Happy June! I’m happy to be back blogging this month! I meant to get this post out sometime last week, but life gets in the way for all of us from time to time. I’ve known exactly what I wanted to blog about for this month for a while, but it’s tough to sit down and get your thoughts fleshed out on paper. I’m encouraged by the initial reaction to the blog site and my initial post. I’ve received so many positive comments and have heard from many people who are excited to learn more. I figured I would spend some time discussing stock fundamentals, and give you some additional insight into the investment style I choose for myself and for Nicholas Jr. (the two are different). So, let’s get started!

So, exactly what is a stock? I find many people look at the stock market as a way to make fast money, but how can one participate in the market if they don’t know the fundamentals of what a stock is? Stocks can be defined as securities that represent an ownership share in a company. For companies, issuing stock is a way to raise money to grow and invest in their business. For investors, stocks are a way to grow their money and outpace inflation over time. When you own the stock of a company, you are defined as a shareholder of that company. Shareholders participate in the growth of the company’s assets and earnings, over time. Simply put, as the company grows its profits, the shares of stock you own in that company grow in value as well. If you are a shareholder, you’re an owner! You own a piece of that company, and ownership (as stated in the “Our Story” portion of this blog), is a powerful mindset.

People make money by buying stocks in one of two ways. The first way is something called “Capital Appreciation” (also called Capital Gain). Capital Appreciation is defined as the difference between the average purchase price of the stock (also known as cost basis) and the sale price of the stock. Let’s use Disney as an example. Disney is currently trading at $141.65 per share. If I purchased 1 share of Disney at $100, I have a capital gain of $41.65. The percentage gain is calculated as ($141.65 – $100) / $100. This gives me an answer of 0.4165 or 41.65% gain on my investment. Most people focus on Capital Appreciation because it is the easiest way to calculate the growth on your investment. “Guess what bro? I bought Apple at $100 per share and sold it $200 per share.” This is the concept of Capital Appreciation in everyday conversation. It is the primary way that people make money on their stocks, but it is not the only way to make money.

The second way to make money off of stocks is through Dividend payments. Dividends are defined as a sum of money paid regularly (typically quarterly, meaning every 3 months) by a company to its shareholders out of its profits. Not all companies pay dividends, but typically more mature companies do. I will use Disney again as an example to show you how dividends work. Disney pays an annual dividend of $1.76 per share to Disney shareholders. So if I owned 10 shares of Disney, Disney would be pay me $17.60 ($1.76 multiplied by 10) per year just to own the stock. The concept of free money just to hold a stock is amazing to me! Now, admittedly $17.60 doesn’t seem like a lot of money to make from dividends, but let’s elevate the example. Bob Iger (Disney’s CEO) owns roughly 1 million shares of Disney stock. This means his shares are worth $141,650,000 (1 million shares multiplied by $141.65 (current price of Disney stock)). As a shareholder, Disney has to pay Iger $1.76 per share of Disney that he owns. This means Iger has an annual income of $1,760,000 from dividends alone! This doesn’t include his salary, bonuses, and other awards included in his CEO pay package. Imagine earning $1.7 million from doing nothing but just existing! Well this is how, conceptually, dividends work. Back to my original example….if I owned 10 shares, I would be paid $17.60 for doing absolutely nothing. This small amount of money adds up over time, and contributes to your total return. Imagine what this turns into 20, 30 years down the road. It’s just a snowball that gets bigger and bigger over time. Total return is defined is Capital Appreciation + Dividends. As mentioned elsewhere in the blog, the total return of the stock market for the last 100 years has been about 10% per year. Out of this 10% annual total return, I would say 7% is due to capital appreciation, and 3% is due to dividends. Dividends are in important part of the equation that people tend to overlook. It’s easy to overlook, because dividends aren’t sexy to talk about.

If you are an investor who is not retired (anybody generally under the age of 60), you should be reinvesting the dividends that you earn. Dividend reinvestment is the concept of using the dividends you receive to purchase more shares of stock in the company you are invested in. Reinvesting your dividends should be a no brainer for anybody reading this blog, because you don’t need the income at this point in life. In using our 10 shares of Disney example again, I would use the $17.60 of free money that I receive from Disney, to purchase more fractional shares of Disney. $17.60 would buy me 0.12 additional shares of Disney ($17.60/$141.65 = 0.12). Dividends should be seen as fuel to buy more shares of the company that you are invested in. All brokerages will reinvest your dividends for you, free of charge! You just have to ask them to do so.

Stocks can be categorized in the following ways:

  • Growth stocks have earnings growing at a faster rate than the market average. They rarely pay dividends and investors buy them in the hope of capital appreciation. A start-up technology company is likely to be a growth stock.
  • Income stocks pay dividends consistently. Investors buy them for the income they generate. An established utility company is likely to be an income stock.
  • Value stocks have a low price-to-earnings (PE) ratio, meaning they are cheaper to buy than stocks with a higher PE. Value stocks may be growth or income stocks, and their low PE ratio may reflect the fact that they have fallen out of favor with investors for some reason. People buy value stocks in the hope that the market has overreacted and that the stock’s price will rebound.
  • Blue-chip stocks are shares in large, well-known companies with a solid history of growth. They generally pay dividends.

I tend to invest in a mix of growth stocks, value stocks, and blue chip stocks for my portfolios. For Nicholas, I lean heavily towards growth stocks above all the others, because Nicholas has a 30+ year runway before he’ll need the money. This means I can swing for the fences and be very aggressive for him, because he’ll have the time to make it up should I make unintended mistakes. I truly swing for grand slams when investing for him. When investing for myself, I tend to try and hit singles and doubles. Sometimes I’ll swing for the home run, but I have to be more defensive because I’ll be retiring in about 20 years or so.

Ownership in stocks are also more beneficial for you from a tax perspective versus earning a salary. Salaried income is treated at the standard marginal tax rates. Marginal tax rates in 2019 range from 10% – 37%, depending upon what you earn. The capital gains tax rates are typically between 15% and 20%, assuming you hold the investment for more than a year. Back in 2013, Warren Buffett famously stated that he paid a lower tax rate than his secretary. How is this even possible for one of the Top 5 wealthiest people in the world? This is because the majority of Warren Buffet’s wealth comes from investment gains. Since he owns stocks (admittedly a lot of them) his capital gains tax rate caps out at 20%. Another recent example of why equity (participating in the ownership of a company) is important is what Jay-Z has accomplished. Jay-Z recently became the first rapper to become a billionaire, which is an amazing feat. How exactly did Jay get to a billion?

  • $310 million as controlling owner of Armand de Brignac (Ace of Spades) champagne
  • $220 million in cash and investments. He invested $2 million in Uber, and that stake is now worth $70 million
  • $100 million ownership stake in D’usse
  • $100 million ownership stake in Tidal
  • $75 million for his music catalog
  • $70 million art collection
  • $50 million in real estate

You’ll notice that less than 10% of his net worth is from his actual day job. Rap money for Jay is “only” worth $75 million. We all cannot be Jay-Z, but there is a powerful lesson here. Your day job is not going to make you wealthy. Your salary is not going to make you rich. Ownership and equity in companies is the only way to truly grow your wealth. Don’t be impressed when people talk about how much money they make from their jobs. This mentality what I call “first order thinking”. First order thinking is being satisfied with your annual salary, or your “rap money”. People like to quote these numbers to you, to make themselves feel more important. Second order thinking is understanding that ownership is the only thing that matters in building wealth. If you’re truly interested in building wealth, don’t just be satisfied with your annual salary. Focus on ownership! Focus on owning pieces of pieces of companies (stocks!) or real estate that will grow your wealth over time. Don’t just go watch the new Avengers movie or the new Lion King movie, be a Disney shareholder! Don’t just buy your favorite cup of Starbucks coffee every morning, own shares in Starbucks! Don’t just be a videogame player of NBA 2K, own shares of Take Two Interactive! Don’t just watch “Stranger Things” on Netflix, own shares of Netflix. Don’t just go grocery shopping at Kroger, be a shareholder of Kroger. Second order thinking understands that your salary should be a mechanism that is used to purchase ownership in assets that will appreciate over time. Be a second order thinker!

I hope this post gives you some insight into the basics of stocks. It’s not very fun to read some of the basics, because most people just want to know how to make the most amount of money in the quickest amount of time in the market. However, one must learn the basics of the game, before playing the game. Hopefully, you feel a little more comfortable with the terminology. I also hope you are more inspired to have an ownership mentality. Once this clicks, you will start observing how much money you waste on consuming “stuff”. Your consumption is contributing to the profits of all these companies, and only making the shareholders richer. Why not participate along with them???

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