Yesterday I picked up 100 shares of Power Corporation of Canada (POW on TSX). Power Corp owns mostly insurance companies and a few financials like IGM, and it looks like a rock-solid company with a strong history of annual dividend increases.
I also acquired my first share of Berkshire Hathaway Class B (BRK.B). I'm pretty excited about that!
I was thinking the other day about what makes a person wealthy. It came to me that true wealth has little do with how much money you have, but is more a function of certain characteristics that wealthy people share.
I prepare hundreds of income tax returns every year, from all sorts of different people and a wide variety of economic backgrounds. A tax return is a little snapshot of somebody's life–after you do enough of them it becomes pretty obvious who the wealthy people are and why.
Here are six characteristics that I've come to believe are essential to wealth. Without them you will never be wealthy, no matter how much money you have. With them you can't help but become wealthy. In fact: you already are!
Wealthy people file all their tax returns on time and pay any balances owing by the due dates. If they are required to make estimated tax payments throughout the year, they make those payments on time.
A lot of the money that wealthy people earn is passive income from investments or rental properties. Passive income is taxed more favorably by both the United States and Canada, making it easier for them to pay on time.
Wealthy people are not usually employees. If they work in an occupation of some kind, they are more likely to be self-employed than employed.
Employees almost always have a great deal of difficulty keeping their heads above water. The tax system is set up to gouge them as much as possible, and since their income depends on the number of hours worked (always a limited resource), they can never quite catch up. It's not impossible for employees to get wealthy, just really, really hard. Many people can't do it.
Since they aren't struggling with cash flow problems from spending more than they earn, wealthy people have time to stop and smell the roses. They walk more, are less likely to have heart attacks from overwork, and have fewer medical expenses to worry about.
The extra money that wealthy people have every month from spending less than they earn is invested in income producing assets such as dividend-paying stocks, high-yield interest bearing investments, rental properties, or other assets. They only invest in assets that produce positive cash flow, and they don't bail out of those assets if the market value goes temporarily south, unless a better investment comes along.
It really is true that you can create more wealth for yourself by giving. I can't explain how or why this happens–it just does!
Everybody knows how important this is, but how many people get caught up in the rat race and forget?
The Dividend Guy Blog
"One guy's journey to passive income through dividend investing."
Dividends Matter
"Everyone else gets paid. Why shouldn't you?"
Living Off Dividends
"Make your money work hard, so you don't have to."
Dividends4Life
"Dedicated to the process of identifying superior dividend investments..."
Stingy Investor
Norm Rothery's blog has good information on picking undervalued Canadian stocks.
Million Dollar Journey
"The making of a millionaire–a Canadian personal finance blog."
LongLeaf Partners Funds
I like to read their quarterly and annual reports.
Warren Buffett Letters to Shareholders
Words from the greatest investor of all time.
In the last post I wrote out my notes after reading Robert Miles' book Warren Buffet Wealth. One of the recommendations in the book is that you come up with your own investment philosophy. Rather than blindly following the Buffet principles, you should adapt them to your own situation, taking into account the kind of investor you are.
Warren Buffet wealth comes from investments that produce cash flow, which for him–as the outright owner of a business–means business profits that flow right into his pocket. Smaller shareholders are advised to consider Earnings per Share to be a form of "look-through" earnings that will reward them in the long term with appreciating stock prices.
Buffet doesn't seem to be that concerned with dividends, perhaps because of the potential for double taxation in the United States. In Canada where I live double taxation of dividends isn't much of an issue, due to the Dividend Tax Credit mechanism in the tax system. Here then is a difference between me and Mr. Buffet: I believe that dividends are more important as an investment goal. EPS should of course be used to evaluate the strength and prospects of a company, but beyond that, a company should pay good dividends to compensate me for taking a risk on their stock.
I intend to invest for cash flow, looking for solid Canadian companies with good dividend yields. Dividends should compensate for risk by exceeding GIC rates. If a stock is generating good dividends for me, I won't sell it unless something better comes along.
My strategy is to estimate future dividend yields and EPS with the tools available at RBC Action Direct, then figure out what price I would pay today for those future earnings. I set up an Excel spreadsheet that calculates Present Value based on future estimates. I plunk the numbers into the spreadsheet and use it to compare PV between different companies, and to see how much I will pay for the company's assets.
It's hard to find the perfect investment according to Buffet criteria, so I enter positions a little at a time, expect the worse, and always keep some cash in reserve.
Recently I read Warren Buffet Wealth by Robert Miles. I liked this book a lot because the concepts were relatively easy to understand, and I can imagine ways to implement them using the tools at my disposal. Here are some notes from the book.
Stick with what you understand. Look for old-economy products that are needed by families. The average founding year of a Buffet company is 1909.
Determine what the company will earn over the next 10 years and discount that to today's Present Value (PV). There should be demonstrated, consistent earnings: future projections are meaningless.
Buy companies with shares priced at a discount to their intrinsic value. Buy for less than you think it is worth.
Some Buffet definitions:
Think like a business owner, not a market trader. Buying an entire company or a piece of a company are almost the same thing, so look for similar criteria. The main difference is that when you own only a share, you benefit from "look-through" earnings (LTE) rather than actual earnings.
LTE is less tangible than actual earnings but ultimately pays off with renewed financial strength of company and increased dividends. When LTE goes up, EPS goes up. Potential look-through earnings (LTE = #shares x EPS)
Buy $1 of assets for $.50 (or even $.40), or $1 of annual earnings (look-through) for $1. Look at the asset worth of a company and its outstanding stock value. Divide stock value into asset value (its "beta").
Other considerations:
The minimum holding period of any stock should be at least three years. Ten years is even better. Don't invest unless you can watch market value decline by 50% with equanimity.
Don't lose capital. Given the previous note, I take this to mean "don't sell at a loss."
Make twenty investment decisions over a lifetime.
Ignore the crowd. Don't fall for the obvious, and don't be in a hurry. If it's too good to be true it probably is.
Forget age-based allocation, and don't diversify. Buy a few companies that you understand. Stick to local stocks. Become a satisfied customer of the company first.
Buy a lot of a few, concentrated amounts of stock. Choose companies you know something about that have good financial statements. Have the courage to put 10-40% of net worth in one stock.
Always spend less than income! Track your investment performance with book value, not market value.
Visit the business, talk to management, count how many customers are on the premises, and come up with your own estimate of annual earnings. Read everything you can about the business. Do the research and think about it. (On the other hand, he also says to not get bogged down in too much information, or paralysis by analysis.)
Look for management buying back shares (adds value to existing shares). Look for management that owns stock in its own ventures. Look for CEOs who admit their errors.
Stock splits are meaningless. All they do is increase brokerage sales commissions.
Businesses need a durable competitive advantage. Invest in the right industry. Don't buy if it can be outsourced to Asia.
Work only with people you like, trust, and admire!
B. Graham and D. Dodd - Security Analysis
B. Graham - The Intelligent Investor
R. Miles - 101 Reasons to Own the World's Greatest Investment
Northern Soundings
Music for Trombone by Canadian Composers
Bedlam in Bethlehem
Christmas with the Pacific Trombone Quartet
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