Steady Income Investments

Stocks likely have more downside ahead. But as Porter Stansberry notes, times like these can also lead to opportunities. Today’s essay is a reminder that when assets are trading at good prices, you want to have a wish list of stocks to own “forever.

By Porter Stansberry, founder, Stansberry Research

Most people think Warren Buffett became the richest investor in history – and one of the richest men in the world – because he bought the right “cheap” stocks.

Legions of professional investors tell their clients they’re “Dodd and Graham value investors… just like Warren Buffett.”

The truth of the matter is entirely different.

Until 1969, Buffett was a value investor, in the style of David Dodd and Benjamin Graham. That is, he bought stocks whose stock market capitalization was a fraction of their net assets. Buffett figured buying $1 bills for a quarter wasn’t a bad business. And it’s not.

I’ve written at length about buying stocks at “no risk” prices. But as Buffett learned, this is still only part of the equation.

It’s just as important to invest in safe stocks that can compound their earnings… for decades. Then you must do the truly hard thing – and never sell…

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Take beverage giant Coca-Cola (KO), for example.

Buffett bought his Coke stake between 1987 and 1989. It was a huge investment for him at the time, taking up about 60% of his portfolio. How could Buffett have known Coke would be a safe stock… and that it would turn into a great investment?

Well, like Einstein said famously about God, Buffett doesn’t roll dice. He only buys sure things.

Coke is a simple business. It made soda 100 years ago. It makes soda today. And it will be making soda in another 100 years. That’s the perfect setup for a business that can keep growing sales and profits… without growing its expenditures.

And judging by Coke’s previous marketing results and its expansion into new markets, its sales would also continue growing. As Buffett would tell you, it wasn’t that hard to figure out.

After he bought, other investors would bid up the shares to stupid levels. Coke was trading for more than 50 times earnings by 1998, for example. But Buffett never sold. It didn’t matter to him how overvalued the shares became, as long as the company kept raising the dividend.

In 2019, Coke paid out $1.60 in dividends per share. Adjusted for splits and dividends already paid, Buffett paid about $2 per share for his stock in 1988.

Thus, Coke’s annual dividend, 32 years later, now equals 80% of his total purchase price. Each year, he’s earning 80% of that investment – whether the stock goes up, or down.

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In his 1993 letter, Buffett wrote about his Coke investment and his approach – buying stable, capital-efficient companies with the intention of holding them forever so their compounding returns would make a fortune…

At Berkshire, we have no view of the future that dictates what businesses or industries we will enter. Indeed, we think it’s usually poison for a corporate giant’s shareholders if it embarks upon new ventures pursuant to some grand vision. We prefer instead to focus on the economic characteristics of businesses that we wish to own…

Is it really so difficult to conclude that Coca-Cola and Gillette possess far less business risk over the long term than, say, any computer company or retailer? Worldwide, Coke sells about 44% of all soft drinks, and Gillette has more than a 60% share (in value) of the blade market.

Leaving aside chewing gum, in which Wrigley is dominant, I know of no other significant businesses in which the leading company has long enjoyed such global power… The might of their brand names, the attributes of their products, and the strength of their distribution systems give them an enormous competitive advantage, setting up a protective moat around their economic castles.

Buffett is looking for companies that produce high annual returns when measured against the company’s asset base and require little additional capital. He is looking for a kind of financial magic – companies that can earn excess returns without requiring excess capital. He’s looking for companies that seem to grow richer every year without demanding continuing investment.

In short, the secret to Buffett’s approach is buying companies that produce huge returns on tangible assets without large annual capital expenditures. He calls this attribute “economic goodwill.” I call it “capital efficiency.”

These kinds of returns shouldn’t be possible in a rational, free market. Fortunately, people are not rational. They frequently pay absurdly high retail prices for products and services they love. Buffett explained how another of his holdings, See’s Candies, earned such high rates of return on its capital in his 1983 annual letter. In explaining See’s ability to consistently earn a high return on its assets (25% annually at the time, without any leverage), Buffett wrote…

It was a combination of intangible assets, particularly a pervasive favorable reputation with consumers based upon countless pleasant experiences they have had with both product and personnel.

Such a reputation creates a consumer franchise that allows the value of the product to the purchaser, rather than its production cost, to be the major determinant of selling price…

That’s the whole magic. When a company can maintain its prices and profit margins – because of the value placed on its product by the purchaser, rather than its production cost – that business can produce excess returns… returns that aren’t explainable by rational economics.

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Those, my friend, are exactly the kinds of companies you want to own.

Now… if it were that simple, we’d all be rich. Buying these kinds of stocks is actually extremely difficult because you rarely get the opportunity to buy them at a reasonable price, let alone a no-risk price.

That’s why I urge you to make a list of these kinds of companies… to determine the prices at which you can buy them on a no-risk basis… and then wait for your opportunity. Strive to buy the companies whose products and services you believe are most loved and most likely to be extremely long-lived. Try to acquire assets that your children’s children will never want to sell.

Set your family’s wealth on the path of compounding. In time, you can join the Rockefellers – but only if you never sell.

Stocks have further to fall before we see a bottom. But soon, the time will come to invest in great companies at fantastic values. In today’s essay, Porter Stansberry covers the exact steps you can take to buy stocks at “no risk” prices…

By Porter Stansberry, founder, Stansberry Research

Make sure you save a copy of this letter.

It’s a step-by-step, paint-by-numbers guide to making a fortune in stocks. No, I can’t promise that your investments will pan out as well as a few of mine have over the last few years. But I believe anyone is capable of becoming a world-class investor. You only need to know three things.

These are the things I know work – no matter what else is happening in the world or in the markets. Let me explain…

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Investing is a simple game.

The goal is to get the most in return for having given the least in exchange. Any serious study of this process will reveal just a few variables control the outcome.

First, the amount of capital employed is important. Thus, the cardinal rule is: Don’t lose money. Money lost cannot be invested. Money lost will not compound.

Second, time matters. The duration an investment may be held continuously with dividends reinvested is critical.

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And the third important factor is the rate of compound growth.

What’s funny about this list is how simple the game really is… and how few people pay any attention to the most basic rules. I doubt many subscribers consider these variables before they buy a stock. What most people consider is simply, “Will this stock go up? By how much? And when should I sell?”

The questions they should be asking are almost the complete opposite.

They should try to figure out…

1. How fast are these shares likely to compound, assuming I reinvest all of the dividends?

2. How long will I be able to hold this company safely?

3. And most important, what’s the most I can safely pay for this stock?

I share these ideas with a large amount of trepidation. These are not ideas that sell newsletters. You, gentle reader, may expect me to deliver the name of a stock that will surely double in the next month, then double again next year. Believe me, if it were that easy, I’d oblige. But the truth is a bit more complicated…

There’s one exception… one sure way to get rich. And that is to buy capital-efficient businesses that have long-lived products and are capable of increasing payouts year after year.

This approach is, without question, the best way to invest. It’s exactly the approach master investor Warren Buffett uses. But it’s difficult to explain. Worst of all… once you understand how it works, it’s just too simple.

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All you have to do is buy the kind of companies that require very little capital to operate and grow their businesses and therefore produce excess capital that they return to their owners (the shareholders). Then you reinvest that capital into more shares. Rinse and repeat. It’s not much harder than washing your hair.

And that means it’s boring. But the truth is, using this kind of a strategy over time will produce returns that dwarf the gains you’re likely to make speculating, even if you’re a great speculator.

Best of all, my approach, which is based on capital efficiency, is totally safe and requires almost zero effort. The whole trick lies in understanding which companies are capital-efficient and have good long-term prospects.

Once you know that… you only buy when you can get the shares at such a low price that they essentially carry no risk.

So how much should you pay for a stock like this, or any other long-term investment? This ends up being the most important variable, because the first rule of investing is “don’t lose money.” Remember… money you lose doesn’t compound.

Here’s an easy rule of thumb to use when trying to figure out a safe price to pay for a stock… Just figure out how much money it would take to buy back every share at the current market price and add in the total net debt of the company.

The number you’ll end up with is called “enterprise value.” That’s the figure it would cost (in theory) for the company to buy itself.

Next, just figure out if there’s any realistic way the company could afford to buy itself. Few companies actually go private this way… But bear with me. Imagine a company with an enterprise value of $15 billion. For the company to borrow this much money, it would have to afford roughly $1 billion a year in interest payments (assuming 7% interest).

If that’s more than its operating income… it can’t currently afford to buy itself. But if its operating income covers that amount, you’ve got yourself a winner. And your chances are better when shares are cheaper, of course – because this pushes down the enterprise value.

Doing this kind of analysis shows whether a company could realistically repay all of its debts and all of its shares. Assuming it can afford to do both, there’s no fundamental difference between the risk of its stock and the risk in its bonds – because all the bonds and shares could be repurchased.

And that means on a fundamental basis, you’re getting all the upside of the shares – all the upside of being an owner – with the same low risk of being a creditor.

I call this buying at a “no-risk” price. There’s no additional risk to buying the equity compared with the debt.

This is the best analysis to consider before you buy any stock – but especially one you’re buying to hold for the long term. You have to make sure you will be comfortable enough to wait for the payoff.

And the only way to do that is to buy capital-efficient companies… at good, safe prices.