Stocks and Used Cars

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Awhile ago I had a discussion about stocks with one of my daughters.  I suggested to her that, in this time of low interest rates, it might make some sense to look for stocks paying dividends at rates (based on their current market price) that were greater than the interest rates available on government bonds, bank savings accounts and certificates of deposit.  We talked about companies with sufficient financial strength to continue and, hopefully, increase their dividends in the future. I explained to her that if she could buy a company's stock for $33 per share which is paying an annual dividend of $1 then she would receive a dividend with a rate of return to her of 3% per annum.  That rate far exceeds current short term interest rates currently offered by the US government and financial institutions.  I told her that once she had locked in her purchase price, any increase in the dividend would result in an even higher rate of return over time.

I pointed out to her one stock which I had purchased many years ago.  The company has increased its dividend every year since then.  Based on the price I paid back then and the dividend paid today, the dividend rate for me today is over 10%.  Obviously, there is always the chance a company might have to reduce or suspend its dividends if it is suffering financial problems, but an investment in a financially strong company lowers that possibility.

I identified for her a few companies which were paying decent dividends with a 3% rate of return.  I was surprised when she said that she would not buy a couple of the stocks I mentioned because she did not want to "support" those businesses.  She thought she would be buying the stock directly from the companies, thereby giving them her money to use in a type of business she could not support.

I explained that, unless she purchased a stock in a company's public offering, she was buying from another investor and the transaction had no effect on the company's business in any way.  Stocks are like used cars.  A car manufacturer makes no money when someone buys one of their used models from a dealer or a private party.  This raises a good point.

Most used car purchasers now ask for the Carfax ® report on the vehicle they are considering.  In addition, there is a wealth of knowledge about car models available on line.  Thankfully, the days of walking onto a car lot and blindly picking out a vehicle based on little more than the salesman's persuasive patter are long since over.  A stock purchaser can and should do the same.  He or she should check out the company before buying its shares.

There are several well respected sources of financial information on companies and their stocks.  One of the most widely known is the Standard & Poor's Report.  An S&P report on a company is several pages of information about the industry in which the company operates, the business and financial state of the company (including most of the financial metrics Ben Graham looked for) and other important information an investor should know before committing to a purchase.  S&P has reports on almost all of the stocks in the market.  If you have an account with a broker, online or otherwise, you should be able to obtain these reports for no charge.

Like the Carfax ® report, the S&P report is essential in order to make a good decision.  You should devote as much time and study to a stock purchase as you would to buying a used vehicle.

In the next blog, we will return to fundamental analysis and learn about another value investor, Al Frank.  Mr. Frank was famous for his investment letter, The Prudent Speculator.

Comments are always welcome.