I’m not looking for the next ten-bagger.
You heard that right.
I’m not out there, searching for the next stock that will return 10 times my money in fairly short order.
Since I’m more concerned with the income my Full-Time Fund generates for me, and since I’m actually a fan of lower prices on stocks (in most cases), seeing a stock multiply in price so significantly over the course of five or ten years isn’t really a dream of mine.
I’ve had people over the years contact me via social media or emails to see what I might think of Stock X or Stock Y in regards to its ability to triple or quadruple in price within a year or two.
First, I have no idea which way any stock’s price is going to go over the short term (though, I do have some kind of inkling as to what’s going to happen over a very long period of time).
Second, I’m more interested in hitting singles and doubles than I am home runs.
Third, I’m more concerned with limiting the 100% losses than I am in seeing the 900% gains.
Getting On Base
In baseball parlance, you can take a couple different approaches to scoring.
You can attempt to knock the cover off the baseball and hit a home run.
Or you can try to safely get on base.
One has a more aggressive risk-reward relationship (the home run attempts), whereas the other is a more conservative approach.
Well, I take the latter approach when it comes to investing.
I like to invest in companies that have business models that are easy to understand. I like to see sound fundamentals, including manageable debt, solid top-line and bottom-line growth over a long period of time, and great margins. I like industry leaders. I want competitive advantages, like switching costs, pricing power, brand recognition, cost advantages, distribution networks, and scale. And most importantly, I want to see a company share its growing profit with shareholders in the form of a growing dividend.
As an investor, I think like an owner. It doesn’t matter if I’m buying 10 shares or 1,000 shares – I pretend I’m buying the whole company. And as an investor, I try to think about what makes this particular business better than others, and why it should continue to succeed over a long period of time.
But what I’m not doing when I look at a stock is attempt to think about where the stock price might be in six months, a year, or five years.
Not only does it not matter to my long-term goals or ability to remain financially free but it’s something that’s out of my control. Moreover, energy spent on this endeavor will not only be wasted but also limit one’s ability to spend energy on things that can be controlled and improve one’s long-term financial health.
I simply do my best to estimate the intrinsic value of the business as a whole (and thus each share), and then buy in at a price as far below that value as possible so as to secure a higher yield, better long-term total return and income growth prospects, and less risk (via a margin of safety).
Major investments of mine include Johnson & Johnson (JNJ), Philip Morris International Inc. (PM), and PepsiCo, Inc. (PEP).
These are all companies that pass most of my tests. There are solid track records of growing profit that’s shared with shareholders in the form of growing dividends. I see sound fundamentals and competitive advantages. And I wouldn’t mind owning the entirety of any of these businesses.
But none of these investments have been “home runs” for me.
I’m sitting on capital gains of approximately 80% with Johnson & Johnson, 40% with Philip Morris, and 70% with Pepsi.
Of course, that’s before talking about the years’ worth of dividends I’ve collected. And I lightened up on Philip Morris not terribly long ago due to exposure and valuation, or else it, too, would be higher.
But the point is that these stocks are unlikely to be ten-baggers any time soon. I’m not swinging for the fences here. These are relatively low-risk investments. And the risk is lowered further when the shares are acquired at a price below intrinsic value.
However, I am getting on base… routinely. My capital is working for me and my investments are worth more than I paid.
More importantly, all of these companies continue to send me large dividend payments every quarter, which covers a nice chunk of my bills.
Instead of buying up some unheard-of pharmaceutical company in hopes it’s bought out by a major player and risking most of my investment, I’m sticking to well-known companies that sell products and/or services that consumers and/or other businesses all over the globe want, need, and buy. The companies I invest in should slowly but surely churn out ever-increasing profit… and dividends.
I’m minimizing risk while simultaneously making sure that my long-term income and income growth allows me the flexibility I want to enjoy my life and pursue happiness.
I just don’t need to chase home runs to get to where I want to be.
Furthermore, while a 50% return won’t bolster your net worth as much as a 900% return, a 50% return is sure better than a 100% loss.
The 100% Loss
I long ago decided to focus on three major areas of my expenses: housing, transportation, and food.
It’s basically approaching budgeting using the Pareto principle. About 20% of my budget line items accounted for about 80% of the money I was spending. So I decided to aggressively cut these three line items as much as possible. Cutting out the regular “latte” visits might make for a sexy headline, but it’s really something like moving to a cheaper apartment and/or getting rid of your car that’s actually going to make a major impact.
I went from spending more than $500 per month on a car to about $50 per month on public transportation.
I went from spending more than $600 per month on rent to less than $500.
And I went from eating out somewhat regularly to eating sandwiches at home, which reduced my food budget down to less than $200 many months.
These savings added up to more than $750 per month that I ended up investing in high-quality dividend growth stocks that ended up providing me even more income to save and invest.
You know what kind of return I would have received on this money had I not made these moves in my personal life to free up that capital to invest?
That’s right. It would have been a complete loss… every single month I was spending the money.
Every frivolous dollar spent earns me -100%.
Instead, all of those extra dollars bought more shares of companies like the ones listed above. So whereas I’m not hitting a lot of home runs, what might not necessarily show up in the stat sheet is that I’m able to accumulate far more shares of these stocks that are getting me on base over the investor that’s hitting more home runs but also saving less and accumulating less overall shares, wealth, and income. I’m getting on base over and over again while someone else is hitting home runs but also striking out a lot more, and probably just plain scoring less often.
So you can imagine my amusement when investors want to try to uncover the next home run, risking a lot of their capital in the process, while still spending way too much money on their lifestyle that’s earning -100%.
It’s essentially throwing away a lot of money on expenses, and then compounding the problem by potentially throwing away even more money on the inevitable strikeouts that will come by trying to knock the ball out of the park (Reggie Jackson leads the MLB all-time strikeout list, ya’ll).
As such, my mind works like this: I’m thinking about that $100 I’m spending and how it’ll turn into $0 instead of $1,093 (what it would be if it were compounded at 8% for 30 years – an eventual 10-bagger). That $100 turns into a nice $0.75 quarterly dividend (at a 3% yield) that, when repeated over and over again, gets me on base and, eventually, home. My portfolio was built on $100 here and $100 there over many, many years. It does indeed add up.
If winning the game is financial freedom, I’ve simply tried to round the bases as fast as possible, and every extra dollar of capital (via spending less) has propelled my hitting and speed.
While I’ve most certainly struck out on occasion, losing a little money here and there doesn’t feel too bad at all when you know that you’re going to make that back up with a week’s worth of savings.
Conversely, someone who isn’t saving as much is that much further behind when an investment goes sideways, because a 100% gain is required to offset a 50% loss, and that’s even harder to do when you’re not loading up with hitters left and right via a high savings rate.
I believe a strong focus on frugality is more important and more effective than trying to become the next Warren Buffett. Besides, it’s far easier to be an all-star saver than it is to be an all-star investor. If anything, I’ve tried to emulate my life after Warren Buffett the frugalist more than Warren Buffett the investor.
That $750 I was saving by making a few tweaks to my lifestyle, focusing on just three budget line items, was $750 that was getting on base over and over again, eventually allowing me to score and become financially free. Instead of losing $750 per month on a -100% return, I was accumulating more shares of great companies and increasing my growing passive income.
Approaching saving and investing conservatively, as part of a holistic lifestyle, puts one in a great position to step up to the plate, hit the ball, and methodically run the bases.
A 10% gain here and there adds up quickly. As does an extra $50 of extra passive income here and there. Every single and double is that much closer to scoring – and eventually winning the game. More savings equals more money equals more hitters equals more singles and doubles. Those focusing on just home runs will eventually get left behind.
Keep in mind, too, that focusing on quality companies that pay growing dividends naturally shifts one’s mindset away from just thinking about total return and toward the dividend income that’s coming in, because it’s really that income that’s going to pay your bills.
A big gain helps the net worth, but that’s not going to do much, if anything at all, if you’re not interested in selling your shares. And I’m also not stating that you won’t do incredibly well in terms of total return by sticking to high-quality dividend growth stocks. I’ve done very well, with many “accidental” home runs (companies that were bought out for big premiums shortly after I invested), in addition to seeing most of the companies I’ve invested in meeting or exceeding operational and income expectations. And I suspect most of my investments, including those listed above, will eventually go on to be worth many times my original investment. But that’s not the point here.
For some reason, I believe people like to do mental gymnastics. They’ll bemoan a $1,000 loss on an investment but won’t bat an eye to the extra $1,000 of fat in their budget. And instead of focusing on their spending, they want to try to hit the lottery with the next investment they make.
If a 3% drop on a stock’s price causes you a little bit of concern but you don’t yet have your spending down to maximum efficiency, there’s an opportunity there to really think about why you’re more concerned with a 3% unrealized loss on a stock’s price than the 100% realized loss you’re taking on excess waste in your budget.
Look, every frivolous dollar spent is basically money that never leaves the clubhouse. Why not at least step up to the plate?
As always, what you do is up to you. Each person needs to figure out a lifestyle and plan that works for them. But I do think that focusing on things you can’t control instead of that which you can control leaves you prone to striking out. Hitting singles and doubles might not be as sexy as hitting a home run, but rounding home base feels a lot better than sitting on the bench after a strikeout. And being financially free feels a lot better than not being financially free.
Full disclosure: I’m long JNJ, PM, and PEP.
What do you think? Do you focus on spending so as to limit your 100% losses instead of trying to hit home runs with your investments?
Thanks for reading.
Image courtesy of: vectorolie at FreeDigitalPhotos.net.