Source: Bloomberg

Notice on the treasury yield curve that even the 30 year bonds only yield 3%.  This is amazing considering the state of the economy.  What’s even more ludicrous is that if you buy treasuries now, you’ll actually be losing real money every month.  That’s because the highest treasuries yield 3%, but current inflation rates are closer to 3.5%.  That means that the government is actually making money on treasuries, as the cost to pay back the debt will be lower because of the decreased purchasing power that inflation brings.

Now, let’s look at the historical yield of dividends, as represented by the S&P 500.

Source: Standard and Poor and Robert Shiller

Note that the yield on the Dow Jones Industrial Average is higher than the S&P 500, but for some reason that data is not available, or at least very hard to find.  Notice that even though the dividend yield has declined over the past 20 years, it is currently at about 2 percent.  The average dividend yield of the Dow is currently 2.9%.  So what does this tell us?

For the first time in over 60 years dividend yields are higher than treasury yields!  That makes treasuries and many other bonds a pretty bad investment.  And if you’re willing to take on more risk, you’re much better off investing in dividend stocks.  Not only do dividend stocks pay about the same or more in yield now, but they are also a good hedge for inflation, and have a chance for stock price appreciation.

Another factor to consider if you are deciding between investing in bonds and stocks, is what will happen next.  While the global economy can never be predicted, there’s at least a good chance that it rises and that stocks do well for years to come.  The longer your term, the more certain your conviction can be.  However, when it comes to bonds, interest rates have no where to go but up.  And when interest rates go up, bond prices go down.  That means that there is not really any upside into investing in treasuries or most other high quality bonds at the moment.

So, the takeaway from all of this.  Besides these are historic times and this is something interesting to think about, you may want to think twice about investing in bonds these days.

Start by Measuring Your Gold

Collect all of the gold that you would like to sell.  This can include necklaces, chains, rings, jewelry and of course, any other items made out of gold.  Jewelry is the most popular item to trade for gold because it is light and easy to ship.  If you have items such as gold candlesticks, rings with diamonds or other valuable gems, or gold coins, you should make sure that they are not worth more if sold outright.  In many cases, you could make more money selling your item if you sold it on ebay or at a local auction.  In some cases, even a pawn shop would pay you more than someone just buying the gold content of your item.  The best types of items to sell are those that are not antiques and that are out of style.  These types of items have little value at a pawn shop so you can usually get more for them by using a gold dealer.

When you’ve got your items sorted and ready to go, the next step is to weigh them.  Use a small digital scale such as a kitchen scale or a postal scale to find exactly how many ounces or grams you have.  If the items are not pure gold, then try to account for the weight of any extra things like gemstones or whatever else is attached your item.  Come up with your best estimate of the actual amount of gold you have  to sell.  You may even want to document this by taking a picture of the gold on the scale, so that in case you have a complaint later on, you have some type of evidence of the purported value of your gold.  Use this figure to estimate how much money your gold will be worth in the later steps.

Research the Going Rate of Gold

Next, it’s time to research the going rate of gold.  Start by looking at a chart on the price of gold.  These prices are the prices paid on gold bars and are not reflective of the price your gold is worth, however, you will be able to see if gold is high or low relative to the past few years prices.  If gold is low, you may want to consider waiting until its price rises before making your trade.

Once you’ve looked at gold commodity prices, its time to figure out a going rate that you can expect to recieve for your gold.  After all, the company you are sending your gold to has to pay for postage, identify the gold type, measure the value, document their work, and then have the gold sorted and melted before it can be resold at market value.  There are a lot of administrative costs associated with running a gold trading company, so you should expect that the price you get paid will be less than half of that of the commodity price of gold.  To find a going rate, start by doing searches online.  Most websites will not tell you how much they pay for gold.  They do this for two reasons.  First, the price of gold changes every hour of every day, so it would be pointless to make a promise that they may not be able to keep.  Second, they don’t want their competitors to know how much they are paying.  Most companies offer a guarantee that they will give you the highest price, but this is nearly impossible to monitor.

To find a going rate, start calling local companies such as pawn shops, jewelry stores and cash for gold stores.  Then, start calling the websites themselves.  If they refuse to give you a number for your gold, ask them the price that they paid yesterday, so that you can at least get a ballpark figure.  When you have a figure that you think your gold is worth, it is time to go on to the next step.

Find a Reputable Online Gold Trading Company

Next, it’s time to pick a company to sell your gold.  With the research you’ve done you can probably find the places that pay the best.  Typically, the large companies that advertise on TV have an advantatge because they do business in bulk and have better supply channels that in turn build more gold.  The more gold a company deals in, the better prices they can sell it for and the better prices they can pay you for it.  However, don’t ever assume that because a company is big or popular that it is the best deal. Before you send your gold off in the mail, make sure you call several gold companies in your local area.  Also, call a couple jewelry stores and pawn shops to see if they are buying gold and what they can offer.

Once you’ve chosen a few companies that offer the most money for your gold, its time to pick the best one.  Do several searches online and at the better business bureau to make sure that the company is legitimate.  If the company you like is cash4gold, then do some searches such as “complaints against cash4gold” or “dont use cash4gold”.  You may find that many people had problems or were duped by the company you chose.  Try to find a reputable company before you send in your gold.

Trade Your Gold for Cash

When you’ve done your research on your gold, the price of gold, and the most reputable gold trading companies, then its time to start trading your gold for cash online.  This typically means getting a prepaid package or mailer from the company you choose and sending the gold to them.  Never send gold without making sure that it is insured properly.  While mail theft isn’t that common, any mail being sent with the word “gold” on it is much more likely to be stolen than other packages.   Once you’ve sent in your package, then you just have to wait for them to process it and send you a check.  This can take a few weeks and you can sometimes check the progress on the company’s website.

If you get your results and they are not what you were expecting, take some time to look into what happened.  Then, determine if you think the company was at fault or if you made an error in your estimation.  If you feel like you got screwed over, you should do something so that the same thing doesn’t happen to others.  Start by contacting business bureaus and posting your situation on any websites or forums that discuss these companies.  Hopefully, your transaction goes as planned or even better.

Calculating EV to EBITDA

To calculate this ratio, you must first calculate enterprise value and EBITDA.  Enterprise value can be calculated by taking the company’s market capitalization (shares outstanding x share price) and adding back all of the net debt (total debt – cash).  Enterprise value is a figure for one point in time and it changes as the company’s stock price changes and as their debt levels change.  EBITDA, on the other hand, is a measure of cash flow over the course of a period.  To calculate EBITDA, decide if you want to use historical data (like the last twelve months, last four quarters, or last fiscal year) or future data (based on your estimates or the estimates of analysts or the company).  Then, from the income statement start with the operating income and add back any interest expenses that were not included in the operating income (sometimes they are included below the operating income line).  Then, visit the statement of cash flows and find any lines that refer to depreciation and amortization.  Add these figures back to the previous figure and you’ll have arrived at the earnings before interest, taxes, depreciation and amortization (EBITDA).

Now, simply divide the enterprise value by the EBITDA and you will have calculated the EV to EBITDA ratio.

What Does EV/EBITDA Mean?

Now that you’ve computed the ratio, it’s time to figure out what it really means.  First of all, it is a valuation metric used to guage the relative valuation of a company based on its earnings.  In this case, the value of the company is measured using not only the equity value, but also the debt.  And by using EBITDA, you are using a metric that represents cash flow by excluding debt related expenses (interest), and acquistion related expenses (amortization).  EV / EBITDA is similar to a P/E ratio except that it takes into account the company’s debt structure.  The ratio is really a metric to tell us how many times cash flow the company trades for.  For example, if a company trades at 10 times EBITDA this ratio tells you the relative value of the company as compared to its cash flow (earnings).

Why Use EV to EBITDA to Value Stocks?

While the price to earnings ratio is by far the most widespread and popular way to look at the relative valuation of a stock, the EV to EBITDA ratio is a more accurate way to compare two companies.  That’s because the EV to EBITDA ratio includes the capitalization structure of the company so that it can be compared against companies that are capitalized differently.  Here’s what we mean by that:

Assume you have a company that is capitalized with $80 million in debt and just $20 million of stock.  The total value of the company (EV) would be $100 million.  Now, let’s assume we are comparing that company’s valuation to a second company that has no debt and that has $100 million in stock.  In this case, both companies have an enterprise value of $100 million.  Now, let’s assume that the leveraged company earns $6 million in operating income and the debt-free company earns $10 million.  Also, let’s assume the leveraged company earns $2 million in net income and the non-levered company earns $6 million.  If you looked at a P/E ratio, the levered company would be trading at 10 times earnings ($20 million / $2 million) and the non-levered company would be trading at 16 times earnings ($100 million / $6 million).  However, if you added the assumed $4 million in interest expenses ($80 million at 5%) back to the levered company, the EBITDA would be $10 million ($6 million operating income + $4 million interest) and the company would would be trading at an EV / EBITDA of 10 times ($100 EV / $10 EBITDA).  The non-levered company would also be trading at EV / EBITDA of 10 times ($100 million EV and $10 million EBITDA, which assumes they don’t have interest and neither company has depreciation or amortization).

As you can see from the preceding example, while the non-levered company trades at a much higher P/E than the levered company, the companies trade at the same valuation when using the EV to EBITDA ratio.  By taking into account the debt capitalization and the associated expenses of the debt, you are able to give the overall company a valuation that is more reflective of the whole company, and that can more easily be used to compare its valuation to other companies.  These valuation comparisons can help you decide which investments to choose when comparing companies with different capitalization structures.

In conclusion, no single metric is adequate for valuing all stocks and companies, but because of its ability to take capital structure into account, the Enterprise Value to EBITDA ratio is a very useful metric when it comes to comparing companies’ valuations.

Risk Level 1 – Lowest Risk Investments

The lowest level of risk that an investor can take is to not be an investor at all.  That means keeping all of your money in cash.  Whether you hide money under your matress or bury it in your backyard, keeping all of your money in straight cash uses the least amount of risk.  That is, investment risk.  Actual risk that someone steals your money or that you keep up with inflation are actually very high if you take an approach like this, however, you won’t lose any money because of a bank or other type of investment loss.

The next type of investment that also fits this category are savings accounts, money market accounts, and certificates of deposit.  All of these investments can be bought at a bank or at a brokerage.  These types of investments offer extremely low rates of return and, often even fall behind the rate of inflation, which means you are actually losing buying power when you own some of these investments.  With that said, certificates of deposits could be the outlier here, as they can offer higher rates of return than the other two assets, especially when interest rates are not at rock bottom levels.  Also, all of these investment returns are based on current interest rates.  When interest rates are extremely low, these investments return almost nothing.  When interest rates are high, these investments have much better returns and still offer low risk.

Risk Level 2 – Below Average Risk

The next level of risk includes investments that are more risky than cash or cash equivalent funds (see risk level 1).  These types of investments include buying highly rated and government bonds, blue chip stocks, dividend stocks, and even insurance annuities that offer a guaranteed return.  Of course, these types of investments are only below average risk if you buy a diversified portfolio of them.  For example, buying a single bond or blue chip stock is risky because you would be taking on the company specific risk associated with that underlying company or municipality.  However, if you buy a diversified mix of these investments, usually obtained by buying a bond fund or blue chip mutual fund, you get rid of much of the company specific risk and, because these investments are backed by highly rated balance sheets, you typically have less risk than other investments.

Regarding annuities, its true that they have less risk because they guarantee certain return levels.  However, be aware that you pay upfront for the added security of these investments.  Because of this arrangement, these types of investments are typically much lower returns than if you invested the money yourself in a mix of stocks and bonds.  The reason people choose these investments is because they are risk averse and need a guaranteed return, usually during retirement.  Also, investing in some of these annuities can lower a person’s assets so that they can often qualify for aid, healthcare, or retirement living help that they otherwise wouldn’t qualify for.

Risk Level 3 – Investments with Medium Risk

Medium risk investments include traditional stocks, mutual funds, real estate funds and corporate bonds.  While taking on just one of these investments would be risky, building a balanced portfolio of stocks, bonds and real estate would hold an overall risk level somewhere in the medium risk category.  Of course, that would depend on the specific mutual fund categories and bonds that you bought, but generally speaking, if you do your homework and diversify your investments across these categories, you should be in the average risk tolerance level and should be able to get market performing returns above the returns offered by the lower risk levels.

Regarding real estate, while buying individual real estate is risky, there are many different ways to buy real estate through the use of funds or ETFs.  The most common form of real estate investment are through trusts called REITS (real estate investment trusts) whereby you buy a share in a company that invests in real estate.  It is different than other funds because REITs are required to pay out a large percentage of their cash flow, making them a good source for dividends.  REITs invest in such real estate as apartments, storage units, commercial and industrial, as well as focus on different geographies and investment sizes.

Risk Level 4 – Above Average Risk

Higher risk investments include investments in emerging markets, high growth stocks, high risk sectors, individual stocks, and buying real estate.  While you should always diversify your investments across many sources, even diversified portfolios of investments in emerging markets and in ultra high growth stocks can be risky.  And regarding individual stocks, many people take on too much risk because they heavily favor a certain stock that they either really like or that they have access to for some other reason.  An example would be most employee stock plans.  Owning too much stock in your employer is very risky.  That’s because if your company fails or falters, not only will your worth decline rapidly, but you also stand to lose your job at the same time.

And regarding investing in real estate, if you invest in an individual property it would fit into this category.  That’s because owning a single property is much more akin to one-off risks than owning a diversified holding of real estate.  When buying your own property, you face the risks that your neighborhood could decline, that your city could decline, that your state’s taxes could rise, and of course you have the added risk of having a large loan taken out (leverage), which makes small swings in the value of your investment affect your return dramatically.  All of these reasons make  investing in real estate risky.  With that said, you’ll also have a good chance of making good returns, especially if you can manage the property yourself.  That’s because a large share of your profits don’t go to an administrative staff, like happens at real estate funds.

Risk Level 5 – Highest Risk Investments

The highest risk investments include speculating on stocks, buying penny stocks, using naked call and put options, and flipping houses.  All of these investments carry nearly outlandish risk.  Investors that speculate on stocks often buy on rumors that never materialize, or if they do, the stock moves in the wrong direction because everyone else was speculating also.  And penny stocks, which typically trade for a few cents, are manipulated by crooked investors and are so risky because sometimes a few cents can mean more than a ten percent change.  Options, including put and calls, are ways to make short term bets on the movement of a particular stock or index.  Betting on short term movements is very dangerous and impossible to predict.  And finally, flipping houses is another very risk investment.  That’s because you typically use a short term loan to fix up a house and then resell it.  However, if you hit a snag, buy a bad property, or the housing market collapses, you could quite easily lose all of your invested capital.  These types of investments are the riskiest types.  Of these, flipping houses is the least risky, but should only be attempted if you have enough capital to endure any hardships, and then it should be used only as part of your overall portfolio.

In conclusion, these are the types of investment risks that investors can choose from.  Most people fall into the middle, and the next minority would be in the low risk categories.  Have you figured out where you fit?

Does A Low P/E Ratio Mean a Stock is a Good Value?

Typically, the group of investors known as value investors prefer stocks that have low price to earnings ratios.  That’s because, relative to their earnings, these stocks are a good value.  After all, if all other metrics are equal, a stock with a lower P/E is more attractively priced than the same company that trades with a higher P/E.  Furthermore, there has been lots of empirical evidence collected that proves that lower P/E stocks have higher returns over the long run.  Over the last fifty years, the 10 percent of stocks with the lowest P/E ratios returned an average of around 16% per year, while the 10 percent of stocks with the highest P/E ratios returned an average of about 7%.  While these may be facts, there are circumstances that can help explain this phenomenon.  For example, during the dot com days, stocks would start trading at P/E ratios in the hundreds or thousands.  When the bubble burst, many of these stocks lost nearly 100% of their value.  I’m guessing some effects like these skew the numbers some.  Also, having faced some big recessions and crises over the past decade, lower priced stocks have been more in fashion than the high P/E stocks.  After all, even Apple and Google could be considered low P/E stocks these days.

Indeed, if you are looking for a good stock value, you should definitely include low P/E stocks in your search.  However, I wouldn’t limit your search to just low P/E stocks.  That’s because other factors also make stocks a good value.  This brings us to our next category of stocks that may offer good long term value – low PEG stocks.

Using A Low PEG Ratio to Find a Good Value Stock?

While most traditional value investors stick to stocks with low price to earnings ratios, there is another group of investors that look for good stock values based on PEG ratios.  The PEG ratio is a metric that compares the PE ratio to the expected growth of a company.  Investors that use this type of ratio as their main investment philosophy are often called GARP investors, which stands for Growth At a Reasonable Price.  The investment strategy is to look for stocks that trade at a good value.  By using this metric, both low P/E and high P/E stocks are included in any stock screens, and stocks that have high growth rates relative to their valuations are favored.  Let’s look at an example of how to use PEG ratio to find a stock that is a good value.

Let’s assume we are interested in two stocks.  Stock A is trading at $5 and has earnings of $1 per share.  It is expected to grow its earnings by 5% per year.  Stock B is trading at $10 and has $1 in earnings per share, but it is expected to grow at 20% per year for the foreseeable future.  Now, let’s look at some of the valuation metrics for these two stocks.  Stock A is trading at a P/E of 5 and Stock B is trading at 10.  On a strict P/E basis, Stock A appears to be a much better value than Stock B.  However, valuing solely on P/E leaves out the growth factor.

Now, let’s use PEG ratio to compare these two stocks.  Stock A has a PEG ratio of 1.0 (PE of 5 divided by growth of 5% = 5/5 = 1.0) and Stock B has a PEG ratio of 0.5 (PE of 10 divided growth of 20% = 10/20 = 0.5).  As you can see by this valuation metric, Stock B is twice the valuation based on PE but only half the valuation of Stock A based on PEG ratio.  In this case, all else equal, I would choose Stock B as my investment choice based on value.  Here’s why.

Currently, both stocks earn $1.00 per share.  However, in five years, given their projected growth, Stock A will earn $1.28 per share ($1.00 x 1.05^5) while Stock B will earn $2.49 ($1.00 x 1.20^5).  Now, let’s assume that in five years both stocks trade at the same P/Es they started at.  That would mean that Stock A would trade at $6.38 (PE of 5 times EPS of $1.28) while Stock B would trade at $24.88 (PE of 10 times EPS of $2.49).  In this case, Stock A returned 27.6% over the five years, while Stock B returned a whopping 148%.  In reality, many fast growing stocks slow down over the years and when they do, their P/E ratios fall back in line with their growth.  However, using the PEG ratio to help find attractively valued stocks is a great way to invest, at least in theory.

Before you start buying based on P/E’s and PEG ratios, you should look at one last factor that can help you choose the stocks with the best value.  This factor is the qualitative aspect of a stock.  The next section explains what we mean by this.

Consistent and Reliable Earnings Really Matter!

The qualitative aspect of stock valuation is perhaps more important than the quantitative aspect of finding a good value stock.  Usually, if a stock is trading at a low PE relative to other similar stocks, its for a good reason.  Perhaps the management team is inexperienced.  Maybe the quality of their product compared to their peers is below average.  Maybe the financial accounting applied to the company’s earnings are too aggressive and produce poor quality earnings.  Maybe the company just isn’t as good as the other companies in its industry.  Usually, if a stock value looks too good to be true, it is!  In fact, I’d say that is the case for nearly 99% of all stocks.

When you look for good long term prospects, don’t just look at the cheapest stocks based on P/E or other valuation metrics.  Also, don’t just look at the stocks with the lowest PEG ratios.  Chances are there are reasons that they are trading that low.  Be especially suspicious if a stock has traded sideways or down in a bull market.  If you went back to the banking stocks before the financial crisis started, it would appear that they were valued very well, with their average P/E based on future earnings in the ballpark of 8 to 10 times earnings.  However, earnings sank instead of the realizing the growth that investors’ expected.  If you took the actual earnings for the next year and applied them to the price before the financial crisis, the real P/E of banking stocks was actually closer to 80 than 10.

You should always take into account the quality of earnings forecasts when making selections.  When a company has to lower guidance, the higher PE stocks are almost always hit harder than low PE stocks. For that reason, you should give slightly more favor to lower PE stocks, assuming they have a similar PEG ratio to a higher PE stock.

Regarding the consistency and reliability of earnings, these are two factors that matter greatly in choosing stocks.  The longer the track record of sustainable and consistent earnings growth that a company has, the higher the valuation will grow.  These companies typically trade for a premium to other companies, but the premium is often worth the price.  That’s because companies that have trouble posting consistent earnings often anger and lose many of their investors over time.  However, companies that investors can feel confident in, and have a more likely chance of realizing their forecasts, make investors happy and will draw in new investors over the years.

There is a huge difference in how each company is run.  To find the best long term values, you must find reasonable valuations by using the likes of PE and PEG ratios, but more importantly, you must choose companies that are well run and offer superior products.

Invest at a Bank

The easiest way to invest your money is to go to your local bank and make one of several investments.  Investments at banks have gotten more advanced over the years, with many banks now selling stock funds and other types of assets, but the basic accounts that banks offer are typically savings accounts, certificates of deposit and savings bonds.  Savings bonds are being phased out of paper form and will soon only be sold in electronic from through the US Treasury’s website.  Savings accounts are by far the easiest way to invest your money.  However, they have extremely low yields, usually just over 0%.  Certificates of deposit, or CDs, offer better yields but require a time commitment of between one month and a five years.  Overall, these are the easiest places to invest, but they are also the lowest yields and hence some of the poorest investment choices for people with a long term investment horizon.

Invest Through a Brokerage

Within a few minutes, you can set up an online brokerage account at any of the dozens of high quality discount brokers.  From these accounts, you can easily invest in tens of thousands of different investments.  The easiest and most popular investments include mutual funds.  When buying a mutual fund, you are buying a number of shares in a fund that typically holds hundreds of different stocks.  Mutual funds can be invested in specific sectors or geographies, or they can cover entire markets.  Besides mutual funds, you can also buy individual stocks through a brokerage.  It’s very easy to actually buy a stock or mutual fund.  The hard part is deciding which one to buy.  Most broker’s websites offer help in the form of stock and fund screeners.  Also available through brokers are exchange traded funds (ETFs), corporate and government bonds, real estate investment trusts (REITs) and even money market accounts.

Invest in Yourself

Investing in yourself can pay off in big long term gains in the form of higher income, higher job satisfaction, and even higher self esteem.  You can always increase the your market value by becoming better at something.  Ways to invest in yourself include finishing your high school education, attending a technical school, completing college, or even finding a trade association or accreditation program to enroll and graduate from.  And of course there is always higher education in the form of advanced degrees.  Other ways to invest money in yourself would be to take a self improvement course on public speaking or networking.  Even going to the gym is an investment in yourself.  On average, people that are more fit are more likely to get promotions and job offers than those that neglect their body.  There are literally thousands of things you can do to make yourself more marketable and improve your chances of success.

Invest in Real Estate

Investing in real estate is more difficult and takes a longer commitment than the methods mentioned above, but over the long term real estate could possibly be the biggest return on your investment.  That’s because when you invest in real estate you get four kinds of monetary gains – property price appreciation, debt paydown, increases in cash flow, and tax advantages.  Investing in real estate can be very complicated or it can be as simple as buying and renting out a condo.  It can also be very hands on, especially if you buy homes, improve them and then sell or “flip” them.  However, real estate investments can also be very hands off if you hire a property manager.  The most difficult part of investing in real estate is finding the best property to buy.  Real estate markets are not liquid and there are many properties that are listed at unreasonable levels.  Make sure you do your research and shop around for a while before you buy your first property.  Once you own a property, you can start to leverage existing properties to buy more properties in the future.

Invest in a Business

The toughest, and riskiest way to invest money is to invest in a business.  That’s because most small businesses fail after just a few years.  And many of the small business owners lose their life savings when their businesses fail.  If you are going to start a business, make sure you have a good plan and enough capital to get you started.  And if you don’t have any really good ideas, you can still invest in a business by buying an existing business.  Visit with a local small business broker to help you find businesses that are for sale.  Many successful businesses are sold because of disputes or because the owner needs to retire and doesn’t have an heir to their business.

These are some of the most common and easiest ways to invest your money.  If you didn’t find something that suits you, don’t worry, there are thousands of other ways to invest.  Here are some ideas that I can think of right now:

• Antiques
• Collectibles including comics and baseball cards
• Storage Auctions – like on the show Storage Wars
• Loan money to someone using an online site that helps people with small loans
• Invest in a website or start a blog

Have any ideas not listed?  Please leave us a comment below.

Why I Don’t Like Dividend Stocks

Generally, a fast growing company needs to put all of its cash flow back into its business to fund future growth or make acquisitions.  These reinvestments of capital are what usually keeps the company and the stock growing rapidly.  That means that a company that pays dividends has run out of growth, or cannot find enough good investments for its cash.  Therefore, the company decides to pay the cash back to investors.  And after all, the reason that we invest in stocks is because they are better investors than us, right?  For example, let’s say you have $100,000 to invest.  You can either start your own business or invest it in an established business (through stock).  Most people choose to invest in a business that is already established.  You can do so easily by buying stock.  The reason you buy stock in a company is because the business is growing and you believe the value of the stock will go up along with the growth.  So, in essence, you give your money to a company to manage for you and invest in their company.  So, when looking at it this way, why would you want that company to give you part of your money back?  I mean, didn’t you give it to them to invest?  By paying out dividends, a company is foregoing growth.  That is the key reason that I have always shunned dividend stocks.  However, there is also a case to be made in favor of dividend stocks.

Why Dividend Stocks Can Be Good Investments

Generally speaking, I still agree with the reasons above against dividend stocks, however, there are hundreds of dividend paying stocks that are still growing rapidly.  It is these growth / dividend stocks that I find appealing and here are some reasons why.

First, if you buy a dividend stock that is growing, both your cash flow and your portfolio will grow.  Look at a dividend stock like McDonalds (ticker MCD).  Ten years ago the stock was at $30 per share and they paid a 23 cent dividend.  Over a ten year period, their dividend rose over 1,000% to $2.80 per share and their stock has more than tripled.  If you had bought a thousand shares of stock ten years ago you would have paid $30,000.  Today, the stock value would be nearly $100,000 and you would be earning almost $3,000 per year in dividends.  Furthermore, you would have recieved over $13 per share in dividend payments, which would be the equivalent of $13,000!

Second, sometimes companies have extra cash because they are just highly profitable, not because they aren’t growing rapidly.  While its generally true that companies start paying dividends when their growth slows, it doesn’t mean that a company that pays dividends isn’t still growing.  Some companies are just very profitable.  Companies with large profit margins have more difficulty investing all of the excess cash flow, and sometimes prefer to focus on growing their existing business rather than investing in new businesses.  For this reason, it makes sense that some of these companies pay out excess cash in the form of dividends.  For example, long time growth stock Cisco Systems, the icon for growth over the dot com boom, now pays a dividend.  Cisco is a highly profitable company with gross margins over 60% and operating margins over 20%.  For a company that generates that much cash flow, it is hard to fully invest all of that cash and still focus on the business at hand.

Third, companies that offer dividends do so for the long term and are typically focused on longer term metrics.  The one thing that all dividend stocks have in common is that they are commited to paying dividends.  Once a company starts a dividend policy, their main investor goal is to continually and consistently raise their dividend.  That means that they will do whatever they can to keep paying larger and larger dividends.  These companies know they have a specific type of investor interested in their company and that missing a dividend would result in a lot of upset investors.  Companies that pay dividends understand that investors want long term consistency in both dividends and company performance.  That is part of the reason that dividend stocks are more stable than other stocks.  Management is able to focus on the long term rather than just trying to beat analysts’ growth estimates for the next few quarters.

Fourth, during poor markets, your yield actually increases.  Part of the reason that dividend stocks are attractive, is because they offer dividend yields.  So, what happens to your dividend stock investment when the market tanks.  Let’s say you own McDonalds stock, which currently yields 2.8% ($2.80 dividend and $100 stock price).  Now, let’s say the market has a huge sell off and all stocks fall 50%.  It’s true that you lost the same amount of equity as non-dividend portfolios, however, the good news is that your yield has doubled.  Because the dividend doesn’t change and the stock price does, your yield will climb when stock prices fall.  Also, because of the yield, dividend stocks often fall less during bad markets than other stocks, especially growth stocks.  Both of these factors can help you weather down markets more easily.

Finally, dividend stocks are good for those looking to buy and hold.  I have been a real estate investor in the past and kind of relate dividend stocks to real estate.  When you buy real estate, you are hoping to be somewhere around breakeven on cash flow.  Hopefully making a few bucks a month.  However, as you hold your real estate your costs do not increase very much but hopefully your rents and property value do.  This means that your cash flow will grow over time.  The same can be said for dividend stocks.  Buying a dividend paying stock today will not likely yield more than a few percent, however, in dollar terms, that dividend, or cash flow, will continue to grow overtime.  If you hold dividend stocks long enough, your dividends may eventually add up to as much as the price you initially paid for the stock.

We hope this has given you some fresh insight into dividend stocks.  We know that each individual investor favors certain aspects of different investments.  That’s why no one investment is perfect for everyone.  However, with this insight, we hope to shed some light on how you look at dividend stocks in the future.  If you have any comments or additional insight, please leave us a comment below.

Start by running a stock screener to figure out which stocks you want to add to your list.  You don’t have to run a stock screener.  You may already have a list of stocks that you are interested in, or you may go do your own research or read papers or magazines to get some ideas of stocks that you may be interested in.  Then, open a spreadsheet and fill the first column with the name of each company.  In the second column fill in the ticker symbol.  In the next columns, fill in the valuation metrics that you want to compare the companies with.  For example, price, earnings, growth, PEG and P/S.  Here is a sample of what your spreadsheet should look like.

To find the earnings per share estimates and the other figures, you can look at yahoo or google finance.  As you get better at stock valuation, you can also run your own numbers and use your own growth estimates.  Now, let’s look at the information we filled in on Apple, Cisco and Google, three of the most widely held growth stocks.  By looking at the comp analysis you can see that all three of the stocks are considered growth stocks.  However, they are all in different sectors.  While they could all be considered to be technology stocks, Cisco is a manufacturer, Google is a service provider, and Apple is part computer manufacturer and part service provider (iTunes).  You’ll want to keep the underlying business models in mind when you are looking at valuation metrics.

Now let’s look at the valuation metrics.  You’ll see that we added in the current and next year earnings per share estimates.  We then calculated price to earnings ratio based on current and next year estimates.  Based on P/E ratios alone, it would appear that Cisco is the stock with the lowest valuation.  After all it has a P/E of about 10 while Apple is a little higher and Google’s is nearly 50 percent higher. However, in this case it is important to also look at the PEG ratio.  In terms of PEG ratio, Apple has the best valuation, followed by Google and then Cisco.  In other words, even though Cisco is cheaper than Apple, it is not growing as fast and therefore justifies a lower valuation.  The key in finding good investment opportunities is to find stocks that are growing quickly but that do not trade at high valuations.

Also notice that we added price to sales to our comp analysis.  You’ll see that in terms of the multiple of sales, Cisco is also the cheapest, followed by Apple and Google.  However, it’s important to understand why these ratios vary.  In Google’s case, they have ultra high profit margins because they don’t manufacture products like the other two companies.  That means that they bring more of their revenue to the bottom line.  It also means that people pay more for each dollar of revenue.  Hence the higher price to sales ratio.

The example we’ve shown is very basic, and you can download it using the links below and modify it to your liking.  The more you learn about stocks and the more valuation work you do, the better you can make your comp analysis.  I’ve seen comps that have over 50 companies and over 100 columns filled in.  The key is getting the most important information into a format that you can easily look over and compare company to company.  Also, if you’re filling in the spreadsheet and using it to help you buy stocks, you’ll want to make sure you keep it updated.  As prices and company outlooks change, the valuation metrics can swing wildly, sometimes causing you to rethink your preferred investments.

Download Our Comparable Company Spreadsheet

Here is a copy of our Excel comparable company valuation spreadsheet.

Here is a copy of our OpenOffice calc comparable company valuation spreadsheet.

Use these copies of our comp analysis to get your own stock valuation tables set up.  Once you have your spreadsheet adjusted to the metrics that you like to use, it is easy to add new stocks and take out old ones that you are no longer interested in.  Also, you can make seperate sheets for different sectors.  For example, if you really like a particular oil company, it would make sense to create a seperate comp analysis with all of the oil companies in the same industry as the one you like.  Then, you can tell whether the stock you like looks good when compared to its peers.  Sometimes the stock you first thought was a great buy leads you to find another stock that is even better.

One final point.  When you are running comps, don’t ever make your buy or sell decision solely on valuation metrics.  If you do you could be buying the cheapest company because, well, its just a cheap and crappy company.  Instead, take into consideration the history of earnings performance, the effectiveness of its products or services, and how well management has been able to weather downturns in the economy.  And for help choosing which valuation metrics you want to use, check out other sections of our site, as we have detailed posts on how to calculate and compare companies using many different metrics.

Now, one could argue that the law was not passed by the politicians in office, so that they are not really the one’s to blame.  Of course, if you use that defense, then you are probably one of those people that blame everyone else for all of your problems.  Besides, there has been a congresswoman that has been trying to pass a law to make insider trading illegal for lawmakers and related parties.  She has been trying for over six years to pass the law.  And now that the law is finally getting some traction, mainly because of how all of this was exposed on the 60 Minutes TV show, the lawmakers are trying to make bipartisan politics over the law, “not wanting to rush into anything”.  For crying out loud, its been in the works for SIX years!

Furthermore, there’s been a study by Alan Ziobrowski at Georgia State University about how lawmakers investment portfolios have fared compared to the overall stock market.  Apparently, lawmakers have outperformed the market.  Not just in good times, but also in down markets.  This is something that large investment companies can’t even claim to have done.  This is something that Warren Buffet has not even done.  In my opinion, it is proof that lawmakers were able to use insider trading to add to their financial gain.  Although it’s impossible to go back and calculate the amount of money they made from insider trading, I wish they would go back and make these people pay back these gains.

Once again, our government has failed us.  How many more failures can we take before something is done?

Update: Bill is Passed to Ban Insider Trading by Lawmakers

Note that today, February 9, 2012, a law was finally passed to ban insider trading.  The sad part is that it took this long and that much debate over something that everyone knew was the right thing to do.  Is this a sign that our legislators are working or of how dysfunctional they really are?

First of all, he is not predicting the future by using facts.  He is mentioning facts that have nothing to do with the current situation (like historical collapses in markets and economies) and then trying to scare you into believing that they are going to happen in the US.  After all, if you listen to someone that you trust talk about bad things long enough, you’ll probably start to believe them.  The same can be true if you listen to your stockbroker tell you how great a stock is.  If you hear it enough you start to believe it.  Especially if there’s no one telling you anything different.  It’s human nature to want to trust and believe people, and its even easier to believe them when they lay out what seems to be a logical way to arrive at their decision.  That brings us to the second point.

His argument is not logical.  By using facts to form his argument, it’s easy to believe at first.  But if you look closely at those “facts”, they have nothing to do with the future.  They are all facts or scenarios that have happened to other countries and at other points in history.  By talking about facts and then stating his opinion, one may think that his opinion is based on fact, but in reality it is not.  That brings us to the final point about his presentation.

He uses fear to sell his products.  In my opinion, there is no one lower on the totem pole of pathetic than someone that uses fear to sell you their product (except for maybe some of the spammers or outright thieves).  By spending an hour talking about how the US is doomed and how you can move money into assets that you don’t have to report to the us government, he is trying to make you buy his newsletter by using fear.  And this is coming at a time when their is already enough fear in the market.

Now, with that said, I’m hoping you didn’t subscribe to his newsletter.  And so, to answer the question that you were searching for, you know, the four assets that you don’t have to report to the US government, the answer is that they do not exist.  By law, any investments both foreign and domestic, must be reported to the US government as required by the IRS tax code.  That is not to say that there aren’t ways around reporting your assets to the government.  But if you do, you are definitely either breaking the law or in a gray area that you will have to worry about for the foreseeable future.