Lesson 008 - Stocks

Asset Class 1 - Stocks

My motivation and mission:

WCD - Motivation & Mission Statement

Google sheet that contains list of all WCD lessons and links to all content:

White Collar Dad (WCD) - Google Sheet

Lesson reviewing how to use Google sheet:

WCD Google Sheet - User Guide


Lesson 008 is a continuation of Lesson 007 where I discussed all of the major asset classes.

Lesson 008 will be focusing on Stocks.


Topics:

  • Public vs private companies (equity vs stock)

  • Why invest in stocks?

  • Major stock exchanges

  • Major stock brokers

  • Index funds, mutual funds, and ETFs

  • Major stock market sectors

  • Dividend payments

  • Growth investing vs value investing

  • My strategy

  • Free resources and helpful links

  • Paid subscriptions I use


My Current Stock Portfolio - Sep 3, 2021


Terminology

In this post I am going to use stock and equity interchangeably. Effectively they mean the same thing (they are a percent ownership of a company).

There is a subtle difference between the two. Equity is the term applied to ownership of a company when it is private and stock is the term applied once the company is publicly trade.


Private vs Public Companies

As I discussed in L-7 - Asset Classes, there are two primary ways for a company to raise capital. One is by issuing bonds and the other is by issuing stock/equity.

There are two general phases in a company’s life cycle when they issue stock/equity:

  1. Private company

  2. Public company

Private Company

When a company is founded, it is a private company. At this phase no stock is traded on public markets. When the company needs to raise capital the sell equity to accredited investors based on a valuation cap and the terms and conditions (T’s & C’s). The valuation cap basically defines how much the private company is being valued at and how much equity the investor is receiving.

Example:

  • Let’s say private company ABC sets its valuation a $1,000,000

  • If an investor invests $100,000, then they are purchasing 10% ownership of the company.

  • If ABC eventually goes public and grows to a market cap of $1,000,000,00, then the investor would have $100,000,000 worth of stock (assuming they never sold any equity).

The issuing and purchasing of equity in private companies is referred to as “private equity” (fairly self descriptive).

Raising capital in private equity is typically done in 4 steps:

  1. Seed Round - Capital required to get the business started (typically friends, family, or personal money).

  2. Series A - Additional funding to help business scale

  3. Series B - Additional funding to help business scale

  4. Series C - Additional funding to help business scale

The amount of capital raised in each round will typically be greater than the preceding round.

A company doesn’t always have to raise capital. If the business model is profitable, then the owners might opt to grow the company just using profits from the business. That said, a popular business model utilized by high-growth companies (especially tech companies) is to stay un-profitable, re-invest all cash flow into scaling, and continually raise capital in order to grow the business as quickly as possible.

There is not a specific limit to how much capital can be raised via private equity, but if a company grows sufficiently large and still needs to raise capital, then the owners will typically consider taking the company public.

Public Company - 3 Methods

There are 3 ways a company can go public:

  1. Initial Public Offering (IPO)

  2. Direct Listing

  3. Special Purpose Acquisition Company (SPAC)

I will discuss these in more detail in L-25 - Three ways for a private company to go public.

There are some key differences. Main difference between an IPO and a direct listing is that an IPO will create additional shares to be sold to the public markets, where a direct listing just lists the existing private shares.

SPACs are a completely different animal than an IPO or direct listing. Effectively, a SPAC is a shell company that goes public via an IPO and then later acquires a private company. This shell company raises a bunch of capital through the IPO and uses this cash to purchase a private company.

The main *benefits* of a SPAC are:

  • It’s an expeditious way for a private company to go public

  • It avoids a lot of SEC regulations (e.g. making future growth claims)

  • It avoids a lot of underwriting of the private company that would normally be done if the private company tried to go public via IPO

*The benefits are for the two companies involved (not the shareholders).

Public Company - Additional Capital

Regardless of the method a private company chooses to go public, it can always raise additional capital through issuing debt or stocks long-after it has gone public.

For example, many of the cruise-liners like Norwegian and Carnival raised a bunch of capital through issuing additional equity to help sustain their payroll during the Covid-19 pandemic. This equity offering diluted existing shareholders (each share now represents less percent ownership of the company).

A company needs to be very careful when doing additional equity offerings. Existing shareholders don’t typically like getting diluted and this can cause a lot of the existing shareholders to sell their stock resulting in the stock price dropping.


Why Invest In Stocks?

Simple answer

  • Strong capital appreciation over a very long time period

  • Easy - can be 100% passive

  • Aligns your incentives to continuous innovation and growth

Over very long periods of time, stocks have been the highest appreciating and consistent asset class. (They can be volatile on short time horizons, but when you zoom out on a decade or century time horizon… the drops are tiny speed bumps).

Stocks are also the easiest asset class to get exposure to (besides cash… but cash isn’t really an investment). It takes less than 10-15 minutes to create an account and open a portfolio at Fidelity. You can schedule automatic deposits and dollar cost average into index funds.

On a more philosophical level, stocks are a way of aligning your interests with continuous growth and innovation of the human race. The companies that grow to the largest market caps are usually the ones that provide the most value to society. I don’t know how I could live my life without Google and Amazon...

Investing in stocks in investing in human ingenuity. When motivated, the human race can do incredible things (Moon landing in one decade, Covid Vaccine in one year). I would hate to be the person betting against human ingenuity.

For more details on my asset allocation strategy read Lesson 026 where I review my portfolio and long term asset allocation strategy.

L-26 - MY PORTFOLIO - THE THESIS BEHIND MY INVESTMENTS


Major Stock Exchanges

United States

NASDAQ - National Association of Securities Dealers Automated Quotations. Nasdaq has a high concentration of technology stocks.

NYSE - New York Stock Exchange

Note that stocks can get listed on multiple exchanges as long as they meet the exchanges criteria.

International

See this Wikipedia for a list of all international stock exchanges.


Major Stock Brokers

A stock broker is someone who facilitates trading of stocks (allows people to buy and sell stocks).

  • Fidelity (my recommendation - invest in anything - great user interface)

  • Vanguard

  • E*Trade

  • Charles Schwab

  • TD Ameritrade

  • *Robinhood

  • **Paypal

*Robinhood is definitely oriented to short-term trading and options. This isn’t the place to go for first time investors, but they do have great visuals and I do use a small percentage of my money (<2%) for options trading.

**Paypal has announced they are going to build or buy a stock brokerage arm to their payments arm and create a super-app.


Index funds

If you are just getting started with investing, dollar cost averaging (DCA) into index funds is absolutely the best approach.

In Lesson 026 I discuss my high-growth stock investing approach which is similar to venture capital investing and aligns with many of the philosophies of the Motley Fool. However, I don’t recommend this strategy unless you are willing to stay active in the market and listen to quarterly earnings reports.

Index Funds, Mutual Funds, and ETFs

This Investopedia post summarizes these three terms.

All three of these basically represent a basket of stocks.

  • Mutual funds are pooled investment vehicles managed by a money management professional.

  • Exchange trade funds (ETFs) represent baskets of securities traded on an exchange like stocks.

  • ETFs can be bought or sold at any time, whereas mutual funds are only priced at the end of the day.

  • In general, ETFs are lower cost and more tax efficient than similar mutual funds.

An index fund can be a mutual fund or an ETF. I prefer ETF index funds because the indexes I utilize can be done 100% by a computer and I don’t want to pay higher fees for a Mutual fund.

I also prefer ETFs over mutual funds because I can buy/sell the ETF during the normal trading day. I am fairly active in the market and have taken advantage of some intra-day volatility to buy/sell ETFs.

There are many mutual funds and ETFs, but 99% of them are B.S. and a waste of your time. If you are going to spend time research the specific composition of ETFs, you are better off buying individual stocks.

The only index funds you need are ones that trend the entire market.

  • IVV - S&P 500 (500 largest companies by market cap on NYSE or Nasdaq)

  • QQQ - Nasdaq 100 (100 largest tech companies by market cap on Nasdaq)

  • *DIA - Dow Jones Industrial (DJI)

*I only added the DJI because of how popular of an index it is; it is a composition of 30 large companies traded on NYSE and Nasdaq. I definitely don’t recommend using it because it’s a very arbitrary index.

Each broker will have their own version of IVV or QQQ. I have used IVV and QQQ because they had the lowest fees at the time I purchased them.

S&P 500 Index Funds

The only criteria you need to evaluate the S&P500 and Nasdaq indices is the expense ratio. This is the fee you are paying. Mutual funds will have expense Ratio’s that are in excess of 1%. Effectively, you are giving away 1% of your ROI% to pay a money manager who is probably not going to beat the returns of the S&P500 and Nasdaq.


Major Stock Market Sectors

I check this heat map on occasion just to see what is happening on wall street. There is usually a clear trend to which sector is being bought/sold on a given day. This isn’t valuable for long-term investing, but it does help me piece together a narrative to what is happening in the short to medium term.

The GICS Stock market sectors

There are definitely ETFs that track each individual sector. However, I don’t recommend this. Instead, put a majority of your money into the IVV/QQQ and then slowly add a little extra money into the best stock in individual sectors that you are excited about.

I cover this in detail in Lesson 040.

L-40 - MY PORTFOLIO - DEEP DIVE ON INDIVIDUAL SECTORS


Dividend Payments

What is a Dividend?

To understand a dividend you need to understand the concepts of an income statement. I cover this in detail in Lesson 017.

L-17 - BUSINESS ACCOUNTING - INCOME STATEMENT & BALANCE SHEET

A company needs to allocate the cash that their business is generating. Something a company can do with its cash is pay it back to the investors that hold shares. This cash is distributed in the form of a dividend which is paid on a per share basis.

Dividend Example:

  • Company ABC has 1,000,000 shares

  • Company ABC had $10,000,000 in profits this quarter and doesn’t know what to do with it.

  • Company ABC decides to pay back the shareholders with a one time special dividend of $10/share.

  • Let’s say Brian owns 100 shares of company ABC. He would get paid $1,000

Dividend Frequency

Typically dividends are paid on a regular frequency and schedule (once a month, once a quarter, bi-annually, or once a year). The CEO and board of directors will determine this frequency and how much cash they should return per share.

Dividend Yield

Dividends are typically reported by their yield.

  • Y = Yield = D/S

  • D = Sum of Yearly Dividend Payments (Per Share)

  • P = Stock Price (Per Share)

For example, if ExxonMobil is paying $1 per share on a quarterly basis, this is $4 per year. If the stock is trading at $50, then the Yield is $4 / $50 = 0.08 = 8%.

Why Do Some People Like Dividends?

There is huge demand for cash flow (yield). Bonds yield almost nothing these days so a lot of people naturally gravitate towards high dividend yield stocks.

In general, as people age they want more cash flow and less risk. People especially want yield when they retire to fund their life style as their income has stopped.

However, these people tend to lose money in the long term because their capital losses significantly dwarf the cash flow from the dividend. They would have been better off just selling the stock and using the cash to fund their life style instead of trying to live off the dividend.

Why do many high-dividend stocks lose value over time? See next section.

Why Do I Avoid Dividend Stocks?

An individual I recommend you follow on Twitter is Brian Feroldi. He has his own Substack called Long-Term Mindset that focuses on the psychology of investing and foundational principals.

I think some of the screenshots below from Brian’s Long-Term Mindset perfectly capture why high-dividend stocks lose value over time.

  • Yield = Dividend Payment / Stock Price

  • High Yield is usually from the stock price dropping (big red flag)

  • When a company fails to innovate and runs out of growth vectors, that’s when it typically starts to issue a dividend. A dividend is the CEO and Board of Directors telling shareholders that they don’t know how to invest the money in the industry that they operate in (big red flag).

  • I think Brian was being a bit facetious with the above image. Basically he is saying that dividend stocks are bad investments and you are better off investing in growth companies that are still in hypergrowth or maturity phase.

So if dividend stocks are un-investible, then how do you get cash flow? I suggest you read Lesson 010.

L-10 - REAL ESTATE & REITS

I am still in hyper growth phase of my investing career. In the future I plan to get yield from:

  • Rental properties

  • Small and Medium Businesses (car washes, laundromats, gyms, etc.)

  • REITs (this is my one exception to dividend paying stocks)

What’s My one Exception? (REITs)

REITs are my one exception to dividend paying stocks and it’s because they are structured differently.

REIT - Real Estate Investment Trust

The tax structure of a REIT is such that they are obligated to pass a high percentage of their cash flow to shareholders via dividends. You can read more here.

Why am I OK with REITs?

  • I am bullish on real estate as an asset class.

  • REITs are forced to pay dividends from day one. They are paying the dividend for tax purposes and not because they don’t know what to do with the cash flow.

REITs can still be a bad investment and they can still get artificially high dividend yields if the stock price drops significantly (e.g. any commercial property REIT post-Covid pandemic)

My Two Favorite Types of REITs

Should You Re-Invest the Dividend?

Dividends can automatically be re-invested to purchase more of the stock. Conversely, you can receive a cash payment. Typically, you will take the cash payment only if you need it to sustain your life style; otherwise, just reinvest the dividend to purchase more shares.


Growth Investing vs Value Investing

I am definitely a growth investor. My high level philosophy for why is simple. The asset allocation I give to stocks is for capital appreciation. Value investing tends to be more conservative, defensive, and cash flow oriented.

Later on in my life I will start investing more and more capital into cash flowing assets (rental properties, small and medium business, and REITs).

I thinking taking a venture capital approach and investing in a basket of 25-50 stocks that have the largest growth potential is a good way to get alpha (outperformance of the market).

I discuss this in detail here:

L-33 - VALUE INVESTING VS GROWTH INVESTING


My Strategy

See Lessons 026 and 040

L-26 - MY PORTFOLIO - THE THESIS BEHIND MY INVESTMENTS

L-40 - MY PORTFOLIO - DEEP DIVE ON INDIVIDUAL SECTORS


Free Resources / Links

See Lesson 023 for a comprehensive list of all of my information and data sources.

L-23 - TLDR - DATA & INFORMATION SOURCES

But here are some of my top links related to stocks:

Futures Market

NQ00

Futures|10Y%

Futures|30Y%

Frequently Checked

Google Finance (I have my watch list in google finance)

Fidelity

RH - Portfolio

RH - QQQ

S&P 500 Map

Twitter

The Motley Fool

Login | The Motley Fool

Stock Advisor - Motley Fool Premium

Rule Breakers - Motley Fool Premium

MF STOCK PICKS - ALL

MF RB STOCK PICKS - ALL

Brian Feroldi - MF

JIM CRAMER AAP

AAP - HOME

AAP - WEEKLY ROUNDUP

AAP - ACTIONS

AAP - RATINGS

AAP - ANALYSIS / ARTICLES


Paid Subscriptions I Use

Jim Cramer is a hell of a personality. He might have been an old-school hedge fund manager, but I have learned a lot from listening to Mad Money over the past 7 years. After years of getting free information from his podcast, I eventually decided to subscribe to his Action Alerts Plus subscription. My strategy and Jim’s definitely differ, but I do value his insights as a means of checking my interpretation of the market.

Two other subscriptions I have are both from the Motley Fool:

The principals taught by the Motley Fool are definitely very similar to the principals I use investing in the stock market. I use their services as a way of getting stock ideas to research and potentially invest in. (Twitter is also another great source if you follow the right people).

Although I pay for the two subscriptions above, I think I get more value out of their Industry Focus Podcast which is free. I still recommend you use their paid services, but they have a team of excellent podcasters and discuss a lot of the stocks that the Motley Fool is evaluating even before they become recommendations.

The technology segment of industry focus is definitely my favorite (hosted by Dylan Lewis and Brian Feroldi). Brian is also a great Twitter follow.


Reference Material & Social Media

In Lesson 030 I cover how to navigate and utilize the Google Sheet I have built for all WCD lessons. This Google Sheet contains a worksheet for each WCD lesson. Each sheet has all of the Excel calculations, tables, graphs, and charts that I have posted in the respective WCD lesson. Additionally, the Google Sheet has a master “Index” worksheet that has links to all of the content associated with each lesson.

WCD Google Sheet

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