Friday, January 12, 2018

Stock Price Versus P/E and Dividend Ratios

Buying individual stocks and stock-picking are two different things.

A reader writes in response to my previous posting that buying individual stocks is not necessarily a bad thing.   And he is right about this, to some extent - but that is different than "stock picking" as the term is ordinary understood.   I own some stocks directly (maybe 10% of my portfolio) and a whole lot more of them in mutual funds, index funds, and the like.

"Stock Picking" in my book, is the act of buying and selling a stock based on what the media hypes, and looking only at share price and share price history as indicia of whether to buy or sell.  Stock pickers do not hang onto stocks, but buy and sell them, often on the same day, convinced that the only thing important is the share price, and that you can make money by timing your purchases and sales.  "BUY!  SELL!" the shouting guy screams at the camera.   It is not investing, but gambling.

This is what the financial channels tout as the end-all to investing - looking at the share price and its direction of travel.   And this has gone on for a long time.   In the old days, you'd get the newspaper and they'd have stock prices on several pages in the "business section" of the paper.   My Dad would look at this every morning to see how his stocks were doing (he owned like maybe five of them, worth maybe $20,000 or so, he was a playa).   And most people "investing" back then did the same thing.  Mutual funds were still a fairly new thing.

Before that, there was the "ticker" that you see in old movies - a device under a glass dome, usually, that spit out stock symbols and their prices in real-time.   If you were really rich, you had one of these in your home - sort of an early version of the Internet, I guess.   On Wall Street, all the offices had them, and "ticker tape" piled up rapidly.   Whenever there was a parade, they tossed it all out the window in a snowstorm of ticker-tape, hence the ticker-tape parade.   Today, we hardly use paper, and people have to buy confetti to throw - if they even do that anymore.

When I was a kid, they still had ticker-tape parades with real ticker-tape.   Today, it is just a name for a parade where they throw confetti.

The point is, this obsession about stock price goes way back.   And in fact, Joe Blow small investor has a long history of obsessing about stock price and not thinking too much about profits, losses, dividends, or the underlying health of the company.   It is akin to horse racing.   You can go to the track and look a the horses, research their history, talk to the jockeys, and whatnot and figure out which horse is actually the best horse.  Or you can pick the name of a horse that sounds "lucky" or pick a horse based on numerology.   You'd be surprised, a lot of people do just that.

And in stock buying, a lot of people do just that.  They look at the share price, which is the least valuable piece of information available, and then look at the share price chart and think either, "Well, this stock has gone up, so it must be poised to go higher!" or "This stock has gone down, so it must be time for it to go up!"   It is also akin to how some people play the slots.  They follow you around and watch to see if the machine you played paid off.  If not, after you leave, they jump in, convinced that the machine is "due" for a win, not realizing that probability doesn't necessarily work that way.

So when the Shouting Guy says that "Stock picking isn't dead!" what he means is not researching companies and figuring out what to invest in, but instead, him shouting "BUY!" and "SELL!" at the TeeVee screen, based on share price trends and other unimportant indicia.   As I noted in the previous posting - and as many people have investigated - his track record of stock tips really, really sucks and he should not be trusted to interpret a bus schedule, much less the stock market.   But he has a "persona" and that's what TeeVee and TeeVee watchers like - so he's on the air.

Don't confuse entertainment with facts.   And television is all entertainment.   Even Fox News admits this, in their Trademark Registration for "Fair and Balanced" - Entertainment in the form of News Services.   Television is designed to titillate and entertain - not inform.   Don't confuse the two!

For the average small investor, mutual funds are the primary means of investment.   And this is mostly because your 401(k) plan at work offers investment in one or more mutual funds.   There is usually an index-type fund, a bond fund, a growth fund, and an income fund, maybe a few more.  And most investors, like myself, are mystified, so they pretty much divvy it up their 401(k) contributions between the funds offered.   You could do a lot worse in life.

The main thing about investing is investing - taking money out of your paycheck and putting it into your 401(k) or IRA or whatever, instead of leasing a new car.    Most of the money you end up with in retirement will be money you set aside.  The "gains" you get from investing will be proportional to this amount, so it pays to set aside as much as you can afford to do, if you want to achieve the largest amount of gains.   The idea you can invest a dollar in a long-shot deal and win big, is flawed, however.

A lot of people who claim to have no savings whatsoever and are lurching toward retirement, also have all the cable channels, a new leased car, and a new iPhone X or whatever - and snicker at you for not having all these things.  You must be "poor" - right?   And when they find out they squandered their wealth, they petition the government to take away your money and give it to them, because you were fortunate and they were unlucky.   But I digress....

Getting back to mutual funds, the advantage of them is that they diversify your portfolio without a lot of work on your part.   You pick a fund, and someone else manages it, and they buy a panoply of different stocks and bonds.   No one stock can sink your portfolio, or indeed no one sector - for the most part.   If you are invested in a number of different mutual funds with different objectives, you are very well diversified.

There are downsides, to be sure.  You are never quite sure what you are invested in, for starters.  And some funds have large "load" fees or management (expense ratio) fees, and it is difficult for the average investor to find out what these fees are.  I have fallen victim to load fees from financial advisers (including my own father!) who told me to my face the mutual funds had "no loads" but in fact had fees as high as 5%!

Since most of us use a 401(k) as our primary vehicle for investment, buying individual stocks is tricky.   There are a number of ways to go about buying stocks, as I have noted before.   But putting all your eggs into a stock portfolio is a really bad idea, in  my opinion, as our ability to divine what is and isn't a good investment is pretty limited.

As I noted in an early posting, one way to get started in stock investing is through dividend reinvestment programs, or DRiP investing, which is sort of obsolete today.  These are programs run by the company you are investing in (and managed by companies like Computershare) that allow you, as a shareholder, to buy additional stock in the company, as well as reinvest your dividends.  As the name implies, these programs work mostly for old-line "blue chip" companies that make profits (most of the time) and pay dividends.  I have bought stock in companies like Boeing, Ford, GM, Harley-Davidson, Sears, Exxon-Mobil, Stanley Black & Decker, and even a bank my friend started.

I am glad I got out of Harley-Davidson when I did, as well as Sears, of course.   Harley is struggling to re-invent itself for a new generation that doesn't have $20,000 to spend on a toyAnd Sears... well, you know the story there.    You see the problem with choosing individual stocks, though.   I thought Sears would be bankrupt long before today.  Maybe this year - maybe next.  But I am glad I got out with some of my money intact, anyway.  Timing the market is nearly impossible to do.

I ended up closing my Compushare account, not because I was unhappy with it, but because they charged a $1 transaction fee whenever you re-invested dividends, and also a transaction fee when you bought stock through the system.   But, back in the day, when a single trade could cost you $20 or more through a broker, it was a "cheap" way of getting into stocks without going through a brokerage.  I set up my account to debit my checking account every month for $50 to $100 for each stock (making sure I cut my expenses by a corresponding amount first!) and over time, accumulated a lot of after-tax investments.

Of course today, I use a brokerage account with Merrill Edge, as the trades are free.  And I no longer re-invest dividends, but rather let them accumulate as cash and then use that cash to buy a different stock - thus diversifying my portfolio of stocks this way.   It is, in a way, like a self-directed mutual fund, with over sixty different stocks in it.   Since trades are free, there is no overhead involved, and you can buy even a few hundred dollars worth of stock cost-effectively.

I also rolled over an IRA from Fidelity that was in mutual funds and put it into an e*Trade self-directed IRA - buying and selling stocks for $7.99 a trade.   I did OK with this - again having dozens of stocks in the portfolio.   But I have since rolled this over to Merrill Edge as well - free trades are free trades.  Sorry, e*Trade!

But again, the amount I have in individual stocks is about 10% of my portfolio.  I don't think it is worthwhile to gamble my future on my ability to out-think and out-predict people a whole lot smarter than I am.   And my stocks are pretty tame, compared to what is hyped on the television.  These are things with rational P/E ratios (well under 100, most around 20 or so) that make profits, sell products, and pay dividends.   I don't own any speculative stocks in tech companies promising "The Next Big Thing!" which turns out to be a Ferrari in the founder's garage.

Oh, sure, when I started out, I got sucked into that sort of nonsense.  I bought stock in Syntroleum which was a synthetic fuel maker.   Seemed like a good idea at the time, and the guy on television (this is before I ditched cable) told me it was a sure thing.  Then the price of oil plummeted (this was back in the 1990's) and suddenly the whole process was uneconomical.  I also bought stock in "Martha Stewart Omnimedia" which turned out to be a cookbook.   And apparently she was cooking the books as well, as she ended up going to jail.   Lesson learned, I stopped watching the financial channels for "hot stock tips!" shared with only 300 million other people.

And yes, I realized later on that many of these hyped stocks were hyped for a reason - it was the old pump-and-dump, and many of the commentators were paid to hype a particular stock as it made money for someone.

I also learned, firsthand while working at a "tech" law firm, that the hyped IPOs were just vehicles for insiders to cash out.  They are NOT a means of raising capital!  But it is a complicated con, so most people can't figure it out.  It is a scandal, really, but each generation comes to the table not realizing the hard lessons the previous generation learned.   So the cycle repeats itself, again and again - which is maybe why these boom/bust cycles in the economy are about 20 years apart.

The 20-something today "investing" in Bitcoin is saying it is a "new paradigm" and a new era - the same siren song I heard in 1995 during the dot-com boom.   But they weren't even born yet in 1995, and were still in elementary school when the economy melted down a decade ago.   Sadly, they will learn hard lessons as I did - well some of them will.   A lot of people never learn and keep being "raging true believers" for life.

And the reason they remain raging true believers is the same reason people buy lottery tickets.   As one hapless chap chirped at me, "Well, someone has to win, right?  Might as well be me!"   And they think that, even as they tear up ticket after unwinning ticket, for their entire lives.   People feel the same way about IPOs, Bitcoin, Gold, and other hyped investments.   Just enough of them turn out to be winners to keep people buying the losers.

So yea, you can make money on hyped investments, but it is based on luck, not skill.   You can also lose your shirt - it is a predictable outcome - and one way to avoid losing  your shirt is to just walk away from all hyped investments.   You may not "win big" but you won't lose it all, either.

And we can't afford to lose it all.  Not Mr. and Mrs. Middle-Class, struggling to hang on to what little they got.

And yes, I have "picked" stocks on occasion that have done spectacularly well - 7000% gains makes even Bitcoin look tame.   But the lesson I learned from that was not to pick stocks, but rather than I got lucky on what was essentially a drunken gamble.

What the financial media touts and the Shouting Guy shouts is that you can become a millionaire or even a billionaire, not by putting money aside into rational investments, but by putting down small bets of a few thousand dollars or so into "Next Big Thing!" gambles - and this is what they call stock picking - the buying and selling of stocks based on anything other than the underlying health of the company.

Stock picking is a sure way to go broke.   The only thing worse is day-trading!