Category: Income investing

I wrote in July about the performance of my dividend/income account, the one that I have setup in my father’s stretch IRA. The concept was to see what I could do with an income-oriented account (dividends, etc.). Could we get the growth and income necessary to meet our retirement goals, and how did it do in comparison to the Vanguard account I had with the simple allocation?

The base allocation for the income account was 25% dividend paying stocks, 25% REITs (paying good dividends) and 50% Bonds. This was all based on the information in the book “Yes, you can be an income investor” by Ben Stein.

For the year, the account returned a healthy 3.51% dividend return, and growth of around 9.7%. Not too shabby! However, this is in comparison to my Vanguard IRA account, which had a 2.86% dividend, and a 16.51% growth rate. Obviously, the Vanguard account, with its higher weighting of stocks (52.5% stocks, 17.5% REITs, 30% bonds) did better in 2019.

One of the things I noticed, however, was that the income account didn’t drop as precipitously as the Vanguard account in the bear market of 2018. How have the two different accounts done over the last three years?

The Vanguard numbers are a little “screwy” as I have had to add back in the $90K of Roth-IRA conversions that I did in 2018 and 2019, and the Stretch IRA I have to take about $5K out each year for tax purposes. I’ve adjusted the totals and percentages to reflect this.

For comparison, I did the math for if you had invested $1000K in 2016, what would that be at the end of 2019. As of Jan 1, 2020, the Stretch IRA would have $1,232, while the Vanguard account would have $1,321 – the Vanguard account’s return was better. It wasn’t like that at the end of 2018, due to the stock drop.

My intention is to continue to keep the money in my father’s stretch IRA oriented on income, as a learning tool. Should be interesting.

Mr. 39 Months

Previous Updates:

• Oct 2019
• July 2019
• Jan 2019

Some folks have been asking how my income account has been doing overall, especially in comparison to the market. If you remember, I wrote about setting this up back in May of 2017. Using the concepts outlined in Ben Stein’s book “Yes you can be a successful income investor”, I created an account specifically designed to throw off dividends, in an attempt to see if one could create a retirement with this sort of setup. The hope was that the account would throw off sufficient income, and still grow to match inflation.

So how has it done for the last several years? Because it’s an inherited IRA, I have to take money out of it every year, based on my age at the time my father passed away. I will factor that in. I’ll compare the performance to my overall investments in one of my IRAs (which contains a mix of 52.5% stocks, 17.5% REITs, and 30% bonds).

Overall, the stretch IRA’s allocation of 25% dividend stocks, 25% REITs and 50% bonds have thrown off an average of 3.58% dividends annually, and has grown from Dec 2016 to July 2019 at a rate of 2.50% (pretty much keeping up with the US’s low inflation rate).

The Vanguard account has had a dividend yield of around 2.66% (not too shabby), but due to the bad 2017, it has grown at a negative -3.81% for the same time period. However, its growth over the last ten years has probably put the dividend account to shame. If you look at the spreadsheet above, the Vanguard account beat the stuffing out of the Dividend account in 2017 (and appears to be doing it in 2019)

The question comes down to are you willing to have some “low points” like 2018, to get the higher growth periods, or do you want more stability, where it doesn’t crash as much (compare 2018’s -5.44% drop in the dividend account versus the -24.68% in the Vanguard account!). I’d like to think that you could get by with the dividend account once you hit FI and want to follow the 4% rule, but like most folks, I’m very concerned about inflation. The Weimar republic is a brutal lesson, and the US continues to spend way more than it takes in.

For folks who want to know, here is a quick rundown of my dividend account:

Hopefully, this is useful to folks. I’ll continue to monitor in the years ahead and provide regular updates.

Have a great summer!

Mr. 39 Months

I went through my value investing choices in my “fun money” account, and reviewed them for performance. If you remember, this account is around 5% of my total invested assets (the majority of them are in straight index funds, allocated over stocks, bonds & REITs). With this account, I sought to experiment with investing in value stocks, based on the writings of Graham, Buffet and other value stock disciples. I wrote two articles on that back in 2017.

The general tenets of the analysis, I broke down into several categories of analysis for each stock:

1. Market value greater than $2 Billion (Strength)
2. Current ratio (current assets/current liabilities) of 2-1 or greater
3. Positive earnings in each of the last 10 years
4. Paid dividend at least 20 years, and raised over last 20 years
5. Increased earnings per share by at least 1/3 over 10 years
6. P/E of 15 or less
7. Price-to-book of 2.5 or less
8. Return on Equity of 15% or more, and growing

Not every stock can have all of these, but they should have the majority (and be trending in the right direction). Most stock analysis tools (like Morningstar) will let you put in these feature and determine those stocks that meet or are close to these values.

In the account, I had three stocks that, when I did the analysis, matched somewhat close to these values: Gilead Science (GILD), CSS Industries (CSS) and Tahoe Resources (TAHO).

In addition, Graham had a value equation (updated by recent value disciples) that helped to determine real value for the stocks. Using that, I was able to determine that all three of these were undervalued, based on current earnings, growth potential, etc. In it, you took the company’s earnings without dividends, multiplied it by 2*a company growth rate (I chose 6%) plus 8.5%, and then multiplied that times 4.4 divided by the corporate bond yield.

When looking at my three value stocks, I had the following results:

• GILD: 6 out of 8 in the categories. Est value of $101.02/share vs current price of $75.42 (+@$25.60)
• CSS: 6 out of 8 in the categories. Est value of $22.10/share vs share price of $27.86 (-$5.76)
• TAHO: 3 out of 8 categories (they fell off a lot this year). Est value of $4.81 vs current price of $4.49 (+$0.32)

Based on this, I chose to sell my CSS and TAHO at the beginning of the year. I also chose to sell the REITs I had in the account (I was originally setting it up like my dividend paying account, and only in 2017 did I chose to do value investing in it). This would give me a significant amount of money that I planned to put into three value stock plays.

I did the analysis of the eight categories and came up with 2 other stocks that interested me:

• SBS (Companhia de Saneamento Basico do Estado de Sao Paulo SABESP): 5 out of 8 in the categories. Est value of $19.69/share vs. current price of $10.43 (89% upside)
• BBGI (Beasley Broadcast Group Inc.): 5 out of 8 in the categories. Est. value of $29.01/share vs. price of $12.80 (127% upside)
• I also chose to double my investment in GILD, as it still had significant upside.

I was struck by the lack of stocks that met many of the categories, due to price. It appears the stock run-up has cut into the potential for getting good value stocks.

So evenly split, I have about $12K in each of these value stocks. I’ll let folks now how they do throughout the year.

Mr. 39 Months

In my first post, I talked about some of the rules that Benjamin Graham used to sort through the stocks to identify. Back in June, I used the decision criteria from “The Little Book of Value Investing.” I used these to identify seven potential stocks at the time, and saw which stocks matched the most criteria (shown in green)

The next step from there was to look through the stocks, get information and try and see which ones you understand. It does you no good to evaluate a company’s performance if you don’t really understand what they do. Warren Buffet is well known for not investing in technology, because he doesn’t really understand it. He understands Coca Cola, Geico insurance, etc. – so that is what he invests in. In this case, I understood OTEX, Tyson, PAG, Lyb and Gilead, so I chose to concentrate on them.

Graham had a formula for determining intrinsic value. Value = E * (2g + 8.5)  * 4.4/Y

• E = current earnings per share, after taking out dividends
• G = annual earnings growth – with 5 percent figured as a “5”. Typically for young, growth companies he used 10% growth, while using 6% for companies in a mature industry
• 8.5 is the base P/E ratio for a stock with no growth
• Y is the current interest rate, represented as the average rate on high-=grade corporate bonds

An example would be a company with a current earnings of $2.30, a growth rate of 10 percent, and a corporate bond rate of 6 percent. The intrinsic value is $2.30 * ((2*10)+8.5) * (4.4/6) or $48.07 per share

When I took the list above, using this equation, I came up with the following intrinsic value

After this analysis I took the opportunity to look through Gilead’s annual reports. While their stock price had dropped dramatically, their overall economic position was strong, and they had a lot of excess cash. By the time I ended up deciding on the stock , Gilead had actually dropped to $66.46 (almost $6 less than my original analysis).  Using Graham’s numbers, it appears to have a tremendous amount of “up” (it had a P/E ratio of 7, or if inverted, a yield of 14%!). Since I purchased it in late June 2017, it has gone up to $83.27 (a 25.3% jump). Supposedly, based on it earnings, it could go as high as $173.82. I will have to keep track of it going forward.

In August and September, using the same concept, I’ve purchased TAHO (a mining company) and CSS (consumer products) both selling below book value, and seemingly underpriced. While I haven’t gotten a big “jump” on either (TAHO up 6% in 2 months, CSS up 2% in 1 month), they are both doing fairly well. I will keep them until they come close to their intrinsic value – which may be several years.

What systems do you guys use to pick stocks or mutual funds?

Mr.39 Months

Stock Evaluation – Benjamin Graham method

In my ongoing quest to look at finances and improve my financial performance, I’ve done a lot of reading on value investing. The general concept of value investing is that you can, with some accuracy, determine the intrinsic value of a stock.  However, the stock market is often based on emotions, and a stock can be selling for less than its intrinsic value (due to bad news and overreaction, general lack of knowledge of a certain company’s performance, or the stock not being in a “sexy” industry.

I worked for a company in 2000 that was in automotive (i.e. not a “sexy” dotcom in 1999 -2000). Very well run, great numbers, but only trading at $1.68 a share. Once the dotcoms blew up, people starting looking for other companies to buy and found ours. Over the next seven years, it went over $140/share (taking into account splits). While we did great work at this company, even I don’t think it was worth a 833% rise in value.

The key for a value investor is to find these “diamonds in the rough,” purchase them, and then have the patience to wait till they jump up. If you can judge the intrinsic value, it may take the market a year, or 5 years, but eventually you will be rewarded.

Note that this is the exact opposite of the “efficient market” theory that rules Wall Street at this time – the belief that information is known to all, and therefore the market is correctly priced, each day. These investors tend to emphasize hot growth stocks. However, if everyone had total knowledge, why are there always sellers and buyers for a share of stock, with both of them thinking they made a good deal?

One of the earliest proponents of the value theory was Benjamin Graham, and most of the big value investors are disciples of his teachings (Warren Buffet and many others actually took classes from Graham and worked for him).

In looking through books authored by Graham, liked The Intelligent Investor, or other value investors, they ended up with a process to evaluate and pick value stocks:

1. Learn to understand a company’s basic financial documents (balance sheet, earnings statement, cash flow)
2. Use simple metrics (I will show Graham’s ten values) to weed out the majority of non-value stocks
3. Once you have identified a list of candidates, use some additional rules to weed out those value-type stocks that don’t match your goals, or who are questionable
4. Invest and show patience while you wait for the market to agree with your valuation.

I won’t go into details here on how to reach a company’s documents. There is a wide variety of information on-line, but here are some, in case you need them:

1. Reading a balance sheet 
2. Reading an earning’s statement
3. Reading a cash flow statement

For step 2, Benjamin Graham (and other value investors) used a series of ratios to weed out the stocks that did not meet their value objectives

Graham’s criteria from Value Investing for Dummies

In my next post, I’ll explain how I used these criteria to identify a group of stocks, and then did further research in order to pick one for my “fun money” account. You’ll get to see how I did there.

Mr.39 Months

Back at the beginning of the month (Aug 5^th) I wrote about Stein & DeMuth’s use of long-term metrics and trends to “time the market” in the long term (i.e. over a 10-15+ year period). Unfortunately, their book was published in 2003, and while they kept graphs up on their website (   ) for a while, they stopped updating the graphs in 2015.

I wanted to do a “what if” analysis, where if I had followed their metric strategy from when I first graduated and started investing some of my salary (1987) to the end of 2016, a 30 year period. I would take $1,000 a year and invest it either in the S&P 500 every year (dollar cost averaging) or the S&P or AAA bonds, based on the “market timing” signal that Stein & DeMuth laid out:

1. S&P 500 price vs. 15-year average (if above average, don’t buy)
2. S&P500 P/E vs. 15-year average (if above average, don’t buy)
3. S&P500 Dividend yield vs. 15-year average (if above average, don’t buy)
4. S&P500 Earnings yield vs. AAA bond average (if bond yield is higher, go with bonds, not stocks)

Base Strategy

• Whenever I got a “buy” for S&P 500, I put in $1,000 at the beginning of the year
• Whenever I got a “don’t buy” I put in $1,000 in the average for AAA bonds
• I adjusted for inflation
• I ran the numbers for each of the 4 scenarios, for the 30 year period, including the great run up of stocks in the 90s, the dotcom crash, the low bond rates of the 00s, and the crash of 2008.

The results were very interesting.

• Dollar cost averaging into S&P500: $60,691
• Price metic: $65,576 (8.0% better return)
• P/E metric: $67,583 (11.4% better return)
• Yield metric: $67,133 (10.6% better return)
• Earnings vs bonds: $66,034 (8.8% better return)

What this shows me is that, if you have the patience and long-term outlook necessary, using the metrics outlined by Stein & DeMuth appears to offer slightly better returns. In their book , they showed higher returns (20%), but that could simply have been the timing of the book – right after the dot.com crash.

I will probably continue dollar-cost averaging in my 401K and Roth IRAs across a spectrum of investments with my allocation. I will also probably use some of this timing strategy with my “funny money.” I’ll let you know how I’m doing.

Anybody out there with an interesting market timing strategy?

Mr. 39 months