Follow on Twitter to See Where SmallIvy is Investing

Ask SmallIvy:  Please send to vtsioriginal@yahoo.com or leave in a comment.

In making posts, I have purposely avoided making specific stock recommendation.  The reasons for this are two-fold.  The first is that I don’t want the liability of making specific recommendations.  With investing, not every pick pans out, and what you should buy depends on your situation and a lot of factors.  I also don’t want someone to buy a stock based on my recommendation and then hold too long because I don’t follow-up with sell recommendation.  The second reason is that I’d like everyone to learn the principles of finding good stocks themselves, rather than blindly follow recommendations I make.  My goal is to provide the information needed for individuals to become good investors.

If you would like to see how I personally approach investing, however, I will start making tweets about different stocks I’m considering, evaluations of the market, and so on.  If you’d like to see what I’m doing, please follow SmallIvy_SI on Twitter.

Happy Investing!

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles and see where SmallIvy is investing.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Small Caps and Large Caps

Ask SmallIvy:  Please send investing questions to vtsioriginal@yahoo.com or leave in a comment.

Dear SmallIvy,

What is the difference between small caps and large caps and what percent should I own of each?

Thanks,

Scott

Dear Scott,

Small caps are stocks that have a small value, or capitalization.  These are small companies that often have just started within the decade.  These are bigger than the penny stocks, which are listed on their own exchange, but much smaller than the large companies you think of every day.  Specifics of small caps are:

• Reinvest all of the profits and therefore pay no dividend
• Can grow earnings very rapidly
• Are often only operating in a limited number of locations
• Often operate very efficiently
• Can grow in share price rapidly
• Can go out of business after a couple of bad quarters
• Fluctuate in price a lot

Large caps are big businesses with lots of employees, lots of revenue stream, and many locations.  These companies do billions of dollars worth of business each year, are often international, and have large boards.  Specifics of Large Caps are:

• Usually pay a dividend since the opportunities for growth are limited
• Earnings growth is usually limited to single or low double digits each year
• Operate in many locations and have many business lines – are household names
• Have large boards adn are slow to change
• Don’t typically increase in price rapidly
• Can withstand significant downturns by contracting and using assets
• Often have significant international exposure

So, small caps can grow in price rapidly, and therefore offer a good return, but are less stable.  Large caps are more stable, often offer a dividend, and are unlikely to go out of business, but generally don’t appreciate very fast.  During some periods (especially bad economies), large caps will perform better.  During others (especially rapid expansions), small caps do better.

In setting up a portfolio, the mix depends on your time frame.  You always want a mix because each sector will perform well at different times.  In general those who have a long time frame (a long time until you need the money) should weight more heavily into small caps (and mid caps) since their return will be better.  Those who will need the money sooner and can’t wait out a long drop, however, should weight more heavily into large caps.  Whatever money will be needed within the next five years should be in a money market fund or bank CD because the risk of owning stocks at all is too great for short periods.

Regards,

SmallIvy

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Should You Buy Dividend Paying Stocks?

Utilities, which tend to pay high dividends and have a regulated monopoly, meaning that they have predictable earnings and rarely lose money, were once thought of as “widow and orphan” stocks.  These were stocks for those who needed steady income and could not take a substantial risk.  People would give up the potential gains from growth stocks and smaller companies that could provide large capital gains in exchange for the relative safety of a steady dividend.

Companies that pay large dividends tend to be large companies late in their life cycle.  They have already grown as big as they will and now have a steady business that provides a good cash flow.  Because they are not growing rapidly, they are able to distribute money to investors.  They are not acquiring other companies and opening new locations.  Note that even if they continue to grow (Walmart and Microsoft are still expanding, for example), they are so big that they simply cannot grow at the rate of smaller companies.  For example, how much more oil would Exxon need to produce to double their earnings if oil prices remained fixed?

In fact, the pricing of all stocks assumes that some day they will either start paying a dividend or be bought out by another company that will.  If the company were to keep reinvesting all of their earnings in acquisitions and growth, while the company would be getting bigger and earnings would be increasing, the share holders would never receive anything for their investment.  Eventually the company is expected to reach its elder years and start to pay out a good protion of their earnings in a dividend.  When buying a young stock, the price paid is actually a factor of how large the stock is expected to be, and thereby how much cash it will have for dividends, combined with how likely it is to obtain that size and how long it will take to get there.

So stocks that pay large dividends generally cannot be expected to grow significantly; however, they add stability to a portfolio and (nearly) guarantee a return even when the market is flat.  Those who bought pure growth stocks during the 2000′s may have seen no return at all (at least of  they bought enough to mimic the behavior of the whole market, which has been relatively flat).  If they bought stocks with a 4% dividend, however, they would have at least gotten a return of 4%.

Another advantage of dividend paying stocks is that they tend to be more stable in price.  This is because as long as they are able to keep paying the dividend the yield of the stock will put an effective floor on the price.  If a stock is paying $1.00 per share per year, at $10.00 per share the stock will be paying a yield of 10%.  If it drops to $5 per share but the dividend remains unchanged, it will be yielding 20%.  At some point the yield will become so big that investors will come in and buy the stock  simply for the dividend.

One must be careful, however, when buying stocks with outsized yields.  If the business is suffering along with the share price, the company may not be able to continue paying the dividend and may need to cut it.  When that happens, if people are buying the stock simply for the dividend, the stock may fall in price dramatically.  When looking at stocks, make sure the earnings are substantially larger than the dividends (maybe 2 times as much) and that the company has plenty of cash flow.  Also, see if their peer companies are paying comparable dividends or have cut their dividends recently if they are not.

Finally, dividend paying stocks aren’t for everyone.  When you are just starting out and have little money to invest, growth should be the primary driver.  Investments should be made in stocks that are likely to grow rapidly and produce large returns.  As one starts to build up a substantial net worth, however, and the focus turn from growth to stability and income, the inclusion of some high dividend paying stocks is a necessity.

Think of it this way.  A portion of your portfolio should be for increasing wealth.  This is the portion that is filled with growth stocks – companies that are small and growing and have great prospects for years to come.  The other portion of your portfolio should be for capital preservation.  This includes high yield stocks, bonds, and mutual funds that invest in large portions of the market.  These are established companies and the preferred stocks of companies.  These stocks are not expected to provide a significant portion of their return in capital gains (although the price will generally tend to increase with inflation), but they will provide stability and help protect your net worth during downturns.

As time passes and your net worth grows, and as you get closer to needing the money, the growth portion as a percentage of your portfolio will decrease and the income/stability portion will increase.  As you really start to need the money, some stock should be sold and converted to cash to provide even more of a cushion against downturns.  I always hate to hear about people putting off retirement because of a drop in the market.  With proper asset allocation, you won’t be one of them.  This includes allocating a portion of your portfolio to high yielding stocks when it makes sense.  When they drop, you can sit back and collect the dividends while you wait for them to recover.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Should You be a Stock Investor or a Mutual Fund Investor?

In general, chosing individual stocks requires more skill and the ability to pick stocks, but the advantages are higher potential returns and control over when and how the securities are traded.  Mutual funds offer instant diversification and generally require little investing skill, but the investor has little control over when trades are made and the resulting cost and tax consequences.  In this article, both strategies are discussed to give the reader information needed to make the choice.

Investing in individual stocks and investing with mutual funds could be likened to driving a car with a manual transmission or an automatic transmission, respectively.  For a person who likes to drive, a manual transmission and the control it provides is very desirable.  On the other hand, for a person who just sees a car as a means of transportation, the need to manage the gears could be seen as a nuisance.  Likewise, someone who is skillful with a manual transmission can achieve better fuel economy, but an individual who does not understand what he is doing might end up burning more fuel with a manual transmission than an automatic.

The main advantage of individual stock investing is control over the investment.  By selecting stocks with a long-term growth horizon, one can buy and hold stocks for long periods of time, thus reducing trading costs and capital gains taxes.  In fact, if one could buy and hold a single stock for one’s whole career, one would not pay any income taxes until the stock was sold at retirement even if the stock was not in a sheltered retirement account.  One is therefore able to take advantage of compounding.

A second advantage of individual stock investing is the ability to select just the stocks one really believes in.  Rather than buying one’s first, second, third, and fourth choice in each business line, one can select just the cream-of-the-crop.  If one feels that Apple Computer is a great investment, one could just buy Apple Computer.  A mutual fund manager, because he has so much money under management, would need to buy Apple Computer, Dell, IBM, and several other companies to fully invest all of the cash he has.  Even if he had the same strong convictions about Apple Computer, there would not be enough shares available for him to buy at any reasonable price.  He would also be very clumsy when entering and exiting the market because of the necessarily large size of his positions.

A third advantage is control of fees and trading costs.  When in a mutual fund one typically needs to pay fees to the fund managers and mutual fund company each year.  One would also need to pay some of the marketing costs for the funds and for the trades that the managers decided to make.  If one holds individual stocks long-term, the only costs will be the yearly fee for the brokerage account, which would typically be about $100 even for a million dollar account.  If that is too much one could even ask for stock certificates to be sent and keep them in a safe deposit box or under one’s mattress.

One disadvantage of individual stock investing is that it requires a level of skill by the investor at picking stocks.   If one is a poor stock picker and one’s picks lag behind the market, one would have been better off in a mutual fund.  This means that individual stock investors must be able to read the balance sheets of  companies and know what factors indicate a good likelihood of success.  Often various publications are required to give the needed information.  Likewise, he must know how to enter a trade and establish a position.    Finally, he must have a sense of the state of the economy and be able to see which industries will prosper.  In many ways the ability to pick stocks is more of an art or a craft than a science. 

A second issue with individual stock investment is that the level of fluctuations in individual stocks is fairly high.  It is not uncommon for an individual stock to rise by 100% or fall by 50% or more in a single year or even over a period of several weeks.  For those who are nervous about investing, these fluctuations could make it difficult to sleep at night.  Worse, anxiety could cause one to make irrational decisions, locking in losses and missing out on big gains.

Like the automatic transmission car, mutual funds are well suited for those who just want to use investing as a utilitarian way to build wealth.  One will never be able to beat the markets — in fact one will lag the markets by a few percentage points due to the fees charged — but one will certainly make a good return with little personal effort.  Because the investment is spread out over many stocks – a trait called diversification – the level of fluctuations will be far more subdued.  Typical fluctuations in value of +/- 20% or less are typical.

The disadvantage is lack of control over the frequency of trading, which could lead to capital gains being booked each year, decreasing the ability to compound gains and driving up costs.  Investing in index funds or Exchange Traded Funds (ETFs), which have a specified investment mix, can substantially reduce the frequency of trading (called churn) and fees overall since a full-time management team is not needed.  If investing in mutual funds, the secret is to find the funds with the lowest fees (this is the biggest indicator of long-term return) and to avoid chasing returns (if you buy the funds that did the best last year you will likely be buying a basket of high-priced stocks). 

Finally, there is no reason that one can’t hold a portion of one’s portfolio in individual stocks and the remainder mutual funds.  In fact, as one accumulates wealth, it makes sense to put a substantial portion in mutual funds since the diversification they provide will help protect the value of the portfolio.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing

When Picking a Stock, Think like a Partner

Many recommend against picking stocks.  They point to all of the studies that show that managed mutual funds tend to do worse than index funds over time.  If a professional money manager, with all of his reasearch tools, support staff, and experience cannot beat the market, what chance does an individual investor have?

In some ways they are right.  Certainly someone who spends all day researching companies will have better tools available.  An individual with a wealth of information will know things that others may not.  The lack of performance, however, stems from two fundamental issues that the professional has that the individual does not:  1) The need to buy several stocks since the amount to be invested is too much to concentrate in a few stocks, and 2) The need to demonstrate current performance each year to avoid having investors take their money elsewhere.

An individual has neither of these issues.  A person can usually invest even a life’s savings in a single stock without affecting the share price.  Likewise, an individual can be patient and suffer through down years – what the market thinks of one’s stock pick at any given moment, as reflected in the stock price offered,  is of no consequence.

Trying to time the market and play the little games – rushing into the hot stocks and trying to figure out the various patterns in share price – will eventually lead to ruin.  When investing, one must take advantage of one’s advantage. 

Instead of thinking of buying stocks, think of buying companies.  When one  buys a stock one thinks about the current share price, expectations for earnings in the next quarter and whether there will be a surprise that affects the share price, whether the stock is overbought or oversold.  In general everything is focused on the price per share.

Think instead of the questions you would ask if you were supplying the funding for a friend to start a business.  Stock ownership allows individuals to become entrepreneurs, albeit with less of the risk and somewhat less of the return.  One can find a star leader with a strong concept and invest with him/her.  That individual and his/her team will then work diligently, many hours per day, trying to grow the value of the company, and one’s investment along with it.

What would you be looking for in the investment?  If you were being approached by the management team about giving your money to them and receiving a part of their business, what sorts of questions would you ask?  Here are a few:

How will the company make money?  Is the company currently making money, and have they been able to grow business over the long-term?  Is the management team proven that they know how to execute and deliver results?  Can the company keep growing?  How do they treat their employees – their most important resource?  How about their customers?  Is the company fundamentally honest in how they treat customers (individuals who are honest do much better in the long run when running a business)?  How do the executive treat the shareholders?  Do they carefully conserve resources, or do the squander shareholder money on lavish accommodations and perks?

Think this way and share price begins to matter a lot less.  The companies that execute well, have a good concept, and have good leaders are actually fairly easy to find.  Beyond this, one wants to find companies that still have room to grow earnings because that leads to growth in dividends, which eventually translates into growth in share price. 

If one is buying companies, instead of buying stocks, and one has done the research and determined that the companies one is buying are great companies, it makes sense to concentrate a bit more.  After all, if starting up one’s own business one would put in every dollar.  While this does not make sense when investing in stocks, since one does not have the same level of control as one would have with a business, it also doesn’t make sense to buy 100 companies when one can pick five great ones in the basket. 

Entrepreneurs are the most likely individual to become very wealthy.  If an individual treats investing like becoming an entrepreneur without the long hours, one can do very well as well.

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing