Sure Dividend

Member's Area

SIP002: Andrew Sather on Financial Statement Analysis

In this episode, I interview, Andrew Sather, the Founding Publisher of einvestingforbeginners.com and the Sather Research eLetter.

Andrew is passionate about helping educate individual investors and helping them to avoid common mistakes in the stock market. He’s also a gifted analyst of financial statements, which is a major focus of this episode.

Full Transcript Below

Nick: so I thought we could just start by talking a little bit about you know who you are and what your place in the world of investing is.

Andrew: yep my name is Andrew I’ve been investing since 2012 basically I started out and I was just brand new to the whole world of investing. I didn’t really see any step-by-step guide so I kind of shot from the hip for a while and just tried to kind of glean different lessons as I could from different blogs and websites.

The whole it didn’t really catch on until I started to really dig into some of the best books that are out there. There’s books Warren Buffett has recommended here’s other books that a lot of other investors wrote – you could get their track records and look at as hedge fund managers or general fund managers like. Guys like Buffett who invest as part of his company and he owns that company like Berkshire Hathaway. A lot of these books and so I just happen to stumble into those, and I was able to take those lessons I was learning and since I didn’t see any sort of step-by-step guide to investing.

I ended up starting a blog myself and kind of just tracking my progress and trying to teach as I went and so as I was teaching it really helps solidify the things I was learning and that’s where I’m kind of at today.

So it started out as a blog it progressed into a podcast, and now I’m blown into trying to help people understand the most basic parts of the stock market. Basically understanding that we look at something like the stock market it’s not a bunch of numbers on the screen it’s not brokers coming at each other and big heads on TV making these clips of audio that they’re just so catchy and sounds so dramatic.

Really what’s behind the stock market is it’s a collection of businesses and when you look at a stock as not buying the stock, but I’m actually buying into ownership of a business. Then you can really start to understand how to move how to make the sorts of decisions that an owner would make and you can take and really apply it to your portfolio.

I really believe that’s something like investing I look at a lot of different you know you look at the investing world so many options you can do real estate you can do you know crypto is a huge thing nowadays you have like insurance products and all these types of assets that you can really purchase. I found for my myself, what I prefer and how I like to really stay passive I don’t want to have to deal with contractors and real estate repairs even though it might be very lucrative.

And at the same time, I also try to structure my portfolio so that I’m always getting an income. That’s huge to me when we talk about investing is a steady stream of income once you get income that creates compound interest and that really grows your money in a really big way.

In ways that’s a lot more reliable than being a genius, we have a crystal ball, and we’re able to predict exactly which stock which company or which assets we’re going to grow.

That’s I really try to take these big picture concepts and a lot of the things that are you kind of have to dig into the books a little bit and it can kind of make the average person maybe gloss over it. So I try to really keep things as simple as possible and explain it so that whenever somebody’s listening to what I am talking about that, they can really understand it conceptually.

I think I’m making that first step how am I going to understand the stock market once you get that momentum going then you can really start the great results in the market you’re not going to jump into the market and expect to be somebody who’s going to make fantastic returns overnight, it’s a process it’s an education, and it’s really investing in yourself and it’s an investment that’s going to last for the rest of your life.

In order to get there you really need some like quick wins you need any quick concepts, and you need to let those skills grow, and so really that’s everything I’ve tried to do online that’s everything I do with my own personal investments and it’s something that I hope anybody who’s listening that I can help them with that.

Nick: so you mentioned that you started investing back in 2012 what made you start being interested in the stock market and investing in general and how would you say that your philosophy has evolved over time?

Andrew: so I was fortunate in the sense I really stumbled into it. I got a great entrance my first job, and I happen to have one of my co-workers there, and he started really introducing me to this world he talked about things like dollar cost averaging and diversification and long-term investing.

So that’s really what kind of piqued my interest I know you might hear a lot of people who say they wish they could have started early. Obviously, I wish I started when I was in my teens but you know it is what it is and so the big moment for me was seeing him pull into the parking lot at our other work and pulled up in a brand new Corvette.

I knew he had you know several other cars as well I was like wow that’s really cool he’s like “yeah I just I sold some stock, and I was able to get to have this Corvette”. So that really like fired me up, and I was like wow like you can actually make serious money from the stock market you don’t have to be this guy who’s living on Wall Street you know on the trading floor. These are everyday people who are making money in the stock market so that really kind of kicked me off and got me going and my personality is once I get into something I kind of go 110%.

I have an engineering brain, I come from an engineering background, numbers just speak volumes, and I’m able to look at them and understand what a picture numbers are telling me so I got into that whole numbers side of investing really early. I found an approach that really reflects looking at a business as a set of numbers and underpinning that one exists post their numbers they are telling you how well the business is doing.

So it’s a very objective way of looking and really getting very good evidence on how a business is doing.

That’s basically how I got into Benjamin Graham and value investing, and it’s basically finding great businesses and in them when they’re cheaper than normal, and that’s the approach I’ve taken.

I have a lot of various differences so it’s like I’ll learn these concepts and really master them and then take my own unique approach to it I think everybody has their own unique investing approach. I tend to be very heavily focused on dividends. I only buy a stock that’s paid a dividend and I also always want to buy a stock that is trading at a discount to intrinsic value and the way I evaluate intrinsic value is not something I’ve ever heard anybody else say.

That’s the kind of stuff where I also not only learn from books and other great resources but I also did some research on my own and tried to analyze a bunch of companies. It’s like that as I went along and I looked at whether some things and whether some numbers that companies show when they’re about to do very well what do they show when they’re about to poorly or go bankrupt and from there kind of crafted an approach to where I am buying.

Dave and I talked about this on the podcast all the time I’m buying with a margin of safety with an emphasis on the safety. Warren Buffett talks about his two rules to investing, right? Rule number one is don’t lose money, rule number two is don’t forget rule number one.

I take a very similar approach in a different way, and it’s just basically looking at the numbers looking at what businesses are telling me about how healthy they are and they’re moving forward and building a portfolio of as many of these great businesses as I can and just trying to hang on for the long term.

Nick: now you mentioned that when you started your website and started investing, in general, you read all sorts of investing books and then compiled the knowledge from these books into your website.

With that said, what are your favorite investing books and which ones would you say I’ve had the most outsized impact on you?

Andrew: I think the obvious ones the Intelligent Investor that is the one Benjamin Graham written by Benjamin Graham he is Warren Buffett’s mentor and he had a ton of students that ended up becoming they even dubbed him the Super Investors of Graham and Doddsville because these guys all were able to outperform the market do fantastically well. It’s really when you talk about somebody who says they’re in value investor likely they have read that book and consider it one of the greats.

I also liked A Random Walk Down Wall Street. That book’s more geared towards index testers and talking about why indexing is a good solution for a lot of investors. I loved it because it really laid out a lot of different approaches that you could take to the stock market.

So while I obviously it’s a favorite that had a bit of a bias it still told a good story about what the different options are so you could look you know if like charts and technical analysis tends to be something that kind of jumps out to you as something that speaks to you and you understand the logic behind it.

A Random Walk Down Wall Street presented that as one of your options and presented a lot of the different strategies, so I really like that just from a general investing standpoint.

And I like from a personal finance standpoint The Richest Man in Babylon, it’s like six or five dollar book, and you could literally knock it out in like an hour. I think it’s so critical that you in order to start running you got to learn how to walk and in order to become good at investing you got to make sure you have your finances in order. So that was a really great book for me that put everything into perspective.

Obviously, there’s a ton, and it’s hard to narrow it down, but I would say that those would be probably my big three that I really enjoyed.

Nick: one of the key principles of The Intelligent Investor and it’s something that you touched on earlier in your discussion as well is to buy stocks when they’re trading at a discount to their intrinsic value or in other words to buy them with a margin of safety.

Now the trouble there is that sometimes stocks are trading on a discount for their intrinsic value and they go lower and lower, and it turns out you may have been wrong about their intrinsic value.

So how do you determine whether a stock is a value trap or whether it’s an actual bargain stock that should generate solid returns going forward?

Andrew: yeah I love that question the whole idea of don’t try to catch a falling knife right. So what I did because I understood intuitively I’m going to be charmed by stocks that are if they’re at a discount to intrinsic value that means that the stock market doesn’t view them as favorably as maybe as usual or as truly as the other stocks and the other options that are out there.

You want to be a true value investor you’re going to have to be a contrarian that’s first, and foremost understanding that and then you have to understand there’s there could be several reasons why stocks undervalued. Either a stock is undervalued because yes actually the business is failing, or a stock could be undervalued just because maybe I had a short-term hiccup or maybe it had something that negatively looks bad near future. But in the long term, it might still have a very great business model.

I did some research and I went back because I wanted to see you know everybody talks about how much money can I make everybody talks about the big stocks and the big gainers you know the Amazons and the Netflix’s and all these stocks the Google’s the ones that have just created crazy amounts of money right.

But nobody talks about the losers, and so I kind of flipped it took a backwards approach I went back and since I’m really big with numbers and I loved plugging things into a spreadsheet. I went back, and I took the 30 biggest bankruptcies of the 21st century and I literally just plugged all of those numbers manually into my spreadsheet, and I looked at every major metric on their financial statements.

What I found was that when a company a company that is likely to fail probably has negative earnings. That was that was actually my biggest finding was that the vast majority of these stocks looked at had negative earnings either the year before they went bankrupt or several years before they went bankrupt. When I started to look at stocks trading at discounts to my intrinsic value, I understood that I’m want to stay away from because if this is a common characteristic why do I need to put that into my approach why do I need to buy stocks that have negative earnings it just kind of makes sense.

The other thing I really saw was there seemed to be a correlation a lot of the stocks ended up going bankrupt had really high debt levels and what I kind of saw was a the higher the debt level, the more likely a company was to go bankrupt. And sometimes you’d see this over a several year period you would see the debt maybe look okay and I use a debt that’s the equity ratio that’s how I evaluate this.

But maybe one year it’s okay, and then it starts to rise and that and then it really gets high, and that’s where things can be very troublesome and it’s if the company that’s showing you symptoms of a failing business model and so it’s really just understanding what those what those failings are and then simply avoiding them.

And so those are the big ones that I’ve seen you know a company can have declining earnings, and it can have you know maybe lower cash flows things like that. But to really have like a year of negative earnings or a really high debt increase or both combined I see those are serious issues and so by avoiding those I really avoid a lot of the downsides to picking up these bargain stocks.

Nick: and to get that information do you go directly to the source like the company’s financial statements or do you use a separate data provider?

Andrew: yeah so nowadays I use, and it’s funny because you know in this day and age I hardly ever remembers anything so I haven’t saved as an as a bookmark on my computer right.

It’s either an ADVFN or an ADFVN I can’t remember which one of these that one pulls the information from the financial documents on SEC.gov I tend to use that when I’m sifting through a lot of different companies why not picking stocks today. When I went back and did this research on the history of these different stocks that’s when I went straight to the source so I can ignore potential mistakes on the data.

Plus a lot of these companies that are bankrupt now they don’t show up on a lot of these information providers so if you’re trying to do research, kind of like a backtest, almost but in my case, it’s more manual.

I was kind of having it at Google and pull up the financial statements in that way and not able to use like a data provider but I do like ADVFN I like to use like stock screeners like FINVIZ but obviously going straight from the source is ideal if you can spare the time.

Nick: you mentioned a lot of the key metrics that you look at when doing financial statement analysis. Now obviously those come from not just the income statement, but the balance sheet and the statement of cash flows as well.

Would you say that there’s a particular financial statement that you tend to emphasize more when doing your due diligence?

Andrew: I definitely emphasize the balance sheet and the income statement, not so much the cash flow statement. A lot of investors will look at the cash flow statement I see nothing wrong with that, but I prefer to keep things as simple as I can really.

When I look at something like the balance sheet what a bounce she is telling me is how the long-term health of a business is really performing. So if you think about business in the simplest sense, you have a business, and it has assets what you want those assets to do is to create cash and create revenues and create profits.

So when you have assets, you can create profits. As you grow your assets, then you’re likely to be able to grow your profits as well yeah shrinking assets it becomes harder and harder to create growing revenues and growing profits.

It really starts in the balance sheet, in my opinion, you can find some really great deals by buying stocks that are trading in the discount to their assets that’s who their equity it’s also called book value in the investing world. There’s a lot of great discounts there, but at the same time, you also want to ensure that the assets that the company has are profitable.

You want to make sure that they are efficient and creating profits because at the end of the day it’s all about profits why do we buy businesses is because they create profits those profits can spin off dividends to investors we can take those dividends to reinvest them and create more wealth for ourselves and then as the business continues to grow and continues to make more and more earnings buy more assets to create more earnings.

We have this like compounding force and this compounding ball of wealth that’s being created for everybody who’s involved, and you’re not going to see that if a company is failing on the income side.

We talked to the fallen knife and the debt to equity that’s where the balance she also comes in so I really stress making sure that there’s not too many liabilities enough assets to cover any liabilities that they might have and that really tells me the health of a company, and it really helps me become confident because I can see it’s numbers on the screen you can’t fudge those numbers. I can intuitively tell a difference between there’s a company with a lot of assets even if even if earnings are decreased for a little bit. We still have a big base of assets that are going to create earnings in the future.

Compared to a company that maybe their earnings are really growing rather fast we but if we have so many liabilities that they are picking up then all it takes is one bad year where they’re going to have to sell off a lot of assets or take on even more debt or if interest rates go up and this company has a ton of debt. Now they’re not going to be able to borrow the same levels that they used to so now they’re not going to be able to earn as much as they used to what do you think is going to happen to the stock price there.

These are the type of things you want to keep in mind but really am the balance sheet and the income statement are a one-two punch it’s a really crucial duo and you need both sides and really won’t look at financial statement I want to make sure all three financial statements are at least deep into my liking.

When I look at a cash flow statement I just make sure that a company has enough cash at the end of the year and what that balance does it helps a company stay afloat in the case that they have a year bad earnings.

Cash’ end of year is kind of like looking at your checking account and seen that you have enough money to cover your bills it’s the same kind of concepts.

My company doesn’t have a lot of cash I call it net cash and that’s debatable you know some of these metrics can kind of be veiled in way but I make sure that there’s enough there because I don’t want to see a company borrow a lot just to stay afloat when times come so to me that’s very important as well as the balance sheet and income statement.

But definitely I’m putting a lot of emphasis on the balance sheet because that’s get on the foundation and once that solid all the other things usually fall in place you just got to make sure that okay it seems like for the most part these things are falling in place.

Nick: now earlier you mentioned the importance that you place on dividends and creating an income stream with your portfolio.

What’s your opinion on dividend payments versus share buybacks as a method to return capital to investors?

Andrew: I’m kind of against the grain on this one. I have a lot of things I follow kind of straight to the book this is one of those where I’m kind of on an island as far as my kind of thinking on this, and it is a bit controversial.

I understand the whole idea of from a return perspective it’s essentially the same thing to an investor whether they are buying back shares or whether they’re paying out a dividend. I understand the lure of buying back shares in the sense that its beneficial tax-wise usually for the company and for the investor got that.

But for me I I look at it as who’s really who’s really holding the power here if a company is your dividend I’m receiving that money and I can choose the whether I want to put it back in the business or if I want to put it in another opportunity right so if a cutting stock that you own is it’s extremely a very highly valued and you maybe don’t want to add shares to that position. Well, then I would prefer to at least have the option to put that somewhere else.

for me really the biggest thing though if I can keep it in the most simplest of terms is when I buy a dividend I’m sorry when I’m paying a dividend, and I reinvest it every time I get that dividend, and I buy more shares.

The amount of shares I’m holding is in the case of a buyback you’re not getting any more shares the company is getting less diluted that’s that is true, and so your ownership percentage is growing. But the actual physical amount of shares that you’re getting is not changing at all and so what we have to understand when we look at stocks in the stock market is that the price of the stock is always going to fluctuate.

Even in the most ideal situation where you buy a stock that’s discount earns intrinsic value you’re holding it for a long time period maybe decades even if you’re fortunate and it’s a good company. There’s not going to be it’s not going to be perfectly straight line it’s not going to always go up. There’s going to be inevitable ups and downs though Wow what I see when I see share buybacks is that it’s very short-term and I see the number of shares of the company has outstanding as something that could be in flux right like we don’t know like they could buy back shares this year and then two years down the road dilute the shares again.

And then outs up we’re back at square one whereas when I receive a dividend, I know that that’s always one hundred percent money that I mean there are instances where it is good for neither buy back shares like when the companies and their value it’s a great way for them to allocate capital.

But I there always needs to be dividends paid so that the investor that’s how you’re really going to compound your wealth over time is by growing your holdings and you do that by reinvesting dividends.

I know it’s kind of against the grain in a way but over a long term and an odd take guaranteed return over something that can fluctuate over time so that’s really why I’m if you’re the give me option A or option B I would take a dividend all day long.

Nick: good to know. Now speaking of dividends what are your thoughts on using like a dividend discount model as a valuation technique?

Andrew: yeah I know so I’ve learned a little bit about it my co-host Dave actually uses it very well. I see value in it, but I also have my own intrinsic value calculations, and so it doesn’t for me it’s like I gotta pick one or the other and so I use my own intrinsic value calculations when I’m buying stocks.

I do see a lot of value in it though, and I think it’s it’s a good tool for somebody who wants to try to evaluate whether our stock is a good purchase or not.

Nick: yeah we’ve talked a lot so far on this episode about when to buy a stock what are the signals that a stock when its financial health is in order and when it’s undervalued and when it’s trading in a margin of safety those are all signs that you should buy a stock.

What do you think are the major signs that you should sell a stock that you already own?

Andrew: well for me you know I’m an I’m a younger guy I’m and still in my late 20s, so my holding period is hopefully going to be for multiple decades. really if you look at some of the best stocks and some of the best returns that you that I’ve been possible in the stock market for the past 20 30 40 50 years it’s really these stocks that have been able to grow dividends over a long time and the big portion of investors returns happen from reinvesting dividends.

In my most ideal situation, I’m never selling and I’m continuing to collect dividends when you collect dividends and when they are reinvested what you’re essentially getting is a higher term for its yield on cost. So you’re gonna get a higher yield on cost with each year that you reinvest a dividend.

I’m hoping to invest for financial freedom to me financial freedom means having an income stream without having to see my nest egg shrink. So if I can build up a portfolio of a bunch of companies that are that have really given me a high yield on cost. I can I can pull a really big income, and they can continue to compound and see the share price grow over time, and that’s just going to be like an unending well of wealth right.

That’s ideal, but you have to understand. Obviously, they’re we’re talking about the real world here, and a lot of businesses are going to not work out in the way that I would ideally like.

The way I structure my portfolio is I split it up into two segments I have what I call a dividend fortress segment which is the stock I am hoping to hold for forever and then I have a regular portfolio section.

For the dividend, fortress is I am holding on you know no matter what happens to the stock price unless I see negative earnings unless I see a substantial increase in the debt to equity or if they cut the dividend completely. I understand not every company’s going to be able to grow their dividend every year, so if they’re not growing it, that’s fine for me. But the second that they say that they’re not healthy enough to pay a dividend whatsoever I’m out like this is my money and I can pick how like out what scale of a gamble I want to take.

And to me it doesn’t make sense to invest in businesses even though they might recover if they’re giving you huge red flags like not being able to turn a profit not being able to pay a dividend these are these are huge basic things that you can find so many stocks that are able to do this even during a recession even during a bear market.

It just makes no sense to have my money freely tossed in the wind to maybe work out or not so that really where I’m selling the different fortress.

I’m also a value investor, so I really like to like you said by the margin of safety with a discount to its intrinsic value. When I’m really targeting them these stocks are working down, I understand that maybe these stocks aren’t so much dividend plays as they are capital gains plays or share appreciation plays. And so with those, I said 25 percent is trailing stop and it to me it’s loose enough to where it still gives a company that’s maybe not being perceived well by the market it gives it some sort of a chance to recover, but it’s also not going to completely wipe me out.

In the most ideal scenario, I’m picking up stocks their trading at discounts intrinsic value what what’s great about dividends and what’s the downside to trying to buy dividend fortress’s as I call them is that I’m not always going to have great dividend opportunity all the time. Especially in this day and age with a lot of focus and the chase for yield with the low-interest rates and a lot of dividend stocks being bid up.

Even though a stock my paygrade dividend if you get in at a terrible and very expensive price it’s going to be hard to see that capital grow regardless if they’re able to keep the dividend up or not so I play on the value investing side I play with these trailing stops and then when I see a good dividend opportunity I’m rolling a lot of those positions into a dividend fortress and then just sitting on that hopeful for several decades.

This approach I take and what’s nice about attaching trailing stops to the intrinsic value in terms of value because picks is that I never have to guess when I want to sell it’s like you know you can have so much of a back and forth like man I should have held on because it just continues to skyrocket or I should have got out because it was so overvalued.

You can play that guessing game all day long for the rest of your investing career or you can just set an easy rule that says you know what I’m going to let the winners run and then once they run out of gas they fall 95 percent and I’m going to sell out and then when it comes to the dividend side I have a significant part of my portfolio that I’m going to ride out no matter what, and it’s going to ride out any market any bear market and I’m just going to continue to collect dividends continue to increase my yield on cost continue to increase the amount of and kind of my receiving every year and that’s kind of how I approach the buy side and the sell side.

Nick: giving your focus on dividends and income do you own any MLPs or REITs?

Andrew: so at this time I don’t I had a REIT for a while and did fairly decently for me that was one of the more regular positions where I had a trailing stop, and I sold out that a profit. it for me it’s like I like what they’re doing and I like the idea of having like for a REIT, for example, you you’re they’re required to pay out a certain percentage of their earnings I think that can be a fantastic opportunity and I really think it depends on the timing.

it’s just the way that I’ve been investing so far I haven’t particularly seen one that I want to hold forever, so I haven’t added it as a dividend fortress in this time. But I mean the options always there and I don’t discriminate in that way I analyze them like I would a regular stock. So if they’re giving me those financials that say it’s a green light and I’ll shoot no matter if it’s an MLP REIT or otherwise.

Nick: just thinking about today’s stock market now you know MLPs and REITs are something that sure dividend seizes an opportunity right now they’re kind of hammered in today’s you know in a rising interest rate environment. They’ve gone down quite a bit of yields are higher than they normally happen and you know what the crash in oil price is energy MLP is, in particular, are attractive. So you know as a segue from the discussion of MLPs and REITs what opportunities are you seeing in today’s stock market?

Andrew: l love the question. I’ve been burned in the past year because I really try to time a bottom in retail and that just did not work out for me I had some stocks I stopped out on where you know some of them actually did rebound like I thought they would but I was too early, and they continued to crash, and then I stopped out. Had some others where the stock price is yet to recover really I’m the way even today with all the different things that been going on each one of my picks has been in a different industry I tend to pick a lot of these unknowns.

I call them like the backbone of America it’s a lot of these stocks that you don’t hear in the day-to-day sometimes they’re b2b business models sometimes they’re just such small stocks you know I like to play and though let’s say 1.5 to like 10 billion dollar market cap range.

Again it’s I might ride really hard not to focus on a particular industry, and it tends to be what the numbers are telling me where I’m finding discounts to intrinsic value. And so while I might see for example you mentioned oil there’s a lot of energy companies out there that seem to be a good value right now. I’ve been burned with those as well, but I’m not discriminating against any industry I’m going to find stars that are undervalued, so a big thing to that I look for I haven’t mentioned this yet is I really want to see long-term growth.

Being that I’m picking up on more and more and kind of nothing I’m not buying undervalue socks like I was before these stocks are still in their value but I’m putting maybe less of a focus on being super discounted and more so having great long-term growth. And so what that’s been doing for my pics lately is it’s kind of been spreading them out in a sense and I’m not concentrating in one industry or another.

The way I kind of look at valuation is again like another contrarian which where a lot of people like to focus on metrics, and I love metrics I use stock screeners I’ve screen out for particular metrics, and I have my rules. I might bend the filters a little bit here, and there it’s evolved and then to react to what’s going on in the market but when I look at something that I want to say it’s undervalued I’m looking from a big-picture perspective. It’s going to be like for example a stock that has a PB under two and it has PB of like 0.5 I’m not going to go crazy happy about the PB at being a point 5 I’m just happy that’s below a 3 because also the price to sales and the price to earnings and the price to cash are around where I want to see him.

And then that second component the growth that I’m talking about that’s also extremely important I want to make sure that in the past decade it really been growing. Back to the balance sheet you know is that shareholders equity is really growing I feel like that’s not talked about enough on Wall Street. Everybody talks about earnings growth but what about shareholders equity? We’re not going to have earnings growth sustainable earnings growth unless the assets are growing and so you know a company can cut costs all day long, but at some point, they’re whittling to the bone and if you’re not we shareholders equity that’s essentially what the company is doing to continue growth.

And so I’m making sure that my growth numbers are there and then my valuation metrics are reasonable but not necessarily like the most discounted.

I think to answer your question I think that’s really why I haven’t been cherry-picking a lot of different industries because I’m not going for what’s cheapest now. I’m going for what’s reasonable with great growth, and so that’s really kept my horizons really broad and has opened up a lot of different opportunities, and I guess we’ll see how that plays out.

Nick: your comments are interesting because you know in today’s stock market at least until today there was like a 5% drop in the S&P 500 today. But uh you know until today many of the companies with spectacular growth records have been training at valuation multiples that are far above their normal ranges so you know with that in mind what are your thoughts on the current market valuations and do you think that valuation contraction could be a big issue for investors from this point forward?

Andrew: I think it’s always a potential problem for investors and that I think its scary right I want to be 100% clear when I’m talking about companies with great track records of growth. Valuation is extremely important still like I’ll give you an example the stock I just recommended for my newsletter in February. On Wall Street like the growth as far as from a short term it wasn’t anything spectacular we’re not talking about like a like an Amazon that’s quadrupling revenues or anything like that.

But you know good earnings growth, and when I see over a long very long time period I liked a little 10 years, so I think that gave me kind of like a horizon look compared to what the rest of Wall Street’s looking at. And so I’m still able to like that stock pick price the sales of around 2 price-to-book around 2 price to earnings maybe around 20 ish.

We’re talking about like you compare it to the rest of the market it’s still objectively undervalued that’s kind of where I like to play just to give you a sense of what I’m talking about when I talk about growth and value. You can talk about things like the Shiller PE believe last I checked those around 32. The median P/E right now is around the 26 28 something along that range.

So you know the thing is like everybody wants to predict and because we have this very short-term memory, we can remember that 2008 was so devastating and that the the bull market leading up to that was not high.

If you really look historically in compare the 80s the seventies like and then you compare like the one we had from 2000 to 2007 it’s not that long, and you can define bull markets in so many different ways. Basically the way I see it is yes it’s is historically overvalued is it overvalued to such a point where I think it’s going to implode tomorrow maybe I don’t know not necessarily.

I mean I think this bull market could reasonably go on for another ten years look at interest rates right. there if you look at interest rates since the 60s or 70s there we’ve had interest rates below 1% before so even though the media wants to talk about you know I know a lot of finance people who are way smarter than me like to talk about the government debt and the zero interest rates and all those types of things.

But we have had interest rates below 1% before him we have had very high rise in interest rates, and the market has in the past its reacted, and in the future it will definitely react as well, but that’s the thing we’re all speculating and because we saw what happened in 2008 you could argue on one side of the coin you could argue that we’re all kind of pricing that in and so maybe we’re not as exuberant as it was and say 2007 or 2008 at because some stocks are still very reasonably priced.

You can also argue the other side of the coin and look at things like crypto and talk about how those are just historic bubbles that we’ve seen crazy amounts of cash go into those you can go either way and so I don’t like to make a stance to say it’s one way or the other, but I think it really is crucial if you look at stocks that have been very highly valued. You look at the the dot-com stocks you look at real estate when it was when it was that it’s bubble.

History has shown us time and time again that high evaluation is never sustainable I love the example of Microsoft because I think it’s one of those companies where you look at it today right it’s so prominent it’s such a big company and so many people use it, it’s been a cash flow machine all these sorts of things fantastic company.

But when it was trading in the in the year 1999-2000 it had a p/e around 50 or 60 it took it 17 years about to actually get back to the same market cap it had back in 99 and 2000. in the same time frame, the S&P doubled or something in that range.

So you’re talking about huge losses for investors who invested in a fantastic company but because and care so much about valuation they didn’t get to see the kind of returns that everybody else saw when the market recovered. So that’s the type of things this Microsoft case that’s not an isolated incident this has been shown time and time again look at Cisco look at you know you can pull up countless examples.

and so it’s so important that even though the market might be overvalued as a whole you want to make sure that your own individual stock picks aren’t so that way your drawdown going to be less I mean that’s just assume when it comes out to your you’re going to have less drawdowns when the market inevitably goes from irrationally exuberant to more pessimistic that’s just that’s just what history’s shown us, and that’s just the way that stock my stock market pricing works and that’s the way evaluation works.

Nick: so you when market valuations are above their historical averages like their today your recommendation is just to find pockets of value so that if valuations do contract your portfolio will not be as affected?

Andrew: essentially yeah and again I take somewhat of a contrarian approach in the sense I like to be a hundred percent invested all the time. I think a lot of that has to do again with my age you know if you’re looking at retiring in ten years it doesn’t make sense to listen to what I’m saying because you’re going to have a completely different end goal and you’re going to have a completely different timeframe for when things can recover.

For me, I dollar-cost averaging I’m always putting consistent amount of money in the market every single month and want to I want my stocks to make dividends. I don’t want to miss out from any of that, so I’m always a hundred percent invested and so yes I’m going to try to find these pockets of value and to this day like so I have a my intrinsic value calculator if you want to call it that I call it the Value Trap Indicator to this I’m still finding stocks that are strong buys on the value trap indicator.

In the case where that’s not where that’s not feasible anymore I might change my view, but as of now, I’m having no problems I’m finding plenty and plenty of pockets of value where I can pull the trigger and pick up a stock here and there.

so I’m definitely you know even if I’m selling them I’m constantly reinvesting and getting back in the market, so I just understanding that you know if you look at the S&P; 500 as a whole.

Example its market weighted, so that means that stocks with higher market caps are going to affect the index more. That also means that the stocks that become bubbles the ones that become very overvalued those are going to be the ones that push up the S&P; to higher and higher levels.

When you look at investors like Warren Buffett, who seems every time that there’s a big bull market people like to laugh at them because they’re like well okay you’re not in tech stocks you’re losing an old man like you’re under you’re underperforming the market.

These narratives they never go away and it’s because he’s kind of doing the similar thing I mean I don’t know where this portfolio is exactly but I know he does have a large portion of it still in the market and he has done that for decades, and it’s worked very well for him because when valuations finally dropped to their historical norms. He doesn’t see the same type of drawbacks that somebody who maybe was an indexer and had higher waiting on the overvalued stocks might have had. Or somebody who really went crazy about the tech stocks.

So yes I find pockets of value there might not be as discounted or as much of a bargain stock as I like but they’re still reasonably valued reasonably these valuations are still reasonable when you compare it to what the average is out there and historically as well so as long as everything’s kind of behaving in that sense and I’m getting the growth then that’s where I’m going to be pulling the trigger.

Nick: what are your thoughts on diversification more specifically how many stocks in an ideal world should an individual investor hold?

Andrew: so I’ve seen a couple different books they talk about anything the twenty one it starts to get saturated, and you start to mimic what the market does so I tend to try to say 15 to 20.

What gets complicated is a when your dollar cost averaging you’re not going to be perfectly weighted in every position. So the reason why I like to make the example that anybody can make a portfolio with just $150 a month.

I really like to talk to the average investor somebody who’s just our everyday worker going to the office or going to work construction wherever that may be right. I have a portfolio I’m personally funding and I put 150 dollars a month in it so if you kind of extrapolate that out through the years all right year one month one we have $150 in year one we have $1,500 a year two we have $3,000 so each month that you’re putting in those dollar cost averaging them out that 150s is becoming a smaller and smaller percentage of the portfolio.

So I think when people talk about 15 to 20 stocks if they’re not mentioning dollar cost averaging when they’re talking about diversification they’re kind of missing like half the discussion.

When somebody says 15 to 20 stars what that really needs to say is 5 to let’s say seven and a half percent position sizing that’s really what we’re essentially talking about that’s one thing that technical analysis does get right as they talk about position sizing very intently.

I think the question won’t become let’s make sure we try to get position sizing of around five to seven percent and try to keep it in that way.

The thing is though like because I talked about I talked about how I see certain dividend president or dividend opportunities and I really want to pounce on them. I’ve historically had stocks where I’m fifteen the twenty percent concentrated in them making big bets.

And it’s something that’s constantly evolving because my portfolio is constantly growing right, so it’s really not an easy answer I’m sure you wanted to hear, but I think in general you want to think anything above twenty stocks now you’re talking about four percent position size three percent two percent one percent. You’re really going to get close to the market average with that, and you’re really going to lose the diversification benefits in the sense that you might as well define index.

At the same time, you might not want to be so invested that you can see let’s say ten percent of your portfolio disappear overnight right that that might be something where a stock goes bankrupt, and you lose you don’t want to lose ten twenty eight twenty five percent your portfolio.

But I think if you’re confident, and you have certain opportunities that you know are just going to be better than something that you might see in the next year or two. I like to kind of pick my spots and get higher concentrations. But in general, I’m going to be somewhere around that five to seven to maybe ten percent concentration range,

Nick: now just to wrap things up I was curious if you had one piece of advice for a beginning investor today what would it be?

Andrew: that’s a good question and uh I love it. I just answered one to somebody recently online, so I’ll break it down this way he’s like let’s say you’re starting out as a beginner and you wish you could tell yourself three things.

These are the three things that I would say I would say number one that you know I wish I would have done myself number one don’t forget growth when you’re searching for value that’s so key already touched on that today,

Number two make sure you get into investing books and you start reading right away if you don’t feel like you have a confident grip on investing that and you’re really wasting time by not digging into these books because you’re going to reach a point where you start to see the investing books that everybody recommends and they start to really kind of parrot themselves, and that becomes a good thing because now you’re able to see that some of these principles are really timeless and a lot of people have practiced them and seen them to success, and you can see that for yourself.

I think I am NOT spent reading especially in the beginning I think is a big opportunity I’m even today like I’ll just read kind of when I’m in like a reading mood but when I first started I definitely tried to read as much as possible and so you kind of just have to get over that hump and really dedicate yourself but it can be so financially rewarding, and it’s something you can take with you for the rest of your life.

So I highly recommend it, and then the last thing I would say is it’s something I also said earlier is don’t try to time a bottom. I don’t necessarily go chasing momentum, but at the same time, it’s really hard for a stock to turn even if it might be a great value when the Wall Street hates it so. not to say that maybe I want to bought some of the stocks I did but I’m a more cognizant now about trying to understand that wall you know if the stocks it by its it’s a good buy and so if I weigh a couple months for it to kind of bottom out level I’ll maybe start a little bit of an uptrend. I really missing out that button the big picture.

Those are some of the I guess the three big things I would really try to tell somebody who’s just getting started that those are things that I’ve seen in my own experience that have proven to stand out above everything else.

Nick: awesome well thanks so much for taking some time to talk with us on the podcast today and we look forward to having you back.

Andrew: yeah thanks, Nick it would be great to come back I do have been on my own podcast it was I believe episode 7 so if you guys want to this was a fantastic discussion we talked to them as we talked volume it.

That my podcast is the investing for beginners podcast also investing for beginners calm, we have chill nuts there as well, and that’s kind of where I’m at on if you want to find me.