The current state of the market as measured by the Standard & Poor Index of 500 Stocks is as follows:
Price earnings ratios of 44 times trailing twelve months earnings;
A dividend yield of less than 1.3%.
With price earnings ratios at an all time high, and the dividend yield, or payout to investors, at an all time low, there is no value in the market as a whole. There are some individual values, which will be addressed below, but the market as a whole is very dangerous, very overpriced, and very likely to continue to lose investors more of their hard earned money.
There are only two types of investors: (1) value oriented investors and (2) everybody else.
Value oriented investors will always adhere to the following simple rules:
1. Never risk principal.
2. Don’t be greedy.
3. Respect the time value of money.
4. Limit your choices.
Never Risk Principal – Principal is hard to come by, so it should be invested conservatively. High yield, low risk investments will assure better long-term results for both your pocketbook and your health. Investments in “high risk”, non-dividend paying securities should be limited to what the investor can afford to lose because most investments in high risk, non-dividend paying stocks lose money for the investor. On the other hand, investments in A rated stocks that have a low price earnings ratio (16 or below), that pay a good yield (above 4%) may not have “glamour” stamped upon them, but they usually insure a nice stream of dividend income and good appreciation over a period of years.
This is particularly true of those companies that have a history of increasing their dividends over time and, hence, inviting their stock holders to participate in the earnings of the corporation.
Don’t Be Greedy – Measuring one’s greed is difficult. All of us want to make very high returns. It is easy to listen to a broker’s spiel and get excited. Brokers are in the business of selling stock because that is where commission income is greatest. They are pounded by their firms to sell stocks, sell stocks, and sell stocks. At this point in economic history, brokerage firms are recommending that 70% of ones investment capital be invested in common stocks. The 70% recommendation is a record high suggestion for one’s portfolio to be invested in common stocks. And, this recommendation comes in the most expensive, overpriced market in history. Don’t believe it! This is not the time to carry a significant percentage of common stocks in an investor’s portfolio. Higher returns bear higher risks, and greed among investors is invariably why people lose money. Try to remember this: if you are being “promised a 20% return”, the smartest, best connected investors in the world fight all day long to get 15% returns, let alone 20% returns. The long-term average historical return on stocks is about 11%, almost one half of which comes from dividends.
Respect The Time Value of Money – To comprehend the time value of money, one must learn patience. A 5% compounded annual return will multiply money about 1.3 times in five years, and a 10% compounded annual return will multiply money about 1.6 times every five years. A 15% compounded return will double money every five years and a 20% compounded return will multiply money by 2.5 times every five years. Compounding is the key to riches. If one invests in high dividend paying stocks, those dividends can be reinvested every year in another security. Dividends represent a real return on investment.
The average annual return (dividends and price appreciation) of the Dow Jones Industrial stocks from 1945 to 2000 was just over 11% annually. Dividend yield averaged 4.2% and price appreciation averaged around 7% annually. Ten thousand dollars invested in the Dow Jones 30 Industrial stocks forty-seven years ago would be worth about three hundred and thirty thousand dollars now and the “average” dividend yield on that ten thousand dollar investment would have grown from three hundred and ninety dollars a year to seven thousand dollars a year today.
Limit Your Choices – Stay away from illiquid investments, limited partnerships, commodities and other schemes that are generally sold as “sure shots”. Stick with stocks and bonds priced for good potential for appreciation, and priced to give you a good annual interest, or dividend, return.
Adherence to the above requires discipline. A disciplined approach to money management will yield good cash returns on an annual basis and good appreciation over a period of time. And as mentioned above, a disciplined approach is also best for your health and your happiness.
There are numerous services available to investors, who understand only the rudiments of investing that foster prudent, value oriented advice. They can also be a tremendous supplement to the investor’s knowledge, and an educational tool, as well. The Dow Theory Letters (www.dowtheoryletters.com) provides a daily market summary and a newsletter every three weeks that is the best analysis of the markets. For the value-oriented investor, IQ Trends (www.iqtrends.com) tracks the three hundred and fifty most important, highest rated, dividend-paying stocks available today. And no investor should be without Warren Buffet’s favorite “investment guide” written by his mentor and former professor, Benjamin Graham: The Intelligent Investor.
These educational aids alone are all any investor needs to insure maximum return on their invested capital. Quite simply, if it works for Warren, it should work for us “mere mortals”!
George Rauch
March 22, 2002
