So, what is your answer?
Is it a ‘Yes, the price of a stock is a reflection of a stock’s ability to make money.’ or is it a ‘No, stock prices tend to move independently from stock profits.’. Or, is it a combination of the two where you believe that the stock price is a weighing machine for the long-term for it does reflect on stock profits but it is essentially a voting machine in the short-term?
Your answer to the above will determine what you will do in the stock market.
For instance, if your answer is ‘No’, it is likely you are buying or selling stocks for trading gains in the short-term and would not be reading their financial reports. But, if your answer is either a yes or a combination of the ‘weighting and voting machine’ as stated above, you would likely be the one reading financial reports.
In most cases, the above question often reveals the questioner’s belief on what he believes about the stock market.
To me, the key thing he likes to ask is this, ‘Would I enjoy capital appreciation, if I buy stocks based on its fundamentals?’ So, the focus is still on stock prices and not really much on business ownerships. A person who fixes his eyes on stock prices when buying or selling stocks would deemed a good stock to be one that has risen in prices after buying it and a bad stock to be one that had dropped in prices after buying it.
If that is his focus, he will tend to:
a. Find stocks that he thinks will go up in stock prices.
b. The faster, the better. After all, why wait when you can get it fast?
c. Believe that fundamental investing doesn’t work or it is just too slow.
As a result, it is very likely that he will ask for stock tips, rumours, and advises in pursuit of quick capital gains. It won’t be a surprise to find them wanting to flip real estate in 2015, buy Bitcoins in 2017, and glove stocks in 2020. Please, here, I’m not saying that buying them is wrong. But rather, I like to point out a critical mindset that is shared by this group of people.
Take glove stocks as an example (for it is the flavour of the year 2020). For most of these people, what do you think is their reason for buying glove stocks?
a. Is it to genuinely own shares of glove manufacturing companies?
b. Is it to chase for quick capital gains as the wind now is on these companies?
I don’t intend to tell anyone what they should with their stocks. But indeed, it is my intention to point out the differences in mindset between people who has a habit of chasing the wind and people who has a plan to build, nurture and grow wealth sustainably for the long-term.
One is into stocks for fast money. (Capital Gains)
The other sees stocks as assets that earn income for the long-term. (Yield)
So, what is my take?
Personally, I view stocks the same like real estate. They can generate income for investors for a long time. As such, the value of a stock or a property or any type of investments would be based on their income-generating ability over the long term. Here is an analogy. Let’s assume that we have a property that we can buy at a price of RM 200,000.
The property is a small apartment located in a matured neighbourhood and the apartment is tenanted for RM 1,000 a month or RM 12,000 a year. If the tenant is to vacate the property in the future, no worries. This apartment can be easily tenanted as the rental demand in the neighbourhood is healthy.
So, would you buy?
Well, if you do, you are essentially earning a gross rental yield of 6% a year.
Now, let’s say, over time, you can raise the rent by RM 100 a month once in two years. So, you will receive RM 1,100 per month in rental income in Year 3-4, RM 1,200 per month in Year 5-6, RM 1,300 per month in Year 7-8 and RM 1,400 per month in Year 9-10. Finally, in Year 11, you earn RM 1,500 in rental income on a monthly basis or RM 18,000 a year in annual rent.
Your gross rental yield would rise to 9% per annum as tabulated below:
Question: ‘Will your property by then be valued at RM 200,000, the price which you originally paid for?’
Obviously not. Why? This is because, at Year 11, if a new investor likes to earn a 6% gross rental yield by buying over your property, he would offer RM 300,000 to buy over your property to collect RM 1,500 a month.
New Buyer’s Gross Rental Yield
= (RM 1,500 x 12 months / New Buyer’s Offer Price)
= (RM 18,000 / RM 300,000)
So, in essence, if a stock had built a track record of delivering consistent growth in sales, profits, cash flows and dividend payouts to shareholders, its value shall be revalued upwards as the stock’s business becomes more valuable. To me, I’ll focus on the qualities of the stock and make sure they are invested at relatively cheap prices, the capital gains will take care of themselves as stocks with a rock solid track record in their fundamentals are always demanded, particularly cash rich long-term investors, which include pension funds, mutual funds, sovereign wealth funds, insurers … etc.
To me, the focus is on ‘cash flow’ and let both the ups and downs of prices take care of themselves.
But, the question is, ‘What if the stock price dropped after I buy it?’
Well, let’s go back to the small apartment. If, along the way as you continuously receive your rental income, the owner of a neighbouring unit decides to sell off his at RM 180,000. What would you do? Will you:
a. Immediately put up your apartment unit and sell it for RM 180,000?
b. Keep your unit and just continue to collect your rental income?
c. Buy over the owner’s unit, rent it out and thus, lifting your rental income?
Most real estate investors would opt for ‘c’ if they have the money. Even if they don’t, they will find ways to raise money to buy over the unit.
So, let’s try that with stocks. If you find a stock that pays rising dividends for the past ten years where its last dividends per share (DPS) is 50 sen and you bought it for RM 10.00 a share, it then dropped to RM 9.00 a share. So, would you:
a. Sell it off at RM 9.00?
b. Keep yours and continue to collect 50 sen in DPS per annum?
c. Buy more shares of that stock at RM 9.00?
As you can see, if you are to view stocks like properties, you will make decisions that are objective and logical. You will be less influenced by emotions like greed and fear which often clouded one’s investment decisions.
Here is one thing that I would like to point out on investing.
It is not investing in properties work and stock investing doesn’t work.
Nor, it is not property investing is better than stock investing.
Nor, it is that stocks are riskier than properties.
It is not about the investment. It is all about the investor, his skill and mindset.
For instance, a cash flow investor can invest in both stocks and real estates with the same mindset. He accumulates stocks for dividends and properties for rent. He likes to buy stocks and properties if they are undervalued. He would value a stock based on dividend yields and value a property based on rental yields. Can you see that his mindset is the same when investing in stocks and properties?
So, it is the investor, not the investments.
Likewise, a speculator can buy both stocks and real estates with a similar aim of wanting to make a quick buck. A speculator wants to ‘goreng’ stocks for a faster capital gain. He may want to buy a property to flip it for fast money. He is prone to buy anything that will go in prices quickly for he has little patience.
As such, what makes investing work for the long-term?
Ultimately, the answer is you, the investor, not the stocks, properties, unit trust or … etc.
It is true that you have a better chance of attaining higher returns, if you gained more knowledge, education and experiences in investing. Beginner’s luck could take you only so far and if you are not careful, it is detrimental to your portfolio especially if you think that you are invincible.
So, what’s my message here?
There are three:
a. If you want to invest in stocks, focus on business ownership, not stock prices.
b. Focus on cash flows, the key to valuing a stock or a property.
c. Learn to grow your investment returns over the long-term.
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