Read an Excerpt
COMPOUND YIELD
The Investors Edge in a Traders World
By Robert K. Naguszewski AuthorHouse
Copyright © 2012 Robert K. Naguszewski
All right reserved. ISBN: 978-1-4772-9459-8
Chapter One
Compound Yield
Compound Yield is the term I adapted to crystallize what we are trying to accomplish by this strategy. Effective use of this strategy is straightforward, clear, and truly simple. Even so, it is not appropriate for everyone. It is specifically designed for those who have lost money in the market, have had real skin in the game, and have lost confidence in mutual funds and fund managers. It is for people who have always charted their own course, have gotten kicked in the gut, and have gotten back up again. It is for us, because I am one of those people. For those who expect to be taken care of by the government, unions, or any entity that promises unfair and unreasonable benefits coming off someone else's back, this is not for you. You've not earned the right to be at this table.
Compound Yield, operationally, is a strategy that combines high-yield investing with safe trading to progressively produce increasing income. It is an active strategy that, once clear in the user's mind, can be adjusted to suit individual needs. It is flexible and can be used exclusively or collaboratively with other strategies. For me, the strategy evolved out of my need to secure a retirement that a traditional 401K could not likely produce. This book is a complete description of what I've been able to do in collaboration with my present brokerage firm for my rollover 401K IRA.
Fundamental assumptions of a Compound Yield investor that must be understood:
- We are income investors who focus on yield. Yield is the priority.
- Stock fundamentals are significant to secure confident payment of dividends and much less important in predicting price movement.
- Price movement depends much more on trading/being gamed.
- Yield investing takes advantage of "loans" to companies/ stocks in which neither the principal nor the interest return is fixed. This leads to incredible possibilities as an investor. Because we focus on the relationship between the two, mental paradigm shifting allows maximum return.
- The only thing real is income/dividends paid or capital gain actualized. Changes in dividend payments occur much more slowly than share-price movement. This allows capture of profits in volatility without sacrificing income for profits.
- Allows/provides a plan to enhance yield (income per share price) continually.
- Supercharged process leads to compound yield.
Basic Concept Structure Outline
I hope that what I'm about to discuss will start to change how you look at investing in today's markets. By bringing key elements to attention, we can begin to see how a buy and hold strategy can be optimized to increase income and capitalize on capital gain.
- Find high-yield stocks, preferably with yields greater than 5 percent. Various sources are available. My preferred resources are listed at the end of this book.
- Determine that fundamentals are strong enough to pay the dividend and hopefully increase it over time. These are standard parameters easily available on trading sites. I use a simple E*TRADE account.
- Enter position based on yield and not where the stock price may be in its trading range.
- Trading behavior depends solely on trying to increase yield on the shares held. When shares increase in value, sell enough of that stock to capture profits. The whole position is not sold. By doing this, yield is preserved on the remaining shares held. If the share price drops, yield is increased by buying down into that stock. This dollar cost averages share prices and pushes up yield.
- Size the position. For a million-dollar portfolio, I've chosen $25,000. Where share prices climb, sell enough shares to stay around $25,000. I've chosen this because this was my circumstance. After twenty-three years of sacrifice to save $30,000 to $40,000 annually, my return/growth was a paltry 1 to 2 percent. When share prices go up, sell to stay around $25,000. When they go down, buy to pull back up to $25,000. The $25,000 position amounts to 2.5 percent of the portfolio and is what should be used to guide smaller or larger portfolios.
- Therefore, buy only into declining prices and sell into rising prices. Never (or almost) buy into rising share prices for any given stock. Buying into rising prices reduces yield. We are yield investors. It is important to remember that income/ yield is investing. It is the only thing real. Capital gain/capital loss is trading, not investing. We are income investors first and foremost, and we are special ones at that, because we are Compound Yield investors. Buying into rising stock prices essentially is resetting the position to a lower yield. This is the opposite of being a yield compounder.
- Capital gain is money on the table not being used. It looks good on paper, but it's not doing any work for us. Capital gain can only work for us if we sell it to make income. We use capital gain/profits to buy down into declining price positions to increase yield on that holding. We are supercharging our portfolio by taking profits off the table and putting them to work for us. Capital gain left too long on the table will be taken by traders. On a day-to-day basis, stock prices rise and fall on trading and not fundamentals. Again, fundamentals are to secure that the dividend continues to be paid. We decided what yield we were satisfied with when we entered the position. If the stock price goes up, this is gravy. Sell the profit and put it to work elsewhere. By adhering to these rules, we always preserve or increase yield.
- Buying into rising prices is counterproductive because doing so resets the position to a lower yield. Think twice. Be sure you really want to do that.
- The magic is that we compound our yield by taking profits (free-trade money) to buy more shares of a declined position. The odds should be high that our declined stock continues to pay and hopefully increases its dividend because we bought stocks that met our fundamental criteria.
- We can also use free trades to open new positions in different sectors to broaden our portfolio—diversify. Again, we are interested in buying high-yield stocks with very good fundamentals.
- Trading—again, we are investors. Compound yield is, however, our edge in a trader's market, and we never lose on a trade. We know the outcome before we take a trade, that is, capital gain/profit. We take the proceeds from our trades to invest, adhering to the plan. Eventually, great fundamentals get noticed by the market and share prices rise consequently. This gives us the opportunity to do our kind of trading again and again.
We concentrate on high-yield stocks and build yield. Our money isn't sitting around doing nothing. It's earning interest and dividends. We're making a decent return even while little or nothing may be happening to the stock price of any given holding. A growth stock can't do this for us. I consider a low-dividend or no-dividend stock a growth stock. These are the stocks traded for the hope of capital gain. These stocks do not meet investment criteria here.
For a trade to occur, there must be a buyer and a seller. The market-maker puts these two together for a profit. Therefore, all trading is honestly or dishonestly gamed by the market-makers and institutional investors. That's why they say "the trend is your friend" and "trade with the sharks, not against them." The problem is that you have to know where the sharks are and how they are going to trade (big risk variable). It's often not good enough to know how the sharks are trading now; you really need to know the direction they are going to trade. High anxiety, I'd say, for the individual trader. Compound Yield investors don't have these headaches. We wait for the sharks to come to us, and while we wait, we are rewarded by great dividends and income. When the sharks do show up, we give them what they want. We sell them our shares, but only for a profit. We've baited them by having a broad range of stocks they may be hungry for. Either way, the strategy tells us what to do. If they game share prices up, we keep selling into them until they are tired of buying. We then buy down into our holding should another shark game down prices by shorting them. On the one side we take profits, on the other we increase our yield. What could be better? Either way, we are generating money to compound yield with.
The Compound Yield investor has answers to the difficulties of trading consistently well (tough for even professional traders).
Q: How do we know what the sharks are hungry for?
A: We don't, but we don't have to either. Sharks can be finicky and emotional. We let them decide what they want by having a variety of stocks from different parts of the market. Diversification, plain and simple. We provide a nice department store to shop in.
Q: What if a stock gets no interest from the sharks?
A: That's why we own high-yield stocks, so that our money is always working for us.
Q: What if the sharks don't like one of our stocks?
A: We buy down into it, increasing our yield. Eventually, sharks will game it again, and we'll sell into them. We've also protected the portfolio by sizing positions.
We always sell into sharks to give them what they want (some of our shares). We want to be helpful and generous to the sharks. They are kind enough to tell us where they are and what they want. Because we know this, we always win on our trades. Beautiful symbiotic relationship, isn't it?
The potential of being a Compound Yield investor is best seen in a self-directed rollover IRA. This is because:
- The fund is closed to additional outside contributions.
- It now needs a way to generate revenue that can be reinvested. This essentially becomes the source of new money, replacing the regular contributions made during employment.
- Because it is a closed system, the results of the strategy are much clearer to see. The portfolio lives and dies by the actions of its owner.
- Because my retirement money wound up in a somewhat self-directed rollover IRA, I was able to see what we've talked about and fully develop the Compound Yield investor strategy from conceptualization to actualization, and it's powerful!
Mechanics
What follows next are the individual thought processes that go into preparing for a trade day. Each is worth considering singularly and then together as a whole. This synthesis produces the conviction to pursue a trade day.
1. Choose your stocks. Look for great yield and great fundamentals. My ideal stock has a price-to-book value of less than or equal to one; high return on equity for its industry; reasonably good payout ratio depending on industry average; current and quick ratios greater than one; and good to excellent profitability measures. If quick and current ratios fall short and debt burden is a little high, I may still buy if all profitability measures are at the highest percentiles for the industry. Everybody weights parameters differently. The point is that we want to be confident that in any market cycle, our stock will meet its dividend and likely increase it. It's a great bonus to find a stock that meets requirements and has consistently raised dividends. Just another nice way dividend stocks help us compound.
2. Size each position. I like $25,000. For a million-dollar portfolio, this would be forty positions, or 2.5 percent of the portfolio for each position.
3. Understand trading expenses. My broker is Scott and Stringfellow. At the million-dollar level, I have personal brokerage, and the management fee is 1 to 1.5 percent on the portfolio annually. The expense fees are collected quarterly. There is no restriction on how many times I can trade. You could, of course, just use an online broker, which would be less expensive, but you won't have any broker advice or input.
4. Keep your account Web page as simple as possible. When a position has declined in value compared to your cost, the amount should show up in red. If you are up in a position, that amount should be in green. The importance of red and green is so just by looking at your Web page, you quickly know what stocks you may want to sell shares on and which ones you may want to buy down into.
5. Take profits at the right time. For each position, I keep rough track of my current yield on cost/NAV. This is mainly to tell me when to take profits. As an example, if my dividend yield is 6 percent on a particular stock, I probably won't take profit until the share price is up that far on my cost/NAV. I try to take profits every time that happens. Why? Well, if I'm up 6 percent, I've made the same amount of cash in one trade that my dividend would take a year to make. It would be senseless to not sell enough shares to take that profit off the table and use it elsewhere. Kind of "one in the hand is worth two in the bush." If you are down an amount equal to your annual dividend on a position, recheck fundamentals. If there is no change and no obvious bad news about the company of significance, buy down into to increase yield.
6. Know how much to buy and sell. This is exact and straightforward. If you are up, sell shares to fully capture the profit. If you are down in a position, take that amount and divide by the present cost of a share to tell you how many shares you need to buy. Again, by buying and selling, we're just trying to keep our position steady around $25,000.
7. Go with your instincts. If shares prices keep dropping on a position and you still feel confident in the stock after researching it well, buy into it. This can be a nerve-wracking, and some investors might want to set a mental stop-loss at 20 to 30 percent of their cost basis on that stock. If it hits the stop limit, then you sell the entire position at market. If share prices keep going up, then you are truly blessed. Keep taking profits until you run out of shares. Talk about a home run!
8. Have cash available. I try to keep enough cash on hand in my cash account to always be able to buy at least one new position so as not to miss a great opportunity. Certainly what is a great opportunity for you may be different than for someone else. You decide whether to buy based on what yield you want to start out with. This is not the same as a "good price."
9. Stay proactive. Market timing is really reduced as an issue using this strategy. It has always been drilled into our heads to buy low and to sell high. Yet the market may play out unpredictably. The "market"' is the sum total of its parts, and these are emotional, not rational. There are individual investors trying to buy fundamentals for capital gain. There are institutional investors that move large sums of money that affect share prices quickly. There are the market-makers pressuring prices for their own gain. People short the market, and others trade options. The list goes on and on. The sum total of all of this activity shows up as the spot price of a stock for a moment or two. Eventually, the share price actually reflects its value but probably just for a moment, and then the price changes. What I'm saying is that what the market says the value of a stock is and what you think it may be worth is opinion on both sides. This difference drives trading and not absolute value. "Buy and hold" investors think they are buying absolute value, and they are not. They will continue to get spanked in the market. Trading is emotion being dissipated. We want to be on the upside of this emotion using our strategy to importantly manage longer-term risk. Here is a perfect example. You look at a stock that has a great dividend, but you are afraid to buy it because it is near a fifty-two-week high. Our strategy would encourage you to take that trade. Why? If a stock is at its fifty-two-week high, you're afraid that the price is going to drop. If you did buy it at the starting yield that was acceptable to you and it went down, you would buy down into it and increase your yield. If it goes the other way and had more momentum, well, wouldn't you be lucky! You would keep taking profit until it reversed. Then you would buy down into it. That's a great trade! It would be great if that happened every time. You always have the heads-up which way things are going. If it's green, you sell. If it's red you buy. This is a simple rule, to consistently buy low and sell high over and over. The system tells you what to do. Who is turning your positions red or green anyway? The sharks are! Barring some catastrophic event affecting a company or stock, you're making money either way. It's really more a question of how much you make rather than if you will make money. You are a winner anyway. Now, I want to be a big winner, and I'm not going to let profits sit on the table idly. I'm going to stay proactive. When a sell ripens, I'm going to sell and buy income with it.
(Continues...)
Excerpted from COMPOUND YIELD by Robert K. Naguszewski Copyright © 2012 by Robert K. Naguszewski . Excerpted by permission of AuthorHouse. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
