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The Biggest Lie You Have Been Told About Investing
The dirty little secret of the fund management industry
Hey 👋 - Thomas here.
Good day to my fellow compounders!
In today’s issue, I will debunk the biggest misconception about investing.
Let’s get started!
The biggest lie beginners believe is that buying stocks with high dividend yields are the best way to achieve financial freedom.
The idea of getting passive income by getting paid dividends while you sleep has been romanticized. It's a dirty little secret of the fund management industry that simply adding the word ‘dividend’ to the name of the fund will increase sales.
Focusing on dividend yield alone will hurt your returns!
When evaluating an investment, always consider its total shareholder returns. When we compare the total shareholder returns of dividend generals such as Coca-Cola and Procter & Gamble (P&G), against companies with low dividend yields such as Mastercard and Domino's Pizza, the results are night and day.
If you had invested $10,000 a decade ago, you would have achieved the following returns:
$14,440 for Coca-Cola
$22,700 for P&G
$77,610 for Mastercard
A whopping $111,200 for Domino’s Pizza!
The opportunity cost for focusing solely on dividends is huge.
Focus on total shareholder returns instead.
Total shareholder returns = Appreciation in stock price + Dividends
Dividends alone aren't bad, but we must also consider the potential for stock price appreciation when evaluating an investment. Ultimately, the stock price will follow the growth in cash generated by the company.
Here are four tips on evaluating an investment.
Tip #1: Determine if the company has the ability to grow revenue by looking at its past revenue growth rate, the size of its total addressable market, and the ability to keep raising prices. Generally, I look for companies that are able to grow revenue by 10% annually.
Tip #2: Determine whether management controls expenses prudently. Over time, we want to see operating margins increase as revenue increases.
Tip #3: Find out if the management is shareholder friendly by listening in on earnings calls and reading their letters to shareholders. How transparent are they? Are they willing to own up to their mistakes? Is it clear what their plans are for the company?
Tip #4: Check to see if the dividend payout ratio is below 30%. The lower the payout ratio, the more sustainable the dividends will be. Companies with a dividend payout ratio of more than 70% are likely to cut dividends during a downturn.
Dividend investors are likely to miss out on potential returns that could change the way you live in retirement.
Consider total shareholder returns rather than just dividend yield.
That’s all for today.
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See you again soon.