Pressure and Time
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
“Geology is the study of pressure and time. That’s all it takes really, pressure, and time.” This quote is from the Shawshank Redemption which has been ranked #1 for a long time now on the Internet Movie Database (IMDB). The context of that quote was about breaking through the concrete wall of a prison and escaping. However, you can carry the quote over for your investments because investing really is about pressure and time. Pressure is not you breaking through a prison wall but how hard you work at making the right investments and doing this over and over on a consistent basis. As for time, well that is where the real returns come into play. Time rules your portfolio and with enough time, anyone can be a successful investor. That is why it is important to start as early as possible.
The Power of Math
If you look at the 10 year chart for Johnson & Johnson (NYSE: JNJ), the stock doesn’t look so great at just 23.6% returns. That is less than 3% in returns per year. If you reinvest their dividends which are currently 3.6% and have increased from $0.205/share in 2002 to $0.61/share in 2012, your total returns would have been nearly 61%.
What new investors don’t understand is how the returns compound. They often see some low number like a 3-5% dividend or a share price that has been in a narrow range for what seems like forever, and become uninterested. They don’t yet grasp the potential that dividends can play long term. Let’s look at JNJ for example to better illustrate the power of math. We will say we bought $1000 worth of JNJ at $62/share in 2007. This turns out to be 16 shares plus $8 leftover which we will say is commission. The average dividend yield annually for JNJ is 3.26% the last 5 years so we will use this for simplicity although the yield varies and this slightly changes the final return values.
From the table below, we started with $992 and ended up with $1,166.85 for a total gain of 17.63%. Keep in mind that this was just 5 years during the recession and all the economic instability going on and with a stock whose share price only went up 9.2% or $5.69. 17.63% (reinvested) versus 9.2% (dividends as cash) shows you the power of math and the power of dividends. It also shows you the possibilities if you stretch this out on a longer time scale, find a stock with a higher dividend yield, or a stock that has moved a lot more than JNJ has done in the past decade.
Invest in What People Always Will Need – Not What They Want
New investors tend to invest in fad stocks like a Facebook or some new dining out luxury like Open Table. Despite whether these companies are good or not to invest in today, are they really companies that have products that people need? Some diehard Facebook users might say yes. Many users spend hours each day stalking their friends or posting where they are or will be today, tomorrow, next week, etc. Many spend hours playing the games and various apps on Facebook. However, will anyone really miss Facebook if it all of a sudden vanished besides Mark Zuckerberg? Furthermore, do you know anyone that has spent any money at all on Facebook ever? The same goes with Open Table. OPEN provides a mechanism to make reservations online for restaurants. Can a simple phone call not complete this task quicker and easier? Both FB and OPEN have seen double digit negative returns this year.
Better Choices with Less Risk
Instead of looking at particular stocks to invest in because you think they look ‘cheap’, look at sectors and pay attention to the news at what is happening in the world. Some human needs include sectors of food, energy, food, materials, transportation, and utilities. Once you narrow down sectors you want to focus on, then research which companies lead that sector or are underpriced. If you are looking at energy, find out what kind of energy you want to invest in. There are many that revolve around oil and gas like Exxon (NYSE: XOM) and Chevron (NYSE: CVX). Both companies are solid with diverse portfolios of focus but whose price is somewhat more affected than stocks outside the energy sector by changes in global policy related to petroleum operations. XOM has an annual dividend yield of just 2.61% while CVX has a little higher dividend yield at 3.21%. However, similar to JNJ, these dividends quickly add up when you compound the reinvestments. XOM and CVX are both in the top of the oil and gas sector with huge market caps - $403 billion and $220 billion, respectively, and have a habit of increasing the dividend payouts on an annual basis.
Utilities are another sector with several decent stocks to research further. Humans will always need electricity unless something else is discovered. Electric bills take precedent over making purchases on Facebook or placing reservations on Open Table. Look into companies like Exelon (NYSE: EXC) and FirstEnergy (NYSE: FE).
Although EXC has dropped the last five years from its 2008 share price highs, there is a lot going for the energy company. They carry a 5.8% dividend yield and operate regulated utilities in Illinois, Pennsylvania, and Maryland with 35,000 MW of owned capacity. EXC also has operations in 47 states including DC and Canada. With their recent merger with Constellation Energy and their solid interest in nuclear energy as a whole, EXC ranks as the second largest electric and natural gas company in the US by market cap.
FE carries a 5.0% dividend yield and also a diversified energy company that is involved in generating electricity serving Ohio, Pennsylvania, West Virginia, Virginia, Maryland, New Jersey and New York with 23,000 MW of owned capacity. Similar to EXC, FE saw its share price peak in 2008 and there is a lot more room for both stocks to go up from where they are today. Neither company has any problem generating net income for shareholders. So even though both have dividend payout ratios in the 80-90% range, the dividend is safe for many years to come. While you are researching on these and other utility companies, you might recognize one or two since your electric bill you pay monthly is going to one of them.
TLC said it best when they said “Don’t go chasing waterfalls, please stick to the rivers and the lakes that you’re used to, I know that you’re gonna have it your way or nothing at all, but I think you’re moving too fast”. Many new investors go directly to buying their first few stocks. They don’t have any experience and they still don’t have the basics of dividends, EPS, financial statements, P/E ratio, key statistics, how everyday things affect earnings, or the other thousands of variables that will affect the most important value of all – the share price.
Be realistic. Good things take time. Great things take a lot longer. Pressure your portfolio to be great by investing in solid companies on a consistent basis. Given enough time, you are bound to break through a wall or two and reach new heights you never dreamed of before. If you fill your portfolio with a bunch of penny stocks and speculative plays, you may end up waiting a lot more than investing. Sometimes a home run or two doesn’t win the ball game against a team with far more hits.
mikecart1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson and ExxonMobil. Motley Fool newsletter services recommend Chevron, Exelon, and Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.