The Amateur Investor Ep.11: Small Picture, Big Picture
After writing the last issue, I decided to reward myself by going out to my local climbing gym for a socially distanced climb. It was a good session, my strength was largely there but the skin wasn’t keeping up. Afterwards I opted to go for a walk around a nearby soccer oval whilst stretching and listening to a podcast. My solitude didn’t last long as a pair of young guys wandered on to the oval, kicking a soccer ball around and talking in between drags on cigarettes.
“But she does yoga man! Yoga! What was the problem!?” One of them (we’ll call him Arsenal, for the glaring shirt he wore and his slight British accent) exclaimed to his slightly despondent, cardigan-clad friend (let’s call him Chuck, cause why not).
By now I was slightly invested. Sexism aside, what could the problem have been? I’d been sitting on a nearby bench resting as they approached, a perfect spot to listen in on the drama
“Aw mate you don’t know, she’s crazy.” Chuck offered after a particularly deep drag, talking through the smoke.
“Crazy how man?”
At this point our embattled hero turned away, slightly embarrassed, the ball rolling sadly past his shoes.
“She’s like, crazy man. She thinks the Earth is flat and that corona-virus is some deep state ploy. She’s proper nuts dude.”
“Mate, that’s crazy. You can’t be serious!”
“I am serious! You know how long I’ve been trying to get with her. But mate, she’s – properly nuts. When I was studying for exams, she started talking about how I need to make sure I’m vibrating higher than the stress and how I should keep crystals on me. I mean she’s hot as hell but I had to end it mate. Too much crazy for me.”
“Mate I’m gutted to hear that. When did you end it?”
“Last month. I’ve just kept it quiet with the guys from uni. Don’t need more drama.”
“Ah yeah, cool. Mind if I take a run at her?”
“Yeah man, knock yourself out.”
As good as the Discounted Cash Flow is for forecasting the current worth of future investment, it’s important to make sure that your valuation accounts for dividends, which can skew your outcome. A company that has an 18% dividend is attractive, but don’t let that affect stop you from looking at the nuts and bolts, otherwise you might wind up like our friend Chuck here, drawn into a situation that he hadn’t previously anticipated. Whilst you might not wind up with a company whose executives believe in flat-earth or crystals,you might find yourself in a position where the stocks are losing value, or worse, the company itself is headed for bankruptcy due to shoddy work. This issue’s lesson is all about teaching you how to take the attractions of the little picture into account and making sure you look at every nook and cranny of the big picture.
On paper, accommodating for dividends requires some math, hopefully the last for a little while, though it all depends on how my next meeting with the Mockers goes. The math in question is the Dividend Payout Ratio (DPR) which calculates how well the earnings of a company support the payment of dividends. The formula itself is relatively easy to figure out.
DPR = Total dividends/Net Income
Interpreting it is a whole other matter. Many companies looking to grow tend to reinvest profits, offering little to no dividends. On the other end of the scale, companies paying higher dividends may be in industries that have matured such that there may be little to no room for additional growth. Or they may have no interest in growing and just want to pay out dividends, who knows. Like most pieces of information, it doesn’t mean much unless you take into account other factors like where the company sits within the industry and what its competitors are doing. Let’s look at an example, let’s say The Good Brewing Company declares a $0.50 cash dividend per-share for shareholders of record at the start of the fiscal year of 2018. By the end of the fiscal year in September, the company’s earnings-per-share was $7.50.
The DPR would then be;
$0.50/$7.50 = 0.0667
With a DPR of 0.0667, we know that The Good Brewing Company pays out 6.67% to its shareholders in dividends, retaining the remaining 93.33%, which would be the retention ratio.
Numbers aside, another important factor to consider is also the company’s dividend trend over time. Generally speaking a stable rise in DPR over time could be indicative of a company maturing and settling into a position of stability and maturity. In that same logic, a company with spiking dividends raises a few eyebrows since it might not be able to feasibly maintain those payments, which might bear further scrutiny, there could be any number of reasons why this is the case, but for my appetite as an amateur, it’s best to steer clear.
There’s also a decent argument for doing some old fashioned detective work and looking at the qualitative side of things. These include things like the company’s layout and infrastructure, how the company sits within the industry, how much the industry itself is worth, and if there are any new developments in the industry. It might also be worth looking at things from the employee experience as well, examining employee reviews on glassdoor to see how it is their employees feel about the company’s management style and overall compensation packages. It might seem somewhat excessive but when it comes to your money and improving your investment, it’s best not to take chances. To paraphrase from a common quote about weddings; investing is not by any to be entered into unadvisedly or lightly; but reverently, discreetly, advisedly, soberly, and in the fear of God. Or whatever god you decide.
A lot of valuation, as I’ve said up top, is aimed at taking as much of the guesswork out of investing as possible. That’s said, it’s not the most precise of sciences. As fellow Mocker Hsuan said to me, it’s all a bit fluffy at times. The best we can really do is to do your due diligence as much as possible, decide what you expect the company to do, and formulate a strategy based on that, with contingencies for if things take an unexpected turn.
Above all, play small, go slow, learn the process.
Here’s some further reading on ratios and math things
https://www.thebalance.com/understanding-dividend-payout-ratio-3140781
https://www.investopedia.com/terms/d/dividendpayoutratio.asp
