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Investing

The 3 Most Important Stock Investing Strategies

There are essentially 3 strategies for investing in stocks: Dividends, Value and Growth. Every stock you invest in should be in at least one of these categories. In this article, I will explain what they are and how to find stocks in each of these categories.

Dividend Stocks

Dividend investing focuses on buying stocks with high dividend yields, like 3 to 7% (this is the percentage of your investment that the company pays back to you every year). The goal here is to increase your passive income, while the share price is not as important. With this style of investing it makes sense to hold your stocks as long as they still pay high dividends and the outlook for the company is good. This is strategy has a very low risk and the returns are very stable and predictable. Imagine you buy a company with a 5% dividend yield. After 20 years, you will get the money you invested back while still owning the same number of shares. But there are still some things to look out for when buying stocks with high dividend yields.

Is the dividend sustainable for the company?

One thing to consider is the payout ratio. This is the percentage of earnings a company spends to pay out dividends. If it is too high, that means that a company is likely to cut their dividends. It does not make sense for a company to spend more than it earns just to pay dividends to shareholders. Generally, I would consider a payout ratio above 80% to be relatively risky, while a payout ratio below 50% is pretty good.

Future outlook

Is the business model of the company going to work in the future? Look at trends like digitalization, move to sustainable energy sources, individualization and so on. Are the earnings of the company rising every year? Is the company reinvesting in itself and looking for ways to adapt?
In that case, the future of the company and of its dividends is looking good and the company might even increase its dividends over time.

Learn from the past

You can often measure how reliable a company’s dividend payouts are by looking at its past. A company that has been increasing its dividend for many years is likely going to continue doing so. There is even a name for companies with 50 or more consecutive years of dividend increases: “Dividend Kings”.

Price

dividend yield = annual dividends per share / share price

If the dividend remains the same, then the yield gets higher as the share price decreases. So it also pays to get a good deal (also see Value Investing).

Example: T – AT&T Inc.

Let’s look at one company as an example: AT&T.

From this screenshot we can quickly gather the most important information: as I am writing this, AT&T has a dividend yield of 7.14%, which is extremely high. You could also get this number by calculating $2.08 / $27.46. The payout ratio is 59%, which is not too high and this company has been growing their dividends for the last 35 years, which is good for the safety of the dividend. However, the dividend has not been growing much in the last 5 years.

But these are just the numbers, remember to take a close look at the company as well.

Summary

  • Goal: increase passive income
  • Look for: high yield, low payout ratio, rising earnings, “future-prove” business model, good price
  • Risk: low

By the way, a good website to check all these things is SeekingAlpha.

Value Stocks

The basic idea of value investing is to find companies that are undervalued, which means buying them for less than they are actually worth. Sometimes a company faces a temporary crisis, which gets priced in too much. If you believe that this crisis is really only temporary and that the company can recover, then you may have found a value stock. Probably the best known value investor is Warren Buffett, who said:

Price is what you pay, value is what you get.

Warren Buffett

In other words: sometimes the price of a stock is unjustified and below what it should be. Some useful metrics for determining the value of a company are the following:

Price to Earnings (P/E) Ratio

A very important metric for a company is how much it earns. Earnings are what is left over from the revenue after all the expenses are paid. To get the P/E ratio, you just need to divide the share price by the earnings per share (EPS). For example:

Apple closed at $241.41 with an EPS of 12.60. That gives a P/E ratio of 241.41 / 12.6 = 19.16.

If a company has a low P/E ratio, its price is relatively low compared to its earnings, which could mean that it is undervalued. Average P/E ratios in recent years have been around 15 to 20, but it depends on the industry. Financial companies have lower P/E ratios, while tech companies usually have higher P/E ratios. A stock with a low P/E ratio is not necessarily a good investment, though. A low P/E ratio could also mean that the earnings are just really low or even negative. So you still need to be careful to avoid “value traps”.

Price to Book (P/B) Ratio

If you take all the cash and assets of a company and subtract the debt and liabilities, you get the book value. So if you sold all the parts of the company, that’s how much you would get for it. If this ratio is under one, then you literally get more than what you paid for.

Don’t get distracted too much by these metrics, though. They are just tools to find out if you are getting a good deal. You still need to make sure that you are also buying a great company (more on that in my other articles).

Example: CCL – Carnival Cruises

An example for a value stock right now might be Carnival Cruises, by far the biggest cruise ship company in the world. Because of the Coronavirus, the revenue of this company is zero for the next few months. At the same time, it still spends about half a billion dollars every month to keep everything operational. There is a chance that this company will go bankrupt, which is how the stock is priced. Right now CCL is trading at a 0.23 price to book ratio. If it did go bankrupt, you would lose your entire investment. On the other hand, CCL has recently raised enough cash (through bonds and stock offerings) to survive about 12 months without any revenue. The cruise ship business model was very successful in the past and growing at a steady rate. If you believe that CCL can survive this crisis, the price looks extremely attractive. Especially when you consider the potential future dividend once the company is profitable again, which was relatively high even before this crisis.

Summary

  • Goal: find undervalued stocks
  • Look for: great companies that are going through short term trouble, low P/E and P/B ratios
  • Risk: medium, if you know what you are doing

Growth Stocks

These are companies that are growing at a very fast rate (often exponentially). Unlike value stocks, it is not uncommon to see extremely high P/E ratios or even negative earnings in growth stocks.

Growth companies can offer very high returns. With some companies, you could have doubled your money in one year by investing in them at the right time. But they also have the highest risk associated with them. The key is to find an innovative company, with a disruptive approach and great products, which you believe can execute their vision. Valuations don’t matter as much here, but they should not be disregarded entirely.

Metrics

One metric to measure growth is year-over-year growth in revenue. Above 20 to 30% is pretty high.

Example: TSLA – Tesla

A good example for this would be Tesla. If you believe in Tesla, you might think that it will grow rapidly over the next few years and become a very important and big company which would increase their market capitalisation by multiples. Otherwise, you probably think that $100 billion is too much for a car producer that has been profitable for only a few quarters and sells only about half a million cars per year. Meanwhile competitors like Volkswagen sell 20 times as many cars, are also developing electric cars and are worth only about half as much as Tesla.

Summary

  • Goal: find fast growing stocks
  • Look for: innovative companies, with a disruptive approach and great products, which you believe can execute their vision. High revenue growth.
  • Risk: high, unless you are an oracle (not the company though)
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Investing

Investing Options Overview

If you are just beginning to invest, you might be wondering what the different options are. This article will give an overview of the most relevant investment options for you, but this is not meant to be a complete list. Which investment option or mixture is right for you, depends among other things on what return you are aiming for, your investment time horizon, how much risk you are willing to take and how much time you are willing to spend researching. I deliberately try to avoid using too many technical terms. For more precise explanations I recommend using Investopedia.

Stocks

You can buy parts or “shares” of publicly-owned companies, which are being traded on stock exchanges. By doing so, you will own a small piece of that company. A company issues many shares, and each share has a price. The sum of the price of those shares is how much investors think the whole company is worth (market capitalization). The price of a company depends on how much it earns, if it is growing its earnings, how much cash, debt and assets the company has, the overall economic outlook and many other factors. So if you buy shares of that company at a certain price and the company is able to increase its value, you might be able to sell those shares at a higher price. In addition, some companies use part of their earnings to pay investors dividends. Usually, these dividends get paid once every quarter (i.e. 4 times per year) and over the timespan of one year they amount to about 1 to 5% of the share price.

Buying stocks has a high reward potential, but also a relatively big risk compared to other investments. This is because your investment is entirely dependent on the future of one company. If it goes bankrupt, you can theoretically lose everything you invested. Therefore, you should research the company carefully beforehand, which can be time intensive.

Summary:

  • Stocks = parts of companies
  • Risk & reward: high, depends on performance of company
  • Research: very time intensive
  • Minimum investment: share price, unless you buy fractional shares
  • Fees: order fee and spread for buying and selling
  • Time horizon: very different (day trading, swing trading or investing for multiple decades)

Bonds

Companies and governments can issue bonds. Investors who buy those bonds effectively loan money to an organization. This money is then listed as debt on their balance sheets. On the end date, this organization has to pay you back what you invested. In the meantime, they pay you interest on the money they owe you (sort of like dividends). Bonds are basically reverse loans, because in this case investors are the lenders. There is a complication though: bonds also have a price. It could be higher than what is paid back at the end because investors trust the bond issuer. Because of the interest, investors will still make a profit on their investment, but the return on that investment (“yield”) is not as good. On the other hand, the price could be lower that what is paid back at the end date, which increases the yield. The interest always remains constant. You can buy or sell a bond at any time and it is possible to make a profit or loss from the difference in price as well.

Bonds provide a fixed income and an assurance of how much is paid back on the end date, which is why they are considered to be less risky. The only risk is that the bond issuer might not be able to back its debt, in which case you could also lose everything you invested. That is why it is important to choose stable organizations which you think will be able to pay their debt.

Summary:

  • Bonds are loans to companies or governments with an end date and a fixed interest
  • Risk & reward: low. Only risk: bankruptcy of bond issuer
  • Research required: some, but not as much as stocks
  • Minimum investment: depends on bond
  • Fees: order fee and spread for buying and selling
  • Time horizon: until end date (a couple of years) or less

Actively Managed Funds

Funds offer the possibility to let a professional institution actively manage your investment. They will invest your money in a mixture of different investments. Because of this diversification, funds are less volatile and less risky than buying individual stocks. But there are management fees of usually 1 or 2% per year, which is more than it might seem at first. Also very few funds have outperformed the overall market. This is why Warren Buffett placed a bet that “including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over 10 years”, which he won.

Summary:

  • Actively managed fund = let a professional invest your money
  • Risk & reward: low, because of diversification
  • Research required: very little
  • Minimum investment: depends on fund
  • Fees: order fee + high management fees
  • Time horizon: like stocks, but usually used more by long-term investors

Exchange-traded Funds

Exchange-traded funds, or ETFs, are a grouping of stocks, sort of like mutual funds. But unlike mutual funds, this group of stocks is not being actively managed and they are being traded on an exchange, just like other stocks. An ETF can consist of any collection of stocks. Many ETFs track an index like the S&P-500 or Dow Jones, which means that the composition of stocks in that ETF is set to be the same as in that index. Other ETFs focus on specific areas, like investing in sustainable energy, developing economies or dividend paying companies. Some ETFs reinvest those dividends, others pay the dividends out directly.

ETFs also reduce risk through diversification, but they have a lower fee since they are not being actively managed.

Summary:

  • ETF = collection of stocks
  • Risk: low, because of diversification
  • Research required: very little
  • Minimum investment: trading price of ETF, which is usually affordable
  • Fees: order fee + low running fees
  • Time horizon: like stocks, but usually used more by long-term investors

Real Estate

This is an article is for people who are just starting to invest, so I will mention this only briefly. Buying an apartment or house generates a return in the form of rent and value appreciation (or loss in the form of repairs and depreciation). However, you need a lot of capital and credit-worthiness to start investing in real estate.

  • Risk: very low
  • Research and maintenance: extremely time intensive
  • Minimum investment: 5 figures
  • Fees: often 6% commission, interest on loan, repairs, etc.
  • Time horizon: decades

Cryptocurrencies and Precious Metals

Another option is to buy cryptocurrencies like Bitcoin or Ethereum (e.g. on Coinbase or Bison) or precious metals like Gold, Silver or Platinum. The idea is that these resources are limited and therefore can be trusted as a store of value. Additionally, increasing demand and decreasing supply could lead to rising prices. However, these are not real investments in the strict sense. Companies and real estate have an inherent value as assets with a return: earnings and rent. The value of metals and cryptocurrencies is that they can store wealth and be used as a currency. However, their price depends entirely on how much other people are willing to pay for it, because they do not generate any value on their own.

It can still make sense to own some cryptocurrencies and metals though in my opinion, which I share in another article.

Categories
Investing

Useful investing resources

When you start investing, it might be hard to know where to look for the right information when researching. Here are some links I found useful.

  • Definitions and Explanations: Investopedia
  • Stock information: Seeking Alpha (especially for dividend stocks) and Yahoo Finance (you can download detailed historical data here)
  • Stock screener: Finviz
  • Investing related innovation news: Ark Invest and their FYI Podcast (For Your Innovation)
  • Financial information on a company: go to the investor relations page on a company’s website and look at their quarterly presentations
  • Entertaining/informative Youtube Channels: Graham Stephan (real estate), Financial Education (stock picking), Phil Town (general financial education)

For actually investing, these are the sites I use:

  • Cryptocurrencies: Coinbase or Bison (earn $10 and support my blog for signing up through these links)
  • Stocks: Gratisbroker (only broker in Germany that offers free trading without fees). Otherwise you might use Freetrade, Robinhood or WeBull to avoid fees, but I have no experience with them
  • Precious metals: GoldSilber. I’m not sure if they offer accounts outside of Germany

Hope this helps!

Categories
Investing

How to invest small amounts of money

Everyone has to start somewhere, right? If you’re anything like me when I started investing, you may be wondering if it even makes sense to start investing now (which I think it does) and if it is even possible to invest small amounts of money. While some types of investment have a very high threshold to get started, there are still many opportunities for you. In this article, I will share some things you might want to consider.

What can you invest in?

Many investment opportunities don’t have a minimum amount required to get started, like buying stocks, cryptocurrencies or even precious metals, and for some investments this amount can be relatively small, like funds and bonds. This really surprised me at first. So where is the catch?

Fees

While it is often possible to start investing even very small amounts of money, the fees you pay may be disproportionally large depending on the broker you are using (“a broker is a firm or individual” which you need to buy stocks – more on Investopedia).

Stocks (and Bonds)

Standard fees for buying stocks are around $5 per order, which means buying or selling a stock, plus an additional 0.25% of the order value.

Let me give you an example. If you want to buy a stock for $100, you would pay

$100 + $5 + (0.25% x $100) = $105.25.

And then you would have to pay an additional $5 for selling the stock. This $5 fee really adds up, especially if you make many small orders. Fortunately, there is a way around that. In this article I compare the cost and service of different brokers. Some of these brokers don’t have any fees at all! You still have to pay the spread, though. Another way to buy a little bit of many different stocks at once without having to pay a fee for each stock are funds.

Investment funds

Funds are basically a collection of stocks chosen by different criteria. Funds have different types of fees. There are management fees, which you pay annually and are usually around 1 to 2%. Then there may be additional fees for buying that fund or fees depending on its performance. This really depends on the individual fund though. Generally speaking, ETFs (exchange traded fund) are cheaper. Sometimes there are also special offers by brokers to buy funds at zero initial costs.

Fractional shares

Usually, you can only buy whole shares of a company. Stocks of a company can have theoretically any price, like Nokia at currently $3.15 per share or Amazon at a share price of $1955.98. However, this generally does not say anything about the company, because the number of outstanding shares is also variable. The market capitalization, or how much the whole company is worth, can be calculated like this:

Market cap. = share price x number of shares outstanding

The problem with this is that you usually cannot buy any shares in a company like Amazon if you don’t invest at least $1955.98. One way around that is to buy a fund which invests in Amazon, but then you automatically buy all the other stocks in that fund. But recently, some brokers like Robinhood or Freetrade also offer fractional shares, which means that you can invest an arbitrary amount into any company or fund.

How to invest

To make any investment, you need a broker. Almost every bank is also a broker, but you can also go with a fintech startup. You can find a broker comparison here. After you register for an account, you just deposit money into your brokerage account via a wire transfer, choose what you want to invest in and how much. That’s pretty much it! The exact process depends on your broker and you can also find more detailed instructions there.

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Investing

5 reasons to start investing early

You clicked on this article, which probably means that you haven’t started investing yet or just started looking into it. I can totally understand that. Maybe you think that it is too risky, takes too much time or that you don’t have enough money to invest.

Actually, those are some common misconceptions about investing. It really depends on the investing strategy. But still, I am not a financial advisor. So please do your own research and inform yourself.

There is a chinese proverb that says: „The best time to start is 20 years ago. The second best time is now“. So let’s get right into my top 5 reasons why you should start investing right now.

Reason Nr. 1: Let your money work for you

Have you ever wondered why “the rich are always getting richer”? One reason is that they use money to make more money, instead of working directly for money. That’s basically what investing and all the hype about passive income is about.

“Why would you work for [money], if they can print it?”

Robert Kyosaki

Let me give you an example: imagine you work for one whole month and from that income you save $100. This is money you set to the side and that you don’t need to pay your expenses. Great! Now you have $100 more in your savings account. But really that money is just sitting there, doing you no good (but your bank is using it to make more money for itself). What you could do instead is invest it and buy shares of some company at the price of $100. Now you own a part of that company. This company makes profits, which it usually uses to pay investors back through dividends and to grow its business. This in turn increases the value and eventually the share price of your company. But even if we ignore the share price gains, you basically have a coupon now that gives you back 5% of your investment every year. So after one year you receive $5 in dividends.

Reason Nr. 2: Insurance against inflation

Now you may be wondering: „Doesn’t investing mean taking more risk?“. The answer is yes and no. Over time with those $100 that you have saved you can buy less and less stuff, which is called inflation. There are many reasons for this, like a weakening economy or the federal bank printing money. If there is more money available but the value of everything that can be bought remains roughly the same, then your money will be worth less.

By the way, inflation means that your wealth is decreasing exponentially. Currently the inflation rate is at about 2%, so it would take 35 years until your savings are only worth half as much as today (calculation: 1,02 ^ (-35) = 50%).

Value and Supply of the US $1 Federal Reserve Note (Sources: Bureau of Labor Statistics and Federal Reserve)

In the extreme case of a currency devaluation, your $100 could also become actually worthless. Just think about what money really is: the only reason it has any value is because people treat it like it does. Now compare that to owning part of a company. This company does not decrease in value just because some currency becomes worth less (or worthless). A company has real assets, which produce real value. The same thing is true for real estate as well, but I will focus on investing in the stock market for now.

“Cash is Trash”

Ray Dalio

Reason Nr. 2b: No attractive alternatives

Until recently, bank accounts (or treasury bills) also paid a small interest on your savings with practically no risk. This makes sense, because the bank uses your money to invest it in something with an even higher interest rate. But really this interest was never that good to begin with and has been decreasing to the point where it can’t even keep up with inflation. Sometimes you even have to pay for your bank account, which I find just ridiculous.

Reason Nr. 3: Passive income

Earn money while relaxing on a beach – who wouldn’t like that

Depending on your strategy, you can generate a source of passive income by investing. This is money you don’t have to actively work for, which is another kind of insurance. If you had enough money to invest, you could theoretically even earn enough so that you would not need to work at all. You could just live on the dividends that you receive from your investments without ever actually touching the money you initially invested. That is the idea behind being completely financially independent.
Of course, if you could also just invest this passive income again, which leads me to my reason Nr. 4: compound interest.

Reason Nr. 4: Compound interest

Warren Buffett’s net worth by age

Saving means growing your wealth linearly. Investing means exponential growth, because you can reinvest your profits to make even more profits. So while 5% on your investment per year might not seem like much, this will actually double your investment in less than 15 years. And the thing about exponential growth is that it pays to start early (Warren Buffett actually started investing when he was 11 years old). To be fair, if you really want to increase your wealth at the rate that Warren Buffett did it, a 5% return per year is not going to be enough. But exponential growth always beats linear growth eventually, even with relatively low interest rates. You can calculate how much your investment would be worth after X years with the following formula:

Initial amount invested * (1 + annual return in %) ^ X

Warren Buffett on Compound interest

Reason Nr. 4b: Retirement

In extension of the last reason, just saving means that you can’t spend as much in neither the short-term nor the long-term and that you probably won’t have as much savings for retirement. Having a passive income might also be a nice bonus in retirement.

Reason Nr. 5: Experience

Another good reason to start investing early is the experience you gain and to get in the habit of investing regularly. We learn through our mistakes. At the beginning, you cannot lose that much money compared with later. Even if you haven’t saved that much money yet, there are ways to start investing, like buying shares with low prices, fractional shares or fonds. You can find more information about investing small amounts of money in this article (coming soon). Also, you can slowly get used to investing with increasing amounts.

Still skeptical?

Now I have explained why I think it makes sense to start investing now, but as I said at the beginning I understand why you still might be skeptical. After all, I had those same worries before I started investing.

Mainly: the risk involved.

I won’t lie to you: investing always involves more or less risk. But there are some investments which have very low risk, like large companies with a strong balance sheet and future outlook, REITs, or bonds (if you don’t know what all of that means, don’t worry – I this article just for you). You can also minimize your risk through research and diversification.

This graph shows your average annual compound returns over 25 years in the
S&P 500 (a measure for the overall performance of the stock market). Not adjusted for inflation. Source: YahooFinance, graph created by me.

In the very long-term view (25 years), the economy has always been growing exponentially. So even after the Wall Street Crash of 1929, the economy and the stock market recovered in 25 years. On the other hand, investing in 1975 and selling in January 2000 at the peak of the Dot-com bubble would have given you an annual compound return of over 13 % – that means the stock market increased more than 21-fold in that time!

The average annual compound return in the stock market over 25 years is 7,07 %.

Calculated from YahooFinance data

The second reason you might not want to invest is time.

And you are right: depending on how you invest, it takes time to do the research before investing. But for me personally, the benefits I outlined in this article are definitely worth it. Besides, there are ways to invest with relatively low risk and good returns that take almost no time, like buying an ETF.

I enjoy the research. Investing is like a hobby for me, so I don’t really mind that I invest my time in it. Through all this research, I am always informed about current developments. Since I started investing, I have learned so much about the global economy, specific companies, general trends and innovations.

I will keep on learning and try to convert my insights into these neatly packaged blog posts. I hope you enjoy them!