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The Basics of Investing

As a follow up to my Constructing a Dividend Portfolio post I thought I would touch upon my position as it relates to the basics of investing. What I share below are observations and findings based on my personal experiences over the course of many years as an investor in individual companies.

A well diversified mid-7 figure portfolio probably doesn’t really need shares in anything more than roughly 45 companies. As such, a well balanced portfolio does not mean having a low 6 figure portfolio consisting of shares in 100+ companies (I am not exaggerating when I say I have seen this). There is a fine line between insufficient diversification and too much diversification.

There are 500 companies which make up the S&P 500 and 60 companies which make up the TSX 60. The vast majority of investors creating and managing their own portfolio of individual stocks probably do not really need to venture beyond these two pools of companies to create a decent portfolio.

Some of the largest companies found within the S&P500 and the TSX60 have substantial international operations. By investing in these companies there probably is little reason for the average investor to invest in companies headquartered in lesser developed parts of the world in order to get international exposure.

Be careful of the companies in which you invest otherwise the time you spend managing and monitoring your portfolio could become overwhelming. Looking at stock prices and stock charts every day can be a huge waste of time (unless this is something you definitely want to do).

Pay heed to the following advice from Warren Buffett:

  • “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
  • If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes”
  • “You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress.”

Avoid mutual funds. Most mutual fund managers underperform the benchmark and charge high fees which negatively impact your investment returns. The alternative, if you do not feel comfortable creating and monitoring your own portfolio of stocks, is to invest in a low cost diversified Exchange Traded Fund (ETF).

A company with an abnormally high dividend yield should be a “red flag”. The risks with high dividend yield stocks are:

  • The company may not be able to sustain the high dividend yield from profits and free cash flow generated through normal business operations and there is a strong probability of a dividend cut.
  • A dividend should be a return ON capital. Several companies with abnormally high dividend yields are also returning a portion OF capital.
  • They attract investors who require income to sustain their standard of living or unsophisticated investors who are unaware that the company’s earnings are so low or so volatile that the shares are totally unsuitable investments for their investor profile.

The importance of dividend growth is far greater than dividend yield. By way of example, let’s use the metrics for AT&T (NYSE: T) and Broadridge Financial Solutions (NYSE: BR) as at September 9, 2017.

AT&T closed at $35.60, has an annual dividend of $1.96 (5.51% dividend yield), and the dividend has a historical growth rate of 2.20%/year. Broadridge, on the other hand, closed at $79.08, has an annual dividend of $1.46 (1.85% dividend yield), and the dividend has a historical growth rate of 11.0%/year. If these metrics remain in place for the next 5 years, Broadridge’s annual dividend will surpass that of AT&T.

Most investment newsletters aren’t worth the price. If most mutual fund managers can’t beat the benchmark, what makes you think investment newsletters are any better?

Beware of companies that continually issue new shares thus diluting existing shareholders’ ownership. The issuance of new shares, however, is acceptable if for sound business reasons such as a major acquisition. Typically, I look for a reduction in share count especially if the repurchased shares are at attractive prices.

Invest in companies that have a track record of consistently growing their earnings. This is why I avoid investing in companies which operate in cyclical industries (eg. mining, automotive) or which sell a commodity since there is nothing that differentiates the company from the competition (unless you are the lowest cost producer).

Do not confuse investing with gambling. Avoid:

  • Marijuana stocks
  • Lithium batteries
  • Bitcoin, Cryptocurrency
  • Junior mining companies
  • Initial public offerings (IPOs)
  • Stocks traded on junior North American stock exchanges or Pink Sheets
  • Junior biotech companies

If your friends are talking about company XYZ then it is highly probable XYZ is not a company in which you should invest. If you buy what is popular there is a strong likelihood you will not do well. The time to become interested in buying something is when nobody else is interested.

Find companies with competitive advantages. Examples of competitive advantages include but are not restricted to:

  • brand loyalty
  • market share
  • patents
  • cost competitiveness
  • superior product
  • superior service

Invest in companies you understand. Having said this, if you have a deep understanding of the automotive industry AND are employed in the automotive industry it is not a good idea to invest heavily in the automotive sector. Holding investments in companies in the same industry as that from which you generate your income is tantamount to having “all your eggs in one basket”.

There is nothing wrong if you know you don’t know anything about investing. The investors who get into trouble are those who don’t know that they don’t know.

Some industries are known for companies which make significant use of leverage. The banking sector is an example where industry participants have a significant amount of leverage. Rather than suggest you avoid companies with high debt levels, I suggest you avoid companies that are much more highly leveraged than their peers.

Insider selling is not as good an indicator as insider buying. Selling can be for various reasons. Insider buying, however, is only done when senior management view the shares as undervalued.

A recent example of an insider purchase that is a favorable indicator is Richard K Smucker (Executive Chairman) bought 10,000 J M Smucker (NYSE: SJM) shares @ $105.40 on the open market on August 29, 2017 thereby bringing the total number of shares he directly owns to 652,168 (Source: INK Research report) .

Check the company’s most recent Annual Proxy Statement to see the extent to which senior management owns shares in the company. For example, on page 83 of 91 in SJM’s 2017 Annual Proxy Statement dated June 30, 2017 I see that Richard K Smucker directly or indirectly owned over 2.5 million SJM shares. Another Smucker family member directly or indirectly owned in excess of 1.9 million shares.

Investing does not mean continually buying and selling. Well run companies with competitive advantages will make you money if you give them time. Invest in good solid companies and then get out of the way.

Sometimes your investment thesis will not pan out or the company in which you have invested has changed dramatically to its detriment. In this case your best bet might be to just cut your losses and to move on.

Final Thoughts

I think the following two quotes from Warren Buffett sum up the basics of investing very nicely.

“You only have to do a very few things right in your life so long as you don’t do too many things wrong.”

“It is not necessary to do extraordinary things to get extraordinary results.”

Note: I sincerely appreciate the time you took to read this post. As always, please leave any feedback and questions you may have in the “Contact Me Here” section to the right.

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long SJM, T, and BR.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.

By |September 9th, 2017|General Investing|8 Comments

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  1. AussieInvestor September 29, 2017 at 8:45 PM

    I really enjoyed this post – what you wrote takes many investors 10 to 20 years to figure out and that’s if they have not been burned, jaded and scarred from market losses by the time they do learn. What I’m curious about though is why you decide to hold roughly 45 companies? Does this not become a costly exercise when you need to dollar cost average? Why not hold one or several dividend-oriented ETFs as the ‘core’ and high conviction picks as ‘satellites’? Just curious.

    • Charles September 29, 2017 at 11:31 PM


      “Takes many investors 10 to 20 years to figure out”….some NEVER figure it out! Sometimes you “just can’t fix stupid”.

      It is not a costly exercise at all and is actually probably less expensive than owning ETFs. For example, on July 24, 2017 I bought $24,665.70 of NYSE:GPC and on July 27, 2017 I bought $52,047 of NYSE:MA. Each trade only cost me $9.99. That is a cost of just under $20 for $76,712.70 worth of stock. I have these holdings set up for auto dividend reinvestment and I get charged nothing (I would be naive to think that the discount broker is not making anything on the auto reinvestments and suspect that I am not necessarily getting the lowest price of the day but my account is not getting hit with a “fee”).

      Let’s say I bought an ETF that only held these 2 stocks (I know that doesn’t exist but go with me on this one). I would end up paying ETF fees year after year. I intend to hold these shares for ages so over time I strongly suspect the ETF issuer would have extracted more than $20 from me.

      Now, if I were buying a few hundreds dollars of several stocks every month that might be a different story. It would be somewhat foolish of me to invest, for example, $10,000/month over 10 different stocks. Then I would be paying $100/month in fees.


      • AussieInvestor October 2, 2017 at 12:38 AM

        Regarding the investment philosophy Charles, yes I absolutely agree, that some will never figure it out! I’m not sure if I’d call them stupid per se – it’s easy to get tempted and burned by the financial media’s hot stock gossip, various get-rich-quick-schemes made by shady operators and the one friend who thinks that he’s a genius because he made 500% in a month from a speculative company (when in fact all his other positions are probably in loss). Just takes a stroke of bad luck to fall into these things because the marketing can be so appealing.

        Regarding cost, I guess it depends on various factors such as how much you have to invest, the frequency and size of transactions as part of your strategy and the cost of financial services in the jurisdiction you are based in. I live in Australia and while brokerage costs have fallen over the years, $9.99 trading commissions for transaction sizes such as the ones you said you executed in your post are unheard of here.

        I agree with you that, yes, if you were to spread $10,000 over 10 different stocks as an example the commissions would start to bite. But then how do you deal with needing to dollar-cost average your portfolio down? What if the broad market falls 5%, then 10%, then 15%, and 20% etc. like it did in the GFC – do you just keep buying into your individual holdings and deal with the commissions or would it have been better to have a few ETFs?

        • Charles October 2, 2017 at 7:55 AM

          “$9.99 trading commissions for transaction sizes such as the ones you said you executed in your post are unheard of” in Australia….

          Purely an FYI, here are links to the fee structures for the two banks I use for online trading.



          ETFs are probably the route to go for many investors. I just like to be selective and to make my own trades in companies in which I want to invest.

          How will I average down across all my holdings if we get a major market correction? Clearly I won’t be able to. I will need to be selective as to which companies in which I will average down.

          The automatic dividend reinvestment I have set up across several of our accounts will result in the dividends being automatically reinvested at lower prices. Of course, buying 6 – 7 shares (for example) at lower prices is not going to have a meaningful impact on the average cost if I already own several hundred or a few thousand shares in a company.

          In addition, I only get 4 quarterly dividend payments a year so unless the market correction lasts a few years (wishful thinking on my part) I won’t be able to acquire that many additional shares at lower prices. This would certainly be a trade-off I would have to live with.


          • AussieInvestor October 2, 2017 at 5:37 PM

            Thanks Charles, it’s good that you’ve identified and are prepared to live with that trade-off. For a younger investor (I’m in my 30s), how often would you suggest investing in the market and are there certain circumstances that have to be in place? eg I really liked your idea of investing your first $100,000 in an S&P 500 ETF. Should you put say $2,000 a quarter… should you put less if valuations are too high? Would be good to know your thoughts.

          • Charles October 2, 2017 at 7:27 PM

            You use a figure of $2000/quarter. I have absolutely no idea whether this is a decent amount or not because I know nothing of your personal circumstances. As a result, let me approach this from a very high level perspective.

            How did you come up with $2000/quarter? Is this a stretch target or a figure you can easily attain? If it is a stretch target then perhaps the following will get you thinking as to how you can come up with $2000/quarter so it is not a stretch figure.

            In Canada we have Registered Retirement Savings Plans (RRSP); you may have something similar in Australia. If you contribute to these plans you get a tax deduction which lowers your tax obligation. Typically what happens is that Canadians contribute to RRSPs and get a tax refund when they file their tax return. This is not good because essentially the taxpayer has given the government an interest free loan.

            The best thing Canadians can do is to ask the government to provide authorization to their employer to reduce the amount deducted at source because they will be contributing to a RRSP. Once the government provides this authorization, the employer reduces the amount deducted at source to increasing the employee’s net pay. It is very highly recommended this increase in net pay be contributed to a RRSPs otherwise the taxpayer will be in a predicament that they will owe the government money when they file their tax return. Do you have something similar in Australia?

            Another thing you can do is use my Cash Flow Analysis spreadsheet.

            I didn’t prepare one for Aussies but you can certainly download the Canadian version and modify it to meet your needs. Completing this cashflow analysis might help you identify expenses that really are not necessary or expenses which can be cut back.

            Now all of a sudden you may find this $2000/quarter you referenced is probably way too low.

            I can’t stress this enough! A really important thing to do is to approach your budget from the opposite of what probably 98% of the population does. Most people tend to save/invest whatever is left over after they pay all their expenses. I suspect you know this is not the right way to do things.

            My recommendation is that you take your net income (hopefully the amount deducted at source can be reduced). If you want to be aggressive and are really keen on achieving your goals and objectives you may want to say that 20%+ of your net pay is automatically set aside for investing (or debt reduction if you have debt). Whatever is left over is what you have to cover your expenses.

            I suggest you invest more frequently than quarterly. Investing every pay period (would that be every 2 weeks for you?) is preferable.

            Neither one of us can time the market so don’t say “I think valuations are high so I’ll invest $1000 instead of $2000”. Pick a stretch figure and stick with it. By stretch figure I mean a figure you can’t hit with your eyes closed. It is a figure where you will really need pay attention to your inflows/outflows.

            While investing for the future is all fine and dandy, you also need to remember that life is not a dress rehearsal. Don’t sacrifice life experiences all for the sake of investing for the future. Have a healthy balance otherwise one day you’ll stop dead in your tracks and wonder “where has my life gone?”

            Does this help at all?

  2. LGU September 28, 2017 at 8:56 AM

    thanks for sharing your experience.
    what is your cash management strategy for your stock portfolio ?
    are you always full invested ? or do you have a predefined level of cash quickly available (20% for instance) ?
    or do you regulate this level depending on your market analysis ?

    In my case, i like to have enough ammunition, but it was not always true and I can remember short periods (last year just after brexit) when (european) markets were down and i had no enough cash to buy my favourite stocks.

    • Charles September 28, 2017 at 11:01 AM


      I am pretty much fully invested although I have money coming in monthly from dividends which I can use to acquire further shares. It is not a ton of money in the grand scheme of things but if we ever had another market implosion I am certain I would be able to find some money (say $100,000 – $250,000) somewhere.

      The reason I don’t have a ton of money sitting around is because I know I can’t time the market. I figure I may as well just stay invested in good solid companies and collect the dividends.

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