No-Brainer Investments

Phew. Thank goodness the election is finally over. We can now get back to our regularly scheduled lives.

This election was a doozie. In the aftermath, pundits have pondered what it means for the markets. But regardless of what happens to the stock market and the economy in 2017 and beyond as a result of the presidential election, there’s one thing I know for sure:

By focusing on companies that pay you first…
you have a long-term advantage over the market.

Of course, that’s not as easily done as said. And that’s where I come in…

It’s no secret that management teams are highly incentivized to pad their pockets and put their interests ahead of yours. We also know that Wall Street is very focused on the short-term. Miss expectations for a given quarter and the stock price could get hammered. Disappoint investors often enough and you’re out of a job.

So CEOs and other executives often resort to accounting tricks to put lipsticks on their pig of a quarter. Keep the stock price aloft long enough and you can cash out of your stock options and protect yourself. What happens to investors left holding the bag isn’t their problem.

But…

Companies that pay you first actually perform much better than all the rest. Management is looking out for your best interests. And as a bonus, they benefit too by playing the long game and not getting sucked into Wall Street’s quarterly-earnings circus.

We call these companies at the top of the shareholder-friendly pyramid “Phase A” companies. In back testing (back to 2000), my research shows me that these Phase A companies have returned over 870%. That compares to a 26% return for the least shareholder-friendly companies.

Which would you prefer to be invested in?

It’s a no-brainer, right?

But how can these management teams pay you first?

To start, they can initiate and raise dividends. Since the early 1970s, companies that have a strong dividend policy have vastly out-performed all other stocks.

Then they can buy back stock. Buybacks have been a key driver of stock market returns in recent years. But, not all buybacks are created equal. While some management teams may reduce the share count as a prudent use of capital through buying stock at discount prices (these are the guys we’re after), others may buy back stock to make earnings per share look better.

As a forensic accountant, it’s my job to differentiate between the two.

Finally, they can pay down high-cost debt and swap it for low cost debt. Not all debt is a liability. It can be an asset if used to fund high return on capital projects. That may include returning cash to shareholders.

Key to all of this is that the quality of the earnings being reported is solid. Phase A companies not only pay you first, they don’t rely on accounting shenanigans to make their numbers look better on the surface.

It’s these companies’ stocks that you want in your investment portfolio. And it’s my job, as creator and editor of Hidden Profits to find them for you.

I do this by running prospective companies through six tests, including the quality of revenue and cash flow, to determine what the sustainable earnings are for the company. Of course, it’s much more complicated than that, so I’ve prepared a presentation for you to explain it all in more detail. This will be ready for you tomorrow, so watch out for it.

For now, I’ll help solidify the idea of a Phase A company for you by way of an example. One of my most recent favorites has these following characteristics:

  • It’s managed by one of the greatest capital allocators of all-time with a 40-year track record of delivering huge returns to investors (I’m not talking about Warren Buffett here).
  • The company is a consumer media enterprise that gushes cash flow. This allows management to buy back massive amounts of stock.
  • The valuation is attractive and I used a recent sell off to snap up shares at discount prices for Hidden Profit
  • And the CEO has made attractive acquisitions at fair prices. This has broadened the demographic reach of the products and services he sells.

As you can see, researching and locating Phase A companies requires a level-headed look at the numbers. There’s a lot of static when it comes to earnings reports and PR misdirection, but we continue to look past all that in search of hard truths.

As the public and the markets continue to react to the election in panicked and unpredictable ways, this approach is even more critical than ever. Through the chaos we can continue to grow our wealth confidently, one step at a time.

John_Sig

 

 

 

 

John

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Categories: Investing

About Author

In 2007, John Del Vecchio managed a short only portfolio for Ranger Alternatives, L.P. which was later converted into the AdvisorShares Ranger Equity Bear ETF in 2011. Mr. Del Vecchio also launched an earnings quality index used for the Forensic Accounting ETF. He is the co-author of What's Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. Previously, he worked for renowned forensic accountant Dr. Howard Schilit, as well as short seller David Tice.