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Dear Daily Crux reader, Investing for income doesn't have to be complicated. So says our friend and colleague, Dan Ferris. Dan is the editor of The 12% Letter, and he's an expert at finding the world's best dividend-paying stocks that can safely compound your wealth for years. Today, Dan shares four simple questions you can use to find quality income investments for yourself. They're not complicated, but don't let that fool you… These are the same questions he personally uses to uncover the elite "World Dominating Dividend Growers" he recommends to his paid subscribers. Read on for the details… Good investing, Justin Brill Managing Editor, The Daily Crux www.thedailycrux.com |
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The four simple questions to ask before you buy any dividend stock The Daily Crux: Dan, in a recent issue of your 12% Letter, you explained that there are four important questions you ask before choosing any potential recommendation. What are these questions… and why are they so important? Dan Ferris: Let's start with your second question first… Our mission at The 12% Letter is straightforward. We want to find our subscribers the best, safest stocks with solid streams of dividend income that grow year after year for many years. It really is that simple… but that also means we have to be extremely picky about the stocks we choose. One of the most important ways to ensure we stay true to that goal is to avoid risky stocks at all costs. There are four simple questions we use to help us do that. The first is: How does this business earn its revenue? It's a simple question, but probably the most important. We like companies that earn their revenue up front, in cash, from stable, unleveraged businesses. Wal-Mart is a great example. It's got cash pouring in 24 hours a day, seven days a week, 365 days a year, all over the world, through good times and bad. On the other hand, this means we tend to avoid investments in businesses that are highly cyclical or dependent on cheap debt and leverage. Crux: That makes sense. What's the second question? Ferris: The next question we ask is: What are the sources of sustainable cash flow growth? What we're looking for here is a company with a competitive advantage we expect to last for many years. It's the competitive advantage that keeps the excess cash flowing in, year after year. Again, I'll use Wal-Mart as an example. Wal-Mart is the biggest retailer in the world. It can offer more goods at lower prices because it buys the biggest volumes from its suppliers. Wal-Mart is better at pulling costs out of the retail supply chain and passing them along to customers than just about any other company in the world. These kinds of rock-solid, sustainable cash flows are a great sign that we've found a dividend stock we can compound our wealth in for years. ----------Advertisement--------- Why some gold investments could soon be worthless For the past 10 years, Porter Stansberry has been working to expose what he calls "the greatest scam in U.S. history." If you've invested in gold, you'll want to check this out. In this shocking presentation, Porter explains why any gold investments you may have could soon be worthless…Click here for the full details. --------------------------------- Crux: Question 3? Ferris: Question 3 is also related to growth: Is the company's dividend growth reliable? We ask two questions about growth because it's so important… buying a business with consistent growth is the most predictable way to compound your money over the long term. What's important to remember here is the source of dividend growth is profit-per-share growth. If profits don't grow, the dividend can't sustainably grow. This is related to the last question… because the first requirement for consistent profit growth is consistent cash flow growth. In addition to that, we like to see companies that buy back shares when they're cheap. Buying a company with a sustainable competitive advantage that buys back shares and reduces the share count is a hard combination to beat. That'll keep your dividend growing for as long as humanly possible. Crux: And the final question? Ferris: The last question is: What are the key business risks shareholders should understand? Assuming a company has made it past the first three questions, there are two primary risks we need to understand. The first key business risk is capital allocation… or more specifically, the risk that the company will make a bad acquisition or otherwise use its capital unwisely. We can't fully avoid this risk, but we can reduce it by studying the overall effects of a company's capital allocation. Sometimes, what's in the news is overstated. For example, Intel – a fantastic, cash-gushing business – bought security software firm McAfee for $7.7 billion. The deal was widely touted as a blunder at the time. But just recently, McAfee introduced a new network security system built on Intel hardware. McAfee has been building network intrusion prevention software for years… but this is the first time it's ever built it on Intel hardware. Networks run on servers. Intel has a 90% market share of computer chips for servers… So under Intel's roof, McAfee has access to much broader markets, a common phenomenon in a well-conceived acquisition or merger. Another big risk to every business is competition. We can reduce this risk by focusing on the very best businesses with incredible competitive advantages – the stocks I call "World Dominating Dividend Growers" (WDDGs). Buying WDDGs is the best way to mitigate the threat of new competition. Crux: Sounds good. Any parting thoughts? Ferris: Asking these four questions before you buy any income stock will make your investing life so much easier. Sure, you'll end up buying fewer stocks, but that's OK. Life is complicated enough. There's no reason to make it worse by buying businesses you don't understand. Stick to the world's best companies – "real" businesses that provide goods and services people want and that are unlikely to go out of style – and buy them when they're cheap. You'll simplify your life, sleep better at night, and do much better over the long run than folks who chase higher yields in riskier stocks. Crux: Thanks for talking with us again, Dan. Ferris: You're welcome. |
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