The distinction between Qualified and non-Qualified dividends has to do with how you’re taxed on those dividends.
Qualified dividends are taxed at 15% for most taxpayers. (It’s zero for single taxpayers with incomes under $40,000 and 20% for single taxpayers with incomes over $441,451.)
Ordinary dividends (or “nonqualified dividends”) are taxed at your normal marginal tax rate.
The concept of qualified dividends began with the 2003 tax cuts. Previously, all dividends were taxed at the taxpayer’s normal marginal rate.
The lower qualified rate was designed to fix one of the great unintended consequences of the U.S. tax code. By taxing dividends at a higher rate, the IRS was incentivizing companies not to pay them. Instead, it incentivized them to do stock buybacks (which were untaxed) or simply hoard the cash.
By creating the lower qualified dividend tax rate that was equal to the long-term capital gains tax rate, the tax code instead incentivized companies to reward their long-term shareholders with higher dividends. It also incentivized investors to hold their stocks for longer to collect them.
Qualified Dividends
To be qualified, a dividend must be paid by a U.S. company or a foreign company that trades in the U.S. or has a tax treaty with the U.S. That part is simple enough to understand.
Importance of dividends
From 1871 through 2003, 97% of the total after-inflation accumulation from stocks came from reinvesting dividends. Only 3% came from capital gains.”
To put this into perspective, take a look at the example used by John Bogle, where he writes: “An investment of $10,000 in the S&P 500 Index at its 1926 inception with all dividends reinvested would by the end of September 2007 have grown to approximately $33,100,000 (10.4% compounded). If dividends had not been reinvested, the value of that investment would have been just over $1,200,000 (6.1% compounded)—an amazing gap of $32 million.” The reinvestment of dividends accounted for almost all of the stocks’ long-term total return.
Dividends are an important consideration when investing in the share market as they provide a reliable source of return while you wait.
The price-to-earnings ratio, or P/E ratio, helps investors compare the price of a company’s stock to the earnings the company generates. The P/E ratio helps investors determine whether a stock is overvalued or undervalued.
By comparing the P/E ratios companies in the same industry, investors can determine which companies are relatively under or over valued in comparison to their industrial peers.
The P/E ratio is derived by dividing the market price of a stock by the stock’s earnings.
The market price of a stock tells you how much people are willing to pay to own the shares, but the P/E ratio tells you whether the price accurately reflects the company’s earnings potential, or it’s value over time.
If the P/E ratio is much higher than comparable companies, investors may end up paying more for every dollar of earnings.
The typical value investor search for companies with lower than average P/E ratios with the expectation that either the earnings will increase or the valuation will increase, which will cause the stock price to rise.
On occasion, a high P/E ratio can indicate the market is pricing in greater growth that’s expected in the future years.
A negative P/E ratio shows that a company has not reported profits, something that is not uncommon for new, early stage companies or companies undergoing financial perturbations.
Current stock price may be important in choosing a stock, but it shouldn’t be the only factor. A low market stock price does not necessarily correlate to a undervalued or cheap stock.
The P/E ratio is a key tool to help you compare the valuations of individual stocks or entire stock indexes, such as the S&P 500.
References:
Rajcevic, Eddie, Greenbacks & Green Energy, Luckbox, May 2022, pg. 58.
Dividends account for about 40% of total stock market return over time
Value of dividends
There are 2 ways to make money in the stock market: capital appreciation and dividends.
Capital appreciation—an increase in a stock’s price—gets most of the attention, but dividends can be surprisingly powerful.
Fidelity Investments’ research finds that dividend payments have accounted for approximately 40% of the overall stock market’s return since 1930.
What’s more, dividends can help prop up returns when stock prices struggle. For example, stock prices in the S&P 500 fell during the 1930s and 2000s, but dividends almost completely offset the decline. In the 1940s and 1970s, when inflation surged, dividends accounted for 65% and 71% of the S&P 500’s return, respectively.
“From a multi-asset income perspective, I am always seeking investments that pay a high enough level of current income to help cushion the blow during down markets. Conversely, in rising markets, this income component contributes to the overall total return of the investment. In this regard, companies that pay a sustainable and growing dividend have the potential to grow their income to keep up with inflation,” says Adam Kramer, portfolio manager for the Fidelity Multi-Asset Income Fund
“Price is what you pay; value is what you get.” Warren Buffett
“Don’t judge a company’s stock by its share price.” Many people incorrectly assume that a stock with a low dollar price is cheap, while another one with a four-digit dollar price is expensive. In fact, a stock’s price says little about that stock’s value. Moreover, it says nothing at all about whether that the market price of a company is headed higher or lower.
The most important distinction between the ‘market price you pay’ and the ‘intrinsic value you get’ is the fact that price is arbitrary and value is fundamental.
Price is the amount paid for the product or service.
Cost is the aggregate monetary value of the inputs used in the production of the goods or services.
Value of a product or service is the utility or worth of the product or service for an individual.
To effectively deploy this strategy, it’s essential to find a company that you understand, that has solid fundamentals — then be patient and wait until the company’s stock price falls below its intrinsic value before you purchase the company.
Regarding ‘understanding’ a company, it’s important for investors to know how a company makes its money–revenue, profits and free cash flow.
At some point, a stock’s market price over the long term adjusts to its intrinsic value. This fact is how successful investors such as Warren Buffet have used to make billions over the long term.
“Finding differences between price and value is by far the most effective investment strategy”, writes Phil Townes, founder of Rule One Investing . “Not recognizing differences between price and value is also what causes many investors to lose their shirts, as companies are just as often overpriced as they are underpriced.”
How do you find companies that are on sale for less than their true value is to evaluate companies using a set of standards that look beyond the company’s current price tag. Phil Town call these standards the four Ms:
Meaning,
Moat,
Management and
Margin of Safety
The first step is to make sure you understand the company and the company you invest in has meaning to you as an investor. If it does, you’ll understand it better, be more likely to research it and be more passionate about investing in it.
The second step is to choose a company that has a moat. This means that there is something inherent about the company that makes it difficult for competitors to step in and carve away part of their market share.
The third step is to look at the company’s management. Companies live and die by the people managing them, and if you are going to invest in a company, you need to make sure their management is talented and trustworthy.
Finally, calculate the company’s intrinsic value and determine a margin of safety. Margin of safety is the price at which you can buy shares of a company, being more likely that you won’t lose money and have increased confident that you will make a good return on your invested capital.
When the market price of a company is lower than the company’s intrinsic value number, the company is deemed underpriced and represents a great investment opportunity.
“Leveraging differences between price and value is as simple as that”, said Town. “Find a company that you believe in, that has solid fundamentals — then wait until their price falls below their value. If you do this, you can buy companies on sale, sell them for their true value and make a lot of money in the process.”
The goal is to identify stocks that are undervalued—that is, their market prices do not reflect their true intrinsic value.
The overriding goal is to help individuals learn how to successfully invest in assets, to build long term wealth and achieve lifetime financial freedom.
“We continue to believe that the S&P will see a correction of at least 20% over the next one to two years as the Fed is more aggressive than expected to deal with inflation running higher than expected and easy money begins to decrease.” Dan Niles
“The markets are in a volatile and dangerous place as of now,” writes Dan Niles, founder and portfolio manager for the Satori Fund.
In his article entitled “Market Thoughts Following Q1”, Niles contends that investors heed the warning: “Don’t Fight the Fed”.
He states that “Investors are forgetting that it [Don’t Fight the Fed] works on the way down as well as the way up. The Federal Reserve (The Fed) expanded their balance sheet by $4.8 trillion since the start of the pandemic while the US government added ~$5.5 trillion in stimulus. Combined stimulus of roughly half of US GDP of $20.5 trillion is the major driver of why the prices of stocks (along with homes, cars, boats, crypto, art, NFTs, etc) all went up over the past two years during a global pandemic. Now, the Fed dot plot shows 10 rate hikes in less than two years and they will be cutting trillions off the balance sheet probably starting on May 4th along with a 50 bps rate hike.”
“The #1 concern for investors in 2022 should continue to be that the Fed is so far behind the curve on dealing with inflation that they will have to be much more aggressive than in prior tightening cycles despite high inflation & geopolitical risk.” Dan Niles
“We [Satori Fund] continue to believe that the S&P will see a correction of at least 20% over the next one to two years as the Fed is more aggressive than expected to deal with inflation running higher than expected and easy money begins to decrease. Since World War II,
Every time Inflation (CPI) is over 5% a recession has occurred
Every time oil prices have doubled relative to the prior 2-year average ($54 in this case) a recession has occurred
10 of the 13 prior recessions have been preceded by a tightening cycle by the Fed
10 of the last 13 recessions have been preceded by the 10-year yield going below the 2-year yield”
For retail investors, Niles recommends “cash until inflation, Fed tightening and economic slowing run their course over the next one to two years. He writes that “most of the time, cash is a terrible investment especially in a high inflationary environment, but it is better to lose 6-7% to inflation this year than 20%+ in a stock market drop. With the Fed being this far behind the curve on inflation, we will find out how much froth is in valuations as the Fed starts tightening as growth continues to slow.”
Satori Fund likes companies that
Benefit from economic reopening (not pandemic beneficiaries);
Are profitable with good cash flow;
Have growth but at a reasonable price;
Benefit from higher-than-average inflation;
Benefit from multi-year secular tailwinds.
They foresee investing tailwinds in:
Datacenter, office enterprise, and 5G infrastructure.
Reopening plays such as airlines, cruise lines, travel, rideshare, and dating services as people adjust to covid becoming endemic.
Banks which should benefit from higher interest rates.
Alternative energy as geopolitics and fallout from the Russia-Ukraine War drives investment in the space.
Investors are more likely to reach their long-term goals if they remain invested and avoid short-term decisions that may take them off course.
Staying the course during market volatility is often difficult for many investors. Some choose to move to cash investments, while others try to time the market. Regrettably, these investors are often buying high and selling low—and miss the rallies that follow the challenging periods.
Yet, staying invested through market ups and downs can help you stay on track to reach your investment goals.
Once you’ve determined how much you want to invest, setting up automatic transfers to your investment account or periodic investments can help you stay on track.
For example, investors often make suboptimal investing decisions when emotions take over, tending to buy out of excitement when the market is going up and sell out of fear when the market is falling. Markets do ultimately normalize, and when they do, those who stay invested may benefit more than those who don’t. Consider this:
By missing some of the market’s best days, investors can lose out on critical opportunities to grow their portfolio. Market timing can have devastating results.
Seven of the best 10 days occurred within two weeks of the 10 worst days.
The second worst day for the markets during the early days of the COVID-19 pandemic, March 12, 2020, was immediately followed by the second best day of the year.
Trying to time the bottom is never considered a sound strategy for long-term investing.
Staying invested during periods of heighten market volatility is an important strategy as, historically, six of the ten best days in the market occur within two weeks of the ten worst days; those who miss the best days miss out on performance.
Thus, the decision to stay invested during market turmoil is often better than timing
when to sell and buy.
“The stock market is a device to transfer money from the impatient to the patient.” — Warren Buffett
Patience is ofter referred to as the most underused investing skill and virute. And, learning patience could help you reach your financial goals of wealth building and finacial freedom.
Be extremely patient when investing in assets and wait until you can buy an investment at an entry price when everybody else hates the investment or are extremely pessimistic about the prospects of the investment.
In other words, wait until you can buy the asset at a extremely discounted price. Keep in mind that every investment is affected by what you pay for it. The less you pay, the better your rate of return on that investment. Never, Never, Never…overpay for an investment.
People feel losses twice as much as they feel gains.
Successful investors develop a number of valuable skills over their lifetimes. And many report that patience is the most important skill to learn and master, but often it goes underused.
We’re not born patient. But, patience can be learned and, if you’re an investor, learning it could help you reach your financial goals.
Patience often involves staying calm in situations where you lack control. Even if we’re patient in some parts of life, we have to practice and adapt to be patient in new situations. Just because you’re a patient person while waiting in line at the DMV doesn’t mean you’re a patient investor.
Alway keep in mind and retain the mantra that…if there is a good opportunity now, a better one will come in the future.
Yet, patience can be difficult for investors to master, why it’s an important investing skill and how to apply patience to investing.
Why Is it so Hard to Be Patient?
Simply put, your brain makes it hard to be patient. Human beings were designed to react to threats, either real or perceived. Stressful situations trigger a physiological response in people. You’ve likely heard this called the “fight-or-flight” response — either attack or run away, whatever helps alleviate the threat.
The problem is, your body doesn’t recognize the difference between true physical danger (during which fighting or fleeing would actually be helpful) and psychological triggers, like scary movies. Being patient is difficult because it means overcoming these natural instincts. Turbulent financial markets can trigger the response too but, unlike scary movies, there can be real-world impacts you’ll need patience to overcome.
When markets are seesawing and you’re overwhelmed with negative financial media, as we experienced this year during the pandemic-driven bear market, your brain perceives a threat to your financial well-being. Even though stock market volatility isn’t a physical threat, the fight-or-flight response kicks in, emotion takes over, and your brain starts telling you to do something. Your investment portfolio is being harmed! Take action! Now! With investing, action too often translates into selling something because selling feels like you’re shielding your portfolio from further harm. But selling at the wrong time — like in the middle of a major downturn — is one of the biggest investment mistakes you can make.
Impatient investors let anxiety and emotion rule their decision-making. Their tendency towards “doing something” can lead to detrimental investing behaviors: checking account balances too often, focusing on short-term volatility, selling or buying at the wrong time or abandoning a long-term strategic investment plan. And those bad behaviors could damage investors’ long-term returns.
Selling out of the market during a correction might feel like you’re taking prudent action. And you may even derive some pleasure in seeing the market continue to fall after you’ve sold your equities. But that pleasure could soon be replaced by regret, because consistently and correctly timing the market by selling and buying back in at the right time requires an incredible amount of luck — and we don’t know any investors who have that much luck.
Investment entry point and investor patience are super-important too.
Benjamin Graham, known as the “father of value investing,” knew the importance of patience in investing. Patience and investing are actually natural partners. Investing is a long-term prospect, the benefits of which typically come after many years. Patience, too, is a behavior where the benefits are mostly long-term. To be patient is to endure some short-term hardship for a future reward.
The importance of being patient when investing can be best summed in this quote by Benjamin Graham…“In the end, how your investments behave is much less important than how you behave.”
“We agree with Warren Buffet’s observation that the stock market is designed to transfer money from the active to the patient. By only swinging at fat pitches and avoiding curveballs thrown far outside the strike zone, we attempt to compound your capital at an above average rate while incurring a below average level risk. In investing, patience often means the accumulation of large cash balances as we wait to purchase ‘compounding machines’ at valuations that provide a margin of safety.” Chuck Akre
Compounding works exponentially for the patient investor. The power of compounding is one of the most important concepts that investors need to learn and embrace. Since, patient and time are better friends to the investor than experience, expertise, and even research.
“A lot of people historically have done fairly well investing in companies they just genuinely like, whether it’s been Starbucks or Nike.” Gary Vaynerchuk, CEO, VAYNERMEDIA
Value investing is one of the most preferred ways to find strong companies and buy their stocks at a reasonable price in any type of market.
Value investors, such as Warren Buffett and Monish Pabrai, use fundamental analysis and traditional valuation metrics like intrinsic a value to find companies that they believe are being undervalued intrinsically by the stock market.
A stock is not just a ticker symbol; it is an ownership interest in an actual business with an underlying value that does not depend on its share market price.
Inflation eats away at your returns and takes away your wealth. Inflation is easy to overlook and it is important to measure your investing success not just by what you make, but by how much you keep after inflation. Defenses against inflation include:
Buying stocks (at the right prices),
REITs (Real Estate Investment Trusts), and
TIPS (Treasury Inflation-Protected Securities).
The future value of every investment is a function of its present price. The higher the price you pay, the lower your return will be.
No matter how careful you are, the one risk no investor can ever eliminate is the risk of being wrong. Only by insisting on a margin of safety – by never overpaying, no matter how exciting an investment seems to be – can you minimize your odds of error.
Knowing that you are responsible is fundamental to saving for the future, building wealth and achieving financial freedom. It’s the primary secret to your financial success and it’s inside yourself. If you become a critical thinker and you invest with patient confidence, you can take steady advantage of even the worst bear markets. By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave.
Every investment is the present value of future cash flow. Everything Money
Three things to know is that it’s important to understand and acknowledge that a stock is a piece of a business. Thus, it becomes essential to understand the business..
Principle #1: Always Invest with a Margin of Safety – Margin of safety is the principle of buying a security at a significant discount to its intrinsic value, which is thought to not only provide high-return opportunities but also to minimize the downside risk of an investment. No matter how careful you are, the one risk no investor can ever eliminate is the risk of being wrong. Only by insisting on a margin of safety – by never overpaying, no matter how exciting an investment seems to be – can you minimize your odds of error.
Principle #2: Expect Volatility and Profit from It – Investing in stocks means dealing with volatility. Instead of running for the exits during times of market stress, the smart investor greets downturns as chances to find great investments. The guru of value investing Benjamin Graham illustrated this with the analogy of “Mr. Market,” the imaginary business partner of each and every investor. Mr. Market offers investors a daily price quote at which he would either buy an investor out or sell his share of the business. Sometimes, he will be excited about the prospects for the business and quote a high price. Other times, he is depressed about the business’s prospects and quotes a low price. The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.
Principle #3: Know What Kind of Investor You Are – Graham advised that investors know their investment selves. To illustrate this, he made clear distinctions among various groups operating in the stock market.1 Active vs. Passive Investors Graham referred to active and passive investors as “enterprising investors” (requires patience, discipline, eagerness to learn, and lots of time) and “defensive investors.”1 You only have two real choices: the first choice is to make a serious commitment in time and energy to become a good investor who equates the quality and amount of hands-on research with the expected return. If this isn’t your cup of tea, then be content to get a passive (possibly lower) return, but with much less time and work. Graham turned the academic notion of “risk = return” on its head. For him, “work = return.” The more work you put into your investments, the higher your return should be.
Because the stock market has the emotions of fear and greed, the lesson here is that you shouldn’t let Mr. Market’s views dictate your own emotions, or worse, lead you in your investment decisions. Instead, you should form your own estimates of the business’s value based on a sound and rational examination of the facts.
Historic inflation and interest rates hike fears are sinking many high growth technology stock prices. Inflation in 2021 was the consequences of rapidly rebounding demand in a supply-constrained world.
The fear of inflation and the the fear of subsequent Federal Reserve interest rate hikes are creating concern and panic among some investors. Rising interest rate and skyrocketing inflation worries are pressuring stocks. And by the Fed signaling raising rates in the future, it unsettles and sends both Wall Street and Main Street into a panic.
But, what is inflation?
Inflation is when consumer prices rise, goods and services become more expensive, and money loses value.Inflation reduces your purchasing power, eats away at your investment returns, and chips away at your wealth. Currently, Americans are experiencing the pernicious effects of inflation, especially in the areas of escalating food and energy prices.
2021 was one of the worst years for inflation that Americans have seen recently, with a 7% increase, the highest since 1982. For consumers, this means $1 at the beginning of the year was roughly worth only $0.93 at the end. While the impact might seem small when examining it on a dollar level, it represents a change in the purchasing power of retirement savings from January 2021 to December 2021. The Wall Street Journal’s Gwynn Guilford writes: “U.S. inflation hit its fastest pace in nearly four decades last year as pandemic related supply and demand imbalances, along with stimulus intended to shore up the economy, pushed price up at a 7% annual rate.”
American economist and Nobel prize laureate Milton Friedman opined that: “Inflation is always and everywhere a monetary phenomenon.” In other words, inflation is invariably a case of too much cheap money and capital chasing too few goods, services and assets.
In the last twenty years, the United States witnessed a large accumulation of federal public debt under Presidents Bush, Obama, Trump, and Biden administrations. Federal debt climbed from 55% of GDP in 2002 to 105% in 2019. Additionally, the U.S. has also endured a decade plus of loose monetary policy overseen by the Fed which has pumped up asset prices.
As a result of the escalating public debt and loose monetary policy, the Federal Reserve most important immediate task, of its dual mandates, must be to get inflation under control and reduced. Since 1977, the Federal Reserve has operated under a mandate from Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates”—what is now commonly referred to as the Fed’s “dual mandate.”
The Labor Department stated that the consumer-price index — which measures what consumers pay for goods and services — rose 7% in December from the same month a year earlier, up from 6.8% in November. That was the fastest growth in inflation since 1982 and marked the third straight month in which inflation exceeded 6%.”
Three sectors–energy/materials, financials and technology–may be viewed as inflation beneficiaries or, at the very least, inflation-agnostic assets:
Energy and materials are commodity-based, and oil, gas, and most commodities rebounded from prices that had fallen to a fraction of their pre-pandemic levels.
Financials, especially banks, are often viewed as inflation hedges since interest rates historically climb when inflation heats up. This reflects the eroding effect of higher prices on a currency’s value in the future, which is remedied by rate hikes on debt.
Technology is a more nuanced winner in the inflation game. The large tech players and most software companies have tremendous economies of scale. As their revenues scale, their costs, particularly labor, do not grow at nearly the same degree, cushioning profit compression from wage escalation.
In a book called “The Great Inflation”, the authors wrote, “Inflation is not an Act of God…inflation is man-made and can be started, prevented, regulated and stopped by human action.”
“To think that a stimulus of this magnitude wouldn’t cause inflation required believing either that such a huge adjustment was possible within a matter of months, or that fiscal policy is ineffective and does not increase aggregate demand. Both views are implausible”, says Jason Furman, former chair of President Obama’s Council of Economic Advisers.
Thus, slowing down in aggregate federal debt growth per capita, tightening monetary policy, and raising interest rates could be effective tools in stemming runaway inflation.
“If I was Darth Vader and I wanted to destroy the US economy, I would do aggressive spending in the middle of an already hot economy… What are you going to get out of this? You’re going to get a sugar high, the higher inflation, then an economic bust.” — Billionaire investor Stanley Druckenmiller, July 23, 2021
