Investing Fundamentals

Definitions Help with Decisions

What is investing?

You can buy a chicken, kill it and eat it. If you do that, you don’t have another meal or any eggs unless you have leftovers. But you can buy the same bird and it can lay eggs that you can eat for about five years. If you buy that same chicken and a rooster, you will probably have many more baby chickens. These can grow up to lay more eggs and produce more chickens. In a similar way, when you buy a good investment, your goal should be the steady growth of your investment. This will take some time. Investing isn’t a way to get-rich-quick.

If you buy a bad investment, it can die, so you need to know how to tell if an investment is healthy. Some people buy sick chickens and their chicken dies. They not only don’t have their chicken, but they won’t get any eggs either.

Other investors buy “chickens” they think will grow to be super big chickens in a couple of weeks. The goal of the wise investor is to avoid sick chickens and avoid trying to figure out which baby company might be a super-chicken. Therefore, investing requires thought and some planning.

Investing is thinking work.

Investing requires thoughtful activities to put money to work with the goal of gaining even more money in the future. Wise investors have a thoughtful approach and they try to avoid emotion or guessing when selecting investments. This means they invest as follows:

Investing begins with a goal.

With Diversification

Without Love

With Long-Term Patience

Realistic for Growth

Expecting Profit and Income

Avoiding Speculation

Focused on Facts called Fundamentals

When you buy a car, you want to know that the engine works and gets good gas mileage, that the transmission can go forward or reverse and that the safety equipment and brakes are working. For investing, this often means you look at numbers like profit growth, dividend growth and growth expectations. You also look at trends.

Fundamental analysis is a long-term investment strategy whereas technical analysis is considered far more of a short-term methodology. By pricing on intrinsic (real, belonging naturally) values, fundamental analysis is working towards the long-term value of a company, whereas by trading on market trends technical analysis is short-term focused. Invest using facts. Avoid feelings.

Preferring Bargains

Avoids Overpriced Merchandise

How to Select Investments?

With so many numbers, charts and ratios to consider, what should the individual investor do? How you select investments should be based on written your goal statement. The goal statement can help guide in the selection of meaningful buy and sell criteria.

The Goal Statement

Here, for example, was my original goal statement: “Generate a steadily increasing stream of dividends paid by excellent, low-risk companies.” This is missing a key element. Is “increasing” even by one dollar per week acceptable? No, so there should be a numbers-based objective as a part of this goal. Here was my original two-factor numerical objective: “Grow dividend income to $60,000 in five years when I am 70 years old.  Dividends eventually will be withdrawn as RMD’s from the non-ROTH IRA accounts so that income-producing investments will not be sold to fund RMD’s if possible.”

Notice three elements: Dollar amount, target date (number of years and age) and source of income. There was a specific dollar amount, a specified target date (Feb. 2021), and a statement of how to fund RMDs with income not capital gains.

It is important to have a plan when selecting a church, when buying a home or an automobile, as you plan a vacation or mission’s trip to a far-away place and when looking for God’s direction in changing your employment. 

The same is true for investing.  Some things need to be high on your list of things you do and will look for in any investment. Therefore, if my investing goal was to be achieved, I needed to carefully select investments with the potential to reach the goal. I decided to use five primary elements in the process I use to buy an investment.

The Five Elements with a Goal Focus

The five I selected help me achieve “steadily increasing dividends.” I want to find excellent companies, not speculative “maybe this will work” investments. I want to minimize risk, which means I won’t just buy a small number of investments. My five key elements became:

1. Quality counts – Seeking Alpha QUANT, Author and Sell Side Ratings; Fidelity Analyst ratings; Weiss Risk & Reward value (growth, efficiency, solvency, total return, volatility, dividend). What are insider managers and board members doing? What do others say about the company’s strengths and weaknesses? Don’t forget that some of the ratings are based on upward price momentum. That can be a short-term condition, so look at the long-term aspects as well.
2. Diversification (sector, cap, region) – Eggs in different baskets. I won’t just buy health care or technology stocks. This element also increases the attractiveness of dividend growth ETFs with broad diversification.
3. Profitable and growing sales and earnings; relative value (P/E) comparison within industry or segment.
4. Income and growing dividends – growth rate, payout ratio, number of years increasing dividends
5. Costs – annual fees % (mutual funds and ETF’s) eat away at your long-term returns. Therefore, I won’t buy an ETF or mutual fund with an extravagant expense ratio. This generally means the ratio should be less than 0.10%, but can be as high as 0.50% for some types of ETF.

Preparing By Learning

If you were going to fly an airplane, you would take lessons from someone who knows how to fly. Before you can legally drive a car, you should know some rules, laws and even some basic physics, and then practice driving with someone who has experience driving a car. The same is true of investing. I think one great way to learn is to read. Here are my top recommendations for a reading list:

A Reading List

Warren Buffett’s annual Berkshire Hathaway shareholder letters:

2019

2018

ALL

Don’t rush this process. Take time to think about your goal and take some time to choose the most helpful fundamentals.