This is an investment book for millennials
If you're looking for this book you're probably interested in investing strategies for millennial (as per the title of this ebook).
Patrick (author of the book) made the case that most millennials don't take advantage of their youth, by not making early investments in the stock market.
how early should you invest?
Well as soon as you have regular income. So around age 22-25.
Why start investing early though? Because of compounding effect.
What should millennial investors invest in?
According to the book, millennial investors should invest in the stock market in 3 broad categories:
1) Market indexes
A market index is a metric that tracks the performance of a group of stock.
The companies that make it to the list usually have large market value.
An example is the [S&P500], (https://en.wikipedia.org/wiki/S%26P_500_Index) which tracks 500 large companies listed in the US stock exchange (NYSE or NASDAQ).
By investing in market indexes, Patrick is referring to index funds (also called index ETFs, or market index mutual fund).
“An index fund seeks to match the return of the paper index by buying all the same stocks in the same quantities as the paper portfolio.”
For a small fee, ideally 0.09% - 0.2% of your account value per year, you can own a piece of these companies.
Index funds is a good starting point for millennial investors if you've not been exposed to the stock market before.
**Note: ** Investors tend to favor companies in their home country, since they are more familiar with them. Millennial money suggest you should do the opposite and find great international companies.
2) Alternative or "smart" Indexes
Instead of buying the biggest companies (market index), you should buy the cheapest or best value companies that you can build a portfolio with to crush the market.
Index funds that track these companies are called Smart Indexes or Smart Index funds.
4 strategies that Smart Index funds pursue:
This strategy buys stock in each sector with the best momentum over the previous year. Momentum being the acceleration of a stock's price.
Note from author: To measure momentum, I use 3-month, 6-month, and 9-month total return, and 12-month return volatility. These four factors are equally weighted to determine an overall momentum score.
This is the investing equivalent of Newton's first law of motion, stocks in motion tend to remain in motion.
This strategy buy stocks in each sector with the highest shareholder yield. I.e stocks that have returned the most cash to shareholders.
Companies have two ways to return cash to shareholders. They can pay a regular dividend (one to four times per year) or they can repurchase stock from shareholders.
When you buy shares of a company, you are placing your money in the hands of the company’s managers.
These managers are stewards of your money, and the best stewards are those that send cash back to their shareholders.
This strategy buys the stock from each sector that has the lowest volatility over the past year.
Volatility is calculated as the standard deviation of the last twelve monthly total returns.
Like the market momentum strategy, this is based on market movement.
Low-volatility strategies are great for investors worried about risk, as they do very well in markets that are crashing.
Highest quality earnings
This strategy buys stocks with the higest quality earnings.
Earnings quality is defined as (net income – operating cash flow) / market capitalization.
The long-term goal for any company is to earn significant profits, which it can use to reinvest or pay out to shareholders.
But profits vary in quality; they can come from real cash flows, or they can be “created” by corporate managers to make quarterly reports look better than they really are.
So index funds pursuing this strategy will look for companies with strong cash flows.
3) Individual stock
The strategy for picking individual stock is very similar to smart index, that the companies you invest in should:
1) Have shareholder friendly practices (pay dividends, buy back shares, and pay down their debt)
Look for companies with large negative “financing” cash flows relative to their overall market value.
Negative financing cash flows result when companies pay dividends, repurchase shares, or pay down debt (they are negative because cash is leaving the company).
Positive financing cash flows result when companies borrow from creditors or sell new equity shares to the market. ”
2) Earn strong returns on their investments (companies invest in machines, people and research and should earn a good return on these investments)
We can evaluate the returns earned by companies uding a measurement called "return on invested capital"
Return on invested capital defined as operating income divided by invested capital (book value of equity + book value of debt – cash).
3) Have high-quality earnings (strong cash flows)
many investors are fixated on company reported earnings as an indication of company success where they should really be looking at cash flow.
It's because earnings can be made higher than it actually is through accounting whereas cash flow is much harder to fake, and therefore a more reliable indicator of success.
4) Are cheap (attractive price versus their earnings, cash flows, etc.)
Investing in cheap stocks can be somewhat of a contrary investment, becaue stocks that are cheap at any given moment is associated with gloom and doom, otherwise why would it be so cheap?
The cheapest stocks are the ones the market has the lowest expectation for in the future.
Although, you can still pick diamonds in the rough when you have addtional evidence that the market has got it wrong and the stock is a good investment.
By evaluating the stock based on
- price-to-cash flow ratio
especially cash flow.
There are 2 types of price-to-cash flow valuation:
Price-to-operating cash flow: Price divided by the cash generated from the normal business activities of a company
Enterprise value-to-Free cash flow:
Enterprise value, similar to takeover value of the company = market value of equity + book value of debt – cash
Free cash flow is operating cash flow minus any spending on property, equipment, land, and other investments.
This free cash flow is what is left over even after the company makes the required investments to maintain and grow the business.
The goal is to pay the lowest possible price to cash flow generated by the company.
In the stock market, the less you pay, the more you will earn.
5) Have improving market expectations (improving price trends)
Identifying price-to-cashflow helps us decide what to buy, but timing is crucial as well.
As value stocks are cheap for a reason remember, and the market won't start loving them again anytime soon.
So how we will decide when to buy is to use the momentum (price movement) of the stock.
Look for 6-month momentum.
This is a stock’s total return over the past six months. Total return includes any dividends paid by the company during the six-month period and any change in price.
For example, if Google’s stock price was $1,000 six months ago and has risen to $1,200 today, then Google’s stock return was 20 percent over the past six months assuming it didn’t pay any dividends.
If it had paid dividends, then its return would have been even higher.
Buying stocks with strong recent returns has worked extremely well—it helps us find stocks that the market is starting to notice.
The millennial investor's checklist
One rule for each of the factors discussed above:
- Stakeholder yield is greater than 5 percent
- Return on invested capital is greater than 30 percent
- Operating cash flow is greater than reported profits (earnings quality)
- Enterprise-value-to-free cash flow is less than 10 times
- Six-month momentum in the top three-quarters of the market”
Implementing the Millennial Money strategy
The simplest way to get started to start searching/filtering stocks (in market that you prefer) that pass the checklist above.
A few resources mentioned in the book:
- American Association of Individual Investors (AAII) - which will list the stocks that are currently passing the Millennial Money checklist.
- www.portfolio123.com - easy-to-use screening tools
- Yahoo Finance (Free)
- The bloodhound system - Premium, for larger accounts
Then open a brokerage account and buy the stock in equal amount of each stock passing the checklist.
So if there are 20 stocks, you'd invest 5 percent of your portfolio in each.
You can then rebalance your portfolio (buying more of or selling these stocks based on performance) once a year.
Note: Be very conscious of the fee you're paying, whether or not you're buying on your own or through an index fund, there will be charges involved (trading fees, management fees etc). Even 0.25 percent can make a huge difference in return compounded over long period of time.
Compare annual results for the company (profits, sales, cash flows) to its current market price. Investors should pay as little as possible for every dollar of profits or sales a company is producing.