Tag Archives: picking a stock

Choosing a stock – Part 4: Don’t buy if the price will be better next week.

So far we’ve looked at two of the five factors I think are important in choosing a stock. Hopefully you agree that the system seems quite simple and requires very little time. Remember, the name of this blog is Passive Dividend Income. I don’t want to spend too much time or effort on this and I certainly don’t want to have to think about my portfolio all the time. I invest a little time in choosing a stock and then pretty much forget about it until it’s time to buy again, letting that small investment pay dividends in the future. Ok, I couldn’t resist that pun. In the last entry we talked about buying a stock that’s on sale. Now let’s talk about making sure there won’t be a better sale on that stock in the future.

Back to our analogy. I’ve picked the supplier I want to buy from, I’ve found the item I want and now I’m checking to see if it’s on sale. I’m in luck! It is. The trouble is, how do I know this is the best price I can get? In other words, what if I buy it now and then it goes on sale the following week at a deeper discount? Oh, the horror! Last time we learned we can determine if the stock is on sale by comparing the current price to the 52 week high. As with the camping gear, how do I know this is the lowest the price will go? I don’t. But what I can know is how the current price compares to the lowest price people have paid in the last year (known as the 52 week low).

picking_a_stock_part_4Time for another calculation. For each company on the S&P 100 I figure out how far above the 52 week low it is. This gives me an idea of whether the sale price is the best price for this stock or if it’s likely to go lower in the future. In the example at the left, we see the stock is 0.8% above the 52 week low. This is exceptionally close to its 52 week low which means that, while it’s still on sale, the price could go lower still. In other words, if the stock were trading at, say, 10% higher than the 52 week low, it suggests that the price is recovering. To be sure, we could simply look at the price history for the last few weeks. Lots of websites provide that kind of information but the charts at www.google.com/finance are especially easy to use.

A stock that is far from the 52 week low is not at the best sale price anymore. Remember, share prices fluctuate between the 52 week high and 52 week low. Our goal is to try and buy when they are far below the high but not yet far above the low. Incidentally, being a little above the 52 week low also suggests the price is recovering and less likely to go lower after I buy it. I’m a little wary of stocks that are at their 52 week low for that very reason.

Of course, lots of things affect share prices but these are big, blue chip companies with high daily trading volumes that are being bought and sold by lots of institutional investors so the prices don’t move very much day-to-day. Lots of people are doing in depth analyses of company valuations which means we don’t have to – thankfully! We can let the price history be our guide to what people are willing to pay now and what they might pay in the future. While our long-term focus is dividend income, we’d like to see growth in the value of the stock too!

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January’s Pick

This month International Business Machines (NYSE: IBM) came out in the top spot with a score of 13, so we’re increasing our position in them after also recommending it last month. It’s currently trading at 21.6% below the 52-week high, representing a good sale, and offers a dividend of 3.8%.january_pick

The ratios are also still strong with a P/E of 9.49 and EPS of 14.57. Let’s not forget that Buffett still likes them. Works for us! Remember, too, that while our overall goal is to grow dividend income, capital appreciation of the share price is an important way to build wealth. IBM doesn’t have the highest dividend rate but it offers potential for share price improvement and is a safe bet overall. Last month we mentioned keeping an eye on Williams Companies (NYSE: WMB). This month they placed in the top ten but are too risky for us to recommend it. They are currently 60% below their 52-week high becausethey gave up some ground in the last month meaning their share price continues to slide. Sure, their dividend rate is now over 10% but that might not be sustainable and the slipping share price could still offset that return. We’ll keep waiting on that one.

Choosing a stock – Part 3: Buy on sale.

In the last entry we talked about the second factor to consider when buying a stock – the dividend rate. My overall goal is to develop a stream of income from my portfolio and collecting regular dividend payments is one way to do that. I buy companies on the S&P 100 which pay the highest dividend rate. In this entry we’ll move on to step 3.

Let’s go back to our analogy. I’m trying to buy a new piece of camping gear and I’ve decided to go with a well-known supplier. I’ve chosen a good quality piece of equipment (companies on the S&P 100) that will last and add value to my hiking experience (companies that pay the highest regular dividend). Being a frugal person (some friends would say ‘cheap’) I’m going to wait until the item I want is on sale. Why pay more than I have to right? If I wait for a sale I can get the same item for less!

walmart_priceWhen choosing a stock, I apply the same principle. The good news is, with so many companies on the S&P 100, there’s nearly always something on sale. You might be wondering what on earth I’m talking about when I say a company is on sale. Let me explain. I figure a good way to estimate the value of something is to see what people are willing to pay for it. This is true of camping equipment and stocks alike. It’s easy to see what people are willing to pay for a stock because that’s what the current trading price is. We can see from the image above that Walmart was trading at $61.30 per share on December 31, 2015.

Ok, now we know what the current price of a stock is but how do we tell if that’s a sale price or not? Easy! I look at the maximum price people were willing to pay over the last year (called the 52 week high) and compare that to the current price. Pretty simple, right?! Again, I find that price for every company on the S&P 100 and calculate how far below the 52 week high the current price is. Let’s look at an example.

picking_a_stock_part_3Basically, people were willing to pay $66.36 for this stock within the last year and I can now buy it for $33.49 – a discount of 49.5%. This is a solid company on the S&P 100 so, chances are, it’ll be back to that high within a year or so and I will have realized a 98.1% return. Oh yeah, and collected my 5.49% dividend in the meantime. Sweet! Would you be excited to buy something you think is valuable at that kind of discount? Of course, you would!

Just like with the dividend rate, I assign a score to each stock depending on how far below the 52 week high it’s trading. In other words, I look to see which stocks are really on sale. That score is added to the score the stock earned from its dividend and I’m one step closer to making a decision.

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Choosing a stock – Part 2: It’s all about the dividend!

Our last post described the first criterion we use when choosing a stock to buy. We stick to companies listed on the S&P 100. These are safe, solid companies that have a proven track record. They’re not going to post meteoric gains but won’t you lose any sleep worrying about the bottom falling out either. The name of this blog is, after all, Passive Dividend Income, so we don’t want to be spending lots of time working on or worrying about our portfolio. Having said that, let’s move on to step 2.

dividendsRemember our analogy of purchasing a piece of camping equipment (or whatever you want to imagine buying)? We decided to buy from a major supplier – one we feel we can count on to be there if we need them. What else do I want from my purchase? I want the equipment to last so I can enjoy it for years to come. I want it to ADD value to my experience. This is like the dividend a company pays – it’s going to add to the value of my portfolio and, when it comes time to retire, is going to provide the income I’m looking for.

Some companies choose to distribute a portion of their earnings to their shareholders. This is called a dividend. Our goal is to build a stream of income from our investment portfolio and this income will be in the form of dividends. That means it’s important to choose stocks that pay the highest rate. As you learn more about companies on the S&P 100 you’ll see that most of them pay a quarterly dividend but you’ll soon discover that the rate of return of those dividends vary considerably from company to company.

For example, on December  AT&T Inc (T:NYSE) closed at 34.64 and paid a quarterly dividend of $0.48 which is a return of 5.5% (0.48 x 4 times/year divided by 34.64). This means for every $1000 you invest in this stock, you’d be paid $55 in dividends. By contrast, on the same date FedEx closed at $149.65 and paid a quarterly dividend of $0.25 which is a return of 0.67%. For every $1000 you invest in FedEx, you’d be paid $6.70 in dividends. As you can see, the stock you choose makes a HUGE difference. The first step in our strategy is to look up the dividend for every company on the S&P 100 and assign a score to each one based on the dividend it pays. While this score is mostly arbitrary, it serves as a means of ranking the companies based on several factors (the dividend is only one of 5 factors we consider) that we use to make a choice. It’s a way of removing emotion and bias from our investing choices. We’ll see the criteria for assigning scores in a later post.

And that’s step 2. Short and simple. Buy shares in companies that pay the best dividends.

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Choosing a stock – Part 1: Stick to the S&P 100

A few years ago I realized that I had to change my investment strategy. Until that time I had been playing pretty fast and loose with my investment dollars. I was choosing risky stocks and riding the excitement of the big wins while mostly pretending the big losses didn’t happen. Sure, I was coming ahead overall but I knew one big loser could wipe out my capital. As I got older I recognized that I had less time to take advantage of compound growth to accumulate wealth and I had to start looking for a safer alternative.

stock_marketThat’s when I started working on my own strategy for choosing stocks. I have to disclose that I have no formal education or training in stock investing or financial advice but I do know that nobody cares more about my money than I do! I took it upon myself to start learning everything I could about the stock market and evaluating a stock. Let’s just say that didn’t go well. There were all kinds of factors to consider: beta, price/book ratio, return on equity, net profit margin, EBITDA, blah, blah, blah. When I wasn’t falling asleep reading about all that stuff I was worried about being in over my head and that it would never make sense to me. I quickly realized as an amateur I was going to have to dramatically simplify things so I began trying to figure out what the most important things were.

Maybe I could think about choosing a stock like making any other purchase. What are the factors I consider when buying other things? A car, a TV, a mobile phone, whatever. I like to go backcountry camping whenever I can and that hobby requires some special gear which I’ve slowly acquired over the years. I wondered, when I’m thinking about a new piece of gear, what things do I consider when reaching a decision? First, I want to buy from a company with an established reputation I can trust. I want a company that has proved its longevity and is going to be there if I have a problem. I’m likely going to stick with suppliers like Cabella’s, MEC, or REI and manufacturers such as Patagonia, Marmot, or Arc’teryx.

In the world of stock market investing, we’re talking about the companies on the S&P 100. Companies on that list represent a variety of sectors and account for about 57% of the market capitalization of the S&P 500 (a similar index containing a greater number of companies) and almost 45% of the entire market capitalization of the U.S. equity markets. The stocks in the S&P 100 tend to be the largest and most established companies in the S&P 500. These companies have proven themselves worthy of inclusion on that list and that makes me very comfortable buying them. They’re companies we’ve all heard of. They are Coca Cola, Wal-Mart, Microsoft, AT&T and 3M. Take a look at the list and you’ll recognize many of them. Do I occasionally find a deal so great that I stray from a really well-known camping equipment company and take a chance? Of course! But mostly, I’m sticking with the big guys. That’s also true of picking a stock. Once I gained a little confidence – acquired from seeing the performance of my portfolio – I started to occasionally branch out into companies that aren’t on the S&P 100 if I thought they presented an opportunity. More about that in a later post.

So that’s Step 1. Stick to well-known companies that are listed on the S&P 100. They’re solid, safe, blue chip stocks that have a proven track record.

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