Investing Fundamentals II Fall 2024 PDF

Investing Fundamentals II  1. Stocks vs. Bonds TODAY’S 2. Asset Classes GOALS 3. Value vs. Growth 4. Market History 5. Gold  A stock is a share in the ownership of a company. Stock represents a What is claim on the company's assets...

Investing Fundamentals II  1. Stocks vs. Bonds TODAY’S 2. Asset Classes GOALS 3. Value vs. Growth 4. Market History 5. Gold  A stock is a share in the ownership of a company. Stock represents a What is claim on the company's assets and earnings. As a you acquire more stock, your ownership stake in the company Stock? becomes greater. Whether you say shares, equity, or stock, it all means the same thing.  Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as What is such, you have a claim (albeit usually very small) to everything the company a owns. Yes, this means that technically Stock? you own a tiny sliver of every piece of furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company's earnings as well as any voting rights attached to the stock.  A “public company” is a company whose stock is sold on a public market like the Toronto Stock Exchange or the New What is York Stock Exchange. You can own stock in “private” companies too, but a they are a lot more difficult to buy and Stock? sell. 5  A given company will have a particular number of shares outstanding on any given day. They can increase this number by What is selling new shares or decrease this number by buying them back from the public on the stock exchange. a Stock? 15,287,521,000 shares outstanding 3,198,000,000 shares outstanding  The price of a share of stock What is will go up and down everyday. a The price is influenced by “supply and demand”. Stock? If more people want to buy the stock, the price goes up. If more people are trying to sell the price goes down. 7  Making $$$ With Stocks As an investor you purchase stocks with a goal to make money in two different ways: 1. Hope the price will go up over time so you can sell it for a profit in the future (i.e. realize a “capital gain”). 8 2. Possibly receive a “dividend”. Company Value & Stock Price If a company’s income grows, the company is more valuable so the stock price goes up! If a company’s income shrinks, the company is less valuable so the stock price goes down! Company Value & Stock Price A company’s value is “supposed” to represent the present value of all future cash flows/income the company will generate. I say “supposed” to because it is REALLY difficult for anybody to figure this out on a daily basis. Just think of all the assumptions that need to be made to estimate how much cash flow/income a company is going to generate for years and years and years!  What Impacts Cash Flows? The Economy – Growing? Shrinking? Competition New Products/Failed Products Government Regulation Taxes Labour Demands Inflation Interest Rates Supply Chain Issues (see COVID) Societal Trends (Environment, Health, Etc.) Global Conflict Advertising Blunders And ALL of this is different in every county… Company Value & Stock Price This is why the stock price of a company is constantly changing. As new information becomes available it is factored into the “market’s” estimations of a company’s future cash flows! Company Value & Stock Price So….you as an investor are hoping that companies are finding ways to continually increase their cash flow/net income over time so the value of the company keeps going up!  Company Value & Stock Price Once you have “determined” (i.e. guessed) at the value of the company, you divide that by the number of shares outstanding. Estimated Company Value = Share Price # Shares Outstanding 16  “Fun Fact” We Can Do the Calculation in Reverse a r k et M tion ta l i z a Capi et Cap”) rk (“Ma eans m n y’s m p a “A Co lue” Va Let’s Look at an Example https:// www.morningstar.ca /ca/report/stocks/ quote.aspx? t=0P00006899  What is a Dividend? ▫ A “dividend” is a distribution of a portion of the company’s profits. ▫ A dividend is usually received in the form of cash, but can be given is the form of extra stock. ▫ Companies have no obligation to pay a dividend. 20 Do You Want To Invest in Companies That Pay Dividends? When a company pays a dividend, the “wealth” of the company has decreased by the amount of cash it has distributed. Imagine a company takes $5,000,000 out of its bank account and distributes it to the shareholders, the business must now be worth $5,000,000 less. And now that the business is worth less, price of each share must go down accordingly!  One Share of Stock One Share of Worth $19 Stock Worth + $20 $1 in Your Pocket 22 Some investors don’t want Some investors REALLY like dividends as they prefer that dividends because they want the company keeps the cash to the cash so that they can grow the business. choose what to do with it. The investor might think the business doesn’t have any viable growth opportunities.  If you have invested in a GREAT company, wouldn’t you want THEM to “Should” keep the money and make the business even better? If they do that it would you want a make the stock price go up! New companies, or companies with lots company to of growth potential likely won’t pay pay dividends as they need to keep their cash. dividends? Older/established companies with less growth potential likely will pay dividends, as will companies that want 24 to rebalance their capital structure.  Let’s look at an example: “Should” https://www.morningstar.com/ stocks/xnys/brk.a/chart you want a Now ask yourself, would the value company to of Berkshire Hathaway’s stock be “HIGHER” if they had continued pay paid out millions of dollars in cash dividends? dividends? If you think “YES”…..ask yourself “HOW” that is possible? 25 Which Companies Pay Dividends Often? 26  Which Companies Don’t Often Pay Dividends? 27  1. They DON’T have a better internal use for the cash Companies themselves. i.e. they have no quality growth opportunities. Therefore Pay Dividends 2. To change their capital structure and thus lower their Because WACC by distributing retained earnings and raising cash with debt (when prudent to do so). 3. That’s it. Those are the reasons. 28  Many companies DO pay dividends, and on an overall basis “Should” they make up a significant portion of an investor’s “total return”. you want a company to “Total return” is a combination of the dividends you receive and the pay increase in the price of the stock. dividends? At the end of the day we are interested in maximizing total return. 29  “Should” you Let’s look at a little comparison…. purposefully invest in dividend paying 33 stocks?  You buy 1 share of TD Bank Stock on January 16, 1995 for $5.10 On February 6, 1995, TD paid you a dividend of $0.06. This works out to a dividend yield of 1.18%. (0.06/5.10) This equals approximately 4.72% for a year (1.18% x 4 as dividends are paid quarterly). 34  On October 5, 2023, TD paid you a dividend of $0.96. What is your dividend yield on October 5th? A lot of “dividend gurus” will tell you that your yield is based on the price you originally paid for the stock, or: $0.96/$5.10 = 18.82% (or 75% per year) 35  But, on October 5th that 1 share of TD bank stock was worth $79.39. That means that the TRUE dividend yield on October 5, 2023 was: $0.96/$79.39 = 1.21% (or 4.84% per year…which is almost identical to the yield when you bought it) 36  This MUST be true because if you sold your share, collected $79.39, then took the cash and bought back your share the very next minute at the same price, you would now agree you’ve “invested” $79.39….right? So now you would HAVE to agree that your dividend yield is: $0.96/$79.39 = 1.21% https://www.morningstar.ca/ca/report/stocks/quote.aspx?t=0P00006899 37  So please don’t fall for the myth that your return is growing based on the original price you paid. It simply isn’t the right way to look at your investment. Watch this video if you want to explore the myths of dividend investing in more detail: https://www.youtube.com/watch? 38 v=z5imrtGdehc  You should be able to set up your brokerage account to automatically reinvest dividends back into the Should you SAME investment the dividend came from. “DRIP”? (Dividend This is an easy way for you to make sure you are already putting Reinvestment your cash to work. Plan) Or, if you’d rather you can let the cash pile up and invest in a different investment. 39  Note: when you automatically Should you reinvest dividends back into the same company you are in “DRIP”? the same overall position on the day you buy more shares. (Dividend You don’t have more wealth. Reinvestment Plan) Remember this when you read articles/blogs/books/etc. that will try to tell you that 40 dividend investing is “best”.  A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows What is the funds for a defined period of time at a variable or fixed interest rate. Bonds are a used by companies, municipalities, states (provinces) and sovereign governments to Bond? raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer. (http://www.investopedia.com/terms/b/bond.asp?layout=orig) 43  The “key” with bond investing is that the person that holds the What is bond doesn’t participate in the a profits of a company. If a company becomes more Bond? profitable, the bond holder doesn’t make any more money! All they get is their promised interest payment. 44  In August of 2020, Apple issued $5.5 Billion of bonds with interest rates ranging from 0.60% to 2.61% (per year). https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/hg-bonds-apple-launches-5-5b- offering-at-low-yields-59920540 Sounds about as good as a high interest savings account right? Does that return excite you? 45  +270% in 40 months +270% gain in 40 months…or at most 8.7% interest  In 2019: “…the company's wearables division, which includes AirPods and Apple Watch, accounts for more revenue than 300 of all Fortune 500 companies.” https://fortune.com/2019/08/06/apple-airpods-business/ 48  Be a lender and make a small amount of interest? (bonds) OR Be an owner and participate in the profits and growth of the company? (stocks) 49  Most people think bonds are “safe” and “low risk”. Interest It is true that bond prices move up Rates and down less than stocks. and But bonds prices do fluctuate when market interest rates Bond change. Prices And oh boy….have they changed! 50  It IS true that bond prices fluctuate less than stocks…but they still Interest fluctuate. Rates Bond prices fluctuate for the same reason stocks do – supply and and demand. Bond Demand changes because Prices interest rates in the market change. 51 Interest Rates and Bond Prices 52 Interest Rates and Bond Prices 53  Interest Let say you buy a bond today from Bell Canada for $1,000. Bell Rates Canada promises to pay you 5% interest per year for 10 years and and Bond then you get your $1,000 back. Prices – You will get $50 of interest per year. an example That is your “reward” for investing in the bond. 54  Interest Now assume that the interest rate investors want on a bond like yours Rates (similar risk, maturity date, etc.) goes up to 6%. and Bond Prices – Your bond only pays 5% interest. an Now imagine you need to sell you example bond because you can’t wait 10 years to get your money back. 55  Will someone want to pay you $1,000 for a bond that pays 5% interest when they could buy a different bond (of similar features) Ask that pays 6%? Yourself Of course not!!!! You will have to sell your bond for LESS than $1,000 to entice somebody to buy your bond. 56 Interest Rates and Bond Prices 57  Since the early ‘80s interest rates have been trending down which has generally been causing bond prices to go up. So, for 2.5 decades investing in bonds had been a decent investment because bond investors were earning a good amount of interest and bond prices were going up! 63  My opinion is that until someone is 5 years away from retirement they Should should think very carefully about YOU Have WHY they want bonds in there portfolio. Bonds in Bonds WILL smooth out the “roller Your coaster”….but it will also decrease Portfolio the overall total return of your portfolio as well. Is a smoother rollercoaster worth 64 lower returns to you? 65 Investing in Bonds is Like This Investing in Stocks is Like This  Let’s Look at Real World Example “AGG” - “VTI” – iShares Vanguard Core U.S. Total U.S. Aggregate Stock Bond ETF Market ETF https:// https:// www.morningsta www.morningsta r.com/etfs/arcx/ r.com/etfs/arcx/ agg/performance vti/performance 69  Let’s Look at Real World Example “AGG” - “VTI” – iShares Vanguard Core U.S. Total U.S. Aggregate Stock Bond ETF https:// calculators.atb.co Market ETF m/atb/jsp/ EarlyInvesting/ 2.32% EarlyInvesting1_ru n.jsp 13.86% 70  Should YOU Have Bonds in 1. The long-term rate of return on Your bonds is less than the stock Portfolio? market. 2. Since you will NOT get off the rollercoaster….why do you need them before retirement? 71  Should There is ONE “possible” YOU Have justification for buying bonds Bonds in that you may come across. Your Let me show you it and then Portfolio? we can discuss. The problem with this idea is that we can’t know if it will work well over the long term. 72 Only time will tell. 73  What is an Asset Class? “An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. Asset classes are made up of instruments which often behave similarly to one another in the marketplace.” https://www.investopedia.com/terms/a/assetclasses.asp Main Asset Classes  ❖ Cash is technically an asset class, but we all know that when Cash & Cash you hold cash it is slowly losing Equivalents value over time due to inflation. (GICs, Term ❖ So outside of your emergency Deposits, and sinking funds (and having Savings) enough cash on hand to cover your monthly bills), I don’t think it makes sense to hold more cash. 76  ❖ Many people believe you should keep a significant amount of cash on hand to buy into the stock market when it goes down significantly (like in 2020). “Buying the Dips” ❖ I DO think you should “buy the dip”….but not by keeping a lot of cash on hand. ❖ Let’s see why. 77  “Buy the Dip” Keep cash ready to buy when the market has a significant drop.  You may have waited until here to invest… If you stared saving cash here to buy the next big dip… Which means you missed this…  You may have If you stared saving waited until here to cash here to buy invest… the next big dip… Which means you missed this… This opportunity may have worked IF you managed to buy at the bottom. This opportunity may have worked IF you managed to buy at the bottom. But come on….what are the odds YOU know where the “bottom” is?  ❖ The most difficult thing to do is knowing WHEN to “buy” as the market is falling. “Buying the ❖ It is a little scary to put your money into a market when it is Dips” falling fast. ❖ And if you wait for it to start going back up you may miss a lot of the dip. 83 Start here… when would you buy?  JUST KEEP BUYING!  ▪ Commodities refer to agricultural and resource Commodities products like oil, natural gas, wheat, orange juice, etc. ▪ Commodities are VERY volatile (see oil prices!) and don’t have a very good long term track record for earning returns. ▪ I don’t think they are a good “long term investment”. 86  https://finance.yahoo.com/quote/ PDBC/performance?p=PDBC https://finance.yahoo.com/quote/ GSG/performance?p=GSG https://finance.yahoo.com/quote/ DBC/performance?p=DBC 87  ▪ You can also invest in all kinds of real estate other than your house and/or rental properties. Real Estate ▪ There are ways you can invest in industrial real estate, apartment buildings, storage units, warehouses, nursing homes, etc. ▪ Be careful not to invest “too” heavily in this asset class as you probably already have a significant portion of your net worth tied up in your house 88 which is real estate!  ▪ When it comes to bonds you can invest in many different types. Bonds ▪ You can read more about them in your textbook, or you do your own research. ▪ I’m not going to spend any class time on them as I REALLY don’t want to encourage young people to include them in your portfolio! 89  ▪ Corporate vs. Government Types of ▪ Short vs. Medium vs. Long Bonds Term ▪ Fixed Rate vs. Floating Rate ▪ High Yield vs. Low Risk ▪ Convertible vs. Conventional 90 ▪ Bla bla bla  ▪ Now when it comes to “stocks” there are different Stocks classes that we do need to learn more about. ▪ Don’t feel overwhelmed by this. It is easy enough to learn. ▪ I like to think of stocks in 3 91 major classifications.  How to Think Geography About Investing Growth vs. in Stocks Size Value 92  North America International Emerging Markets ▫ Canada ▫ Japan ▫ Taiwan Geography ▫ United States ▫ United Kingdom ▫ Thailand ▫ France ▫ South Africa - divide your ▫ Germany ▫ Brazil portfolio ▫ Australia ▫ South Korea into these ▫ Switzerland ▫ China The big U.S. three companies ▫ Spain ▫ India geographic (S&P 500) give ▫ Italy ▫ Malaysia you a lot of locations ▫ Hong Kong ▫ Poland indirect International ▫ Netherlands ▫ Russia exposure ▫ Etc. ▫ Mexico 93  An emerging market economy (EME) is defined as an economy with low to middle per capita income that is expected to grow rapidly. Such countries constitute approximately 80% of the global population, and represent about 20% of the world's economies. 94 95  “Size” of Company Classified by “Market Cap” 96  “Size” Classified by “Market Cap” y el at - divide your im ox portfolio into pr these three Ap (four) sizes 97  Growth vs. Value A growth stock is A value stock is a stock with a any share in a price that appears low relative - divide company that is to the company's financial anticipated to grow performance, as measured by your at a rate significantly such fundamentals as the portfolio above the average growth for company's revenue, dividends, yield, earnings and profit into both the market. margins. 98  Growth vs. Value You will pay the full You will (hopefully) pay below - divide “fair” price for this the “fair” price for this stock stock and hope to and hope to profit when the your profit by the future stock price recovers to its portfolio growth in the stock’s price. “fair value”. into both 99  RULES of THUMB (Historically) 1. Over a long period of time small company stocks have outperformed (grown faster) than large company stocks. “Small is better than large” 2. Over a long period of time value stocks have outperformed (achieved a higher return) than growth stocks. 102 “Value is better than growth”  The Rules are Changing? 1. Fama’s research became so famous, and turned out to be so correct, that a large portion of the market started buying “small” and “value”. 2. Once that started happening the “premium” an investor could get has been shrinking. 103 110 113 114 115  Is the 3 Factor Model Dead? It is too soon to say if the expected premium on both value and growth are shrinking? Disappearing? Or staying in place. It may seem hard to believe but 10 - 15 years just isn’t long enough to know. 116  Is the 3 Factor Model Dead? I suggest in your portfolio you have some of: U.S./Canada/Int’l/Emerging Markets Small, Mid and Large Cap Value & Growth 117 *You’ll see why in a few slides (buy ALL the boats) Asset Class Annualized Returns International Large Cap Stocks +9.0% i n ce S 6 198 International Large Value Stocks +11.4% International Small Cap Stocks +11.6% International Small Value Stocks +13.6% 118 https://seekingalpha.com/article/4041868-really-long-term-return-on-stocks Asset Class Annualized Returns Emerging Markets Large Cap Stocks +9.6% i n ce S 9 Emerging Markets Value Stocks +13.2% 198 Emerging Markets Small Cap Stocks +11.4% 119 https://seekingalpha.com/article/4041868-really-long-term-return-on-stocks  Canadian Index Annualized Returns Last 50 years +9.2% Last 20 years +7.8% Last 10 years +7.5% 120 https://www.taxtips.ca/stocksandbonds/investmentreturns.htm Canadian Index Annualized Returns U.S. Total Index Annualized Returns Last 20 years +7.8% Last 20 years +10.18% Last 10 years +7.5% Last 10 years +12.24% https://www.taxtips.ca/stocksandbonds/investmentreturns.htm https://www.portfoliovisualizer.com/backtest-asset-class- 121 allocation#analysisResults  Real Estate Investment Trusts It is tricky to find the long term rate of return for real estate because we need know what kind of real estate we are talking about…and in what country. “Generally” speaking the stats I’ve seen show you could historically expect to get between 9% and 11% long term by having a very broad-based real estate investment (we’ll talk about this 122 more next class)  ▪ From one year to the next some investments will go up and others will go down. ▪ Sometimes WAY up and WAY down! ▪ Let’s see what’s happened over the last 15 years. https://novelinvestor.com/asset-class-returns/ 123 124  The reason I think we should have all of these in our portfolio: ✓ U.S./Canada/Int’l/ Emerging Markets ✓ Small, Mid and Large Cap ✓ Value & Growth Is so we can gain benefits 125 from “rebalancing”. 126  Let’s do an example: Assume that on January 1, 2006 we invest $1,000 in each of the following: ▪ REITS, Int’l, Emerging Markets, U.S. Large Cap, and U.S. Small Cap. ▪ Remember that each has a very different annual 127 performance.  Scenario #1: Under Scenario #1 we will not buy or sell any of the investments to “rebalance”. We will simply let each asset class grow/shrink each year until the end of 2020. Let’s see the ending balances. 128  Scenario #1 – Without Rebalancing Asset Class Starting Total Ending Balance Return Balance International $1,000 207% $2,070 Emerging Markets $1,000 274% $2,737 REITs $1,000 282% $2,824 U.S. Small Cap $1,000 360% $3,604 U.S. Large Cap $1,000 411% $4,114 Totals 129 $5,000 307% $15,348  Scenario #2: Under Scenario #2 we will sell the asset classes that went up in value, and buy the ones that went down in value. This will rebalance so each asset class represents 20% of the total portfolio at the start of each year. 130 Let’s see the ending balances.  Scenario #1 – With Rebalancing Asset Class Starting Total Ending Balance Return Balance International $1,000 309% $3,086 Emerging Markets $1,000 338% $3,383 REITs $1,000 270% $2,705 U.S. Small Cap $1,000 342% $3,420 U.S. Large Cap $1,000 337% $3,374 Totals 131 $5,000 319% $15,968  Scenario #1 vs. Scenario #2 Asset Class Without With Rebalancing Rebalancing Difference International $2,070 $3,086 $1,016 Emerging Markets $2,737 $3,383 $ 646 REITs $2,824 $2,705 ($ 119) U.S. Small Cap $3,604 $3,420 ($ 184) U.S. Large Cap $4,114 $3,374 ($ 740) Totals 132 $15,349 $15,968 $ 619  Rebalancing “Rules” 1. Don’t rebalance more than once per year. 2. Rebalance with “new money” rather than selling if you like when your account is still small. 3. Remember that “buying low” is a good thing….even if it can 133 be hard to do.  Let’s take a historical look at what happens when we put the different “market caps” and “growth/value” together. It will also reinforce the “don’t get off the roller coaster” idea. 134 https://soundinvesting.com/wp-content/ uploads/2022/03/2-4-Fund-Equity- Returns-1928-2021-C.pdf 135 https://soundinvesting.com/wp-content/ uploads/2022/03/2-4-Fund-Equity- Returns-1928-2021-C.pdf 136 https://soundinvesting.com/wp-content/ uploads/2022/03/2-4-Fund-Equity- Returns-1928-2021-C.pdf  Expected Returns A lot of (older people) think I’m crazy to tell students about 10% returns. “They” may not have realized returns that high in their life. Why? Let’s see…. 138  Asset Historic Realized Weight Class Return Return 60% Stocks 10% 6% 40% Bonds 6.5% 2.6% Total 8.6% Fees (2.0%) 139 Realized 6.6%  My Personal Approach In my own portfolio I’ll be “ok” if I earn a long term rate of only 6%. I’ll be happy if I get 8%. I’ll be thrilled if I get 10% or more! I’ll show my actual numbers in a 140 coming class.  My Personal Approach I’ll show you the portfolio I use in a future class!