Stop buying stocks
QUESTION: Stock investing is really very taxing. One day, stock prices are up; then without any warning, they fall precipitously. The stress is causing my blood pressure to fluctuate with stock price movements. Is there an easier way to be invested in stocks?—posted on PFA’s “ask a friend, ask Efren” service at www.personalfinance.ph
Answer: In an earlier article, I wrote about the music-inspired approach to stock investing. There were 10 tips, the seventh being: It’s more than just a manic Monday for stock investing. Everyday, the stock market will display manic-depressive tendencies. This is because stock prices are tossed into a volatile soup of the ABCs of investing, clashing with the FGHIs (i.e. fear, greed, hope and ignorance) in daily epic battles.
Rise above the noise of the market and you will see that investing is not that topsy-turvy after all.
You may ask how one can rise above the noise. The simple solution is to stop buying stocks. Instead, if you are a long-term investor, buy companies. After all, it is the company that makes the stock valuable and not the other way around. So take a look at the balance sheet of the company whose stock you want to make a return on.
When you invest, you want a return on your money. This can be expressed in the return on equity ratio. Returns or net income cannot be had from thin air. They are generated from assets that are deployed by companies. The more earning assets there are that are bought with shareholders’ money, the better the return on equity will be.
However, a company’s assets are not just funded by equity but also by debt. Many times, companies would need to use more assets than what the equity of investors alone can afford. That is why companies contract debt. The more that debt is used to create earning assets instead of mindless corporate consumption, the better it is for return on equity. This assumes of course that the additional returns are substantially more than the cost of the debt.
Return or net income for its part is a function of two things: revenues and costs. If a company is deploying the right assets then it should be generating the appropriate level of revenues. But even companies that are generating tons of cash will produce meager net incomes if they are not being prudent with their cost of doing business; consequently they will also produce pitiful return on equity ratios. A company has to hit optimum returns by keeping its production, selling, general, administrative and borrowing costs efficient.
A company with good management will reinvest its earnings to keep the company growing. And management must have no qualms paying out dividends to stockholders using excess earnings.
That is why making money on a company is also about looking at the amount of dividends it can pay in addition to the potential appreciation in stock price—what is called capital gain.
And how can you earn capital gains on a company? A company with a high current and prospective return on equity will be attractive. The trick is for you to find attractive companies that are sold below their intrinsic value based on your research. Buying a company at full value will leave you very little meat on the bone with which to make capital gains.
So stop buying stocks. Buy companies instead. Once you have executed your investment after careful study, follow Warren Buffet’s advice: Turn off the stock market. Your blood pressure will stabilize.
(Efren Ll. Cruz is a registered financial planner of RFP Philippines, personal finance coach, seasoned investment adviser and bestselling author. Questions about the article may be sent by SMS to 0917-5050709 or emailed to [email protected]. To learn more about the RFP program, attend a FREE orientation on June 11, 7 p.m. at the PSE Center. E-mail [email protected] or text <name><e-mail><RFP> at 0917-3464126 to register.)
