuilder – Buy Stocks Online and invest your money at ShareBuilder
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