Just about four years ago I wrote the first article on HowIGrowMyWealth.com “Inflation Destroys Dollars“. I wrote about how what I do to protect against price inflation and dollar devaluation. Specifically value investing and precious metals. So in retrospect, how did those investments do?
As a control we’ll add the U.S. Dollar Index ($DXY, shown in green), which compares the dollar’s strength against a basket of other currencies. To represents “stocks” I’d added the S&P 500 Index (SPX) (shown in black).
I’m using the Vanguard Large Cap Value ETF (VTV) as a proxy for value stocks (shown in red). You can see how my current and past individual value stock picks have done here. Gold futures are in yellow and silver futures in gray.
As you can see the S&P 500 has been the place to be. To be fair gold isn’t too far behind. Gold was in fact keeping pace with and surpassing S&P 500 this past April. So while gold has been a good hedge and having exposure to stocks has continue to be important.
Value stocks have lagged the S&P 500, particularly in the aftermath of the December 2018 selloff.
Silver is only slightly outpacing the dollar index, up just 7.15%. Silver has had a few failed breakout attempts, but continues to underperform. The gold/silver ratio that some precious metal bugs talk about would suggest that silver is a better value right now.
Costs continue to rise each year as the dollar loses value. But as measured by the DXY the dollar has kept its value against other currencies.
As I wrote back in November of 2016 in “I Own Too Much Gold“, you don’t want to own too much gold as a percentage of your net worth. The performance of the S&P 500 is a good reason why. If gold ever were to take off a 10-25% allocation would be more than sufficient.
We certainly haven’t see broad hyperinflation yet in the US, but my rent, food and medical costs continue to rise each year in excess of the government measured CPI. As I have for the past four years, gold and precious metals remains an important (albeit minority) portion of one’s portfolio.
If you are just starting to buy precious metals emphasizing silver over gold (while still buying both) could be a good approach.
It’s been a year since my last value stock pick. I haven’t been buying stock and have been focused on building up a war chest I can use to buy stocks and other assets at a discount when the US economy faces it’s next crash.
I don’t know when the next stock market crash will take place nor have I failed to notice that stocks are up some 300% since the lows of the 2008 financial crisis.
So I maintain some exposure to stocks even though I believe the stock market a whole is overvalued.
1) Enterprise Value to Market Capitalization (EV/Market Cap)
2) Enterprise Value to Free Cash Flow (EV/FCF)
3) Enterprise Value to Earnings Before Interest and Tax (EV/EBIT)
4) Enterprise Value to Owners’ Cash Profits (OCP)
5) Operating Margin
6) Dividend Yield
7) Return on Equity (ROE)
Energy production is very capital intensive so I’ve decided to compare Royal Dutch Shell (RDSb) to similar companies: Exxon Mobil (XOM), Total (TOT), and Chevron (CVX).
Data is from Morningstar as of 13 March 2018 (with the exception of EV/Owner’s Cash Profits) which is from yCharts as of 16 March 2018.
So how does RDS stack up?
1) EV/Market Cap
I like to see an EV/Market Cap below 1. Of these four energy companies none meets this criteria and RDSb is actually the highest. Total is the lowest just edging out Exxon Mobil by what amounts to a rounding error.
RDSb – 1.242
XOM – 1.134 TOT – 1.129
CVX – 1.154
Winner: Total (TOT)
2) Enterprise Value to Free Cash Flow (EV/FCF)
EV/FCF is where RDSb really shines compared to it’s peers. EV/FCF is in my view a more accurate measure than Price to Earnings (PE). The lower the number the better.
RDSb – 19.55
XOM – 24.42
TOT – 28.99
CVX – 36.15
Winner: Royal Dutch Shell (RDSb)
3) Enterprise Value to Earnings Before Interest and Tax (EV/EBIT)
Another metric where lower is better.
RDSb – 18.31
XOM – 18.57 TOT – 14.68
CVX – 26.98
Winner: Total (TOT)
4) Enterprise Value to Owners’ Cash Profits (OCP)
16 March 2018 Update:
EV to Owners’ Cash Profits is another metric that I believe is more accurate than price to earnings.
Shell has a payout ratio of 144.6%. That means that the dividend might be unsustainable.
However, Shell’s payout ratio has been below 100% from 2008 up through 2014 and I think that the payout ratio will drop to a sustainable level in the next year or two.
The return on equity for shell has also been lower than I’d like but they are also in stronger financial shape (based on the current ratio and quick ratio) than ROE king Exxon.
Another Valuation Metric
One way to calculate a margin of safety is by determining what multiple of the EBIT the stock is trading at. I could write an entire article on how this is calculated (shout out to Jason Rivera who I learned this technique from).
Using the number 14 in the equation might seem somewhat arbitrary but it isn’t. The reason I chose that is because if you plug in 13.5 you get the current share price of Shell. In other words Shell is trading at EBIT x 13.5 + Cash Equivalents.
Using this metric (using a multiple of 14) we find a “fair” share price of each of these four stocks would be as follows:
RDSb – $65.9
XOM – $64.1
TOT – $75.8
CVX – $72.7
And if we compare the actual share price to these values we get the following “margin of safety” for each stock:
Using this technique we can see that Shell is trading at about a 3.5% discount to 14xEBIT + Cash. Exxon is trading at a 16.27% premium, Total is trading at a generous 23.91% discount and Chevron is overvalued by a large 60.12%.
Even though it is in a totally different industry, just for fun, I decided to compare this to Netflix (NFLX). NFLX is currently trading at $315.88 per share. At 14 times EBIT plus cash NFLX should be trading at $6.32 and at current prices it is trading at a a 4,900% premium.
I would venture to say that Netflix is overvalued.
Class A or Class B?
I used to own RDSa in a Roth IRA. The RDSa shares are subject to a 15% withholding to the Dutch government. Because of this RDSa trades at a discount to RDSb, which does not have this withholding.
At one point you could get around the 15% withholding through Shell’s scrip program (which they have discounted twice) and get a lower price and higher yield.
But given that the scrip program has been discontinued I choose to own RDSb. I prefer to own it on the London Stock Exchange but I do own it in US markets in a Roth IRA.
Shell is a great value
Shell is a great value and a cash flow machine with a strong dividend. Total is an excellent value as well although it has thin operating margins and has struggled to generate free cash flow with the same consistency as Shell and so for those reasons I prefer Shell.
Over the past few weeks I’ve been writing about the faulty wiring in the United States economy that will eventually result in an Economic Conflagration.
The faulty wiring that will ultimately lead to this economic firestorm includes the fact that the real economy is weak, the economy is crushed by profligate debt and that stocks are overpriced and due for a significant crash.
One of the reasons why candidates such as Bernie Sanders and Donald Trump were popular in the last United States presidential primary and general election is because people know that the real economy is weak. They know how much debt they have and they want someone to make radical changes and do something about it.
Unfortunately government has never been particularly good at creating wealth or prosperity.
Some people might choose to rely on politicians to fix things. This website is not for those people. HowIGrowMyWealth.com is for people who want to take some common sense steps to grow and protect their wealth.
Given the faulty wiring the economy it is more important than ever to grow and protect one’s wealth. It might take a while but this faulty wiring will eventually result in a fire that will burn uncontrollably.
I realize this isn’t necessarily very cheery stuff but fear not! There is plenty of room for optimism.
I’m not a doomsday “prepper” or perma-bear and I’m sure that entrepreneurs, if free to do so, will rebuild the economy and usher in greater prosperity that will not be funneled to the politically connected.
I’m also cognizant that the stock market has gone up nearly 300% since the great recession, there hasn’t been hyperinflation in consumer prices and on the surface the crisis seems to have passed long ago. I don’t have a crystal ball and being right early sometimes looks like being wrong.
Despite the relative calm there is faulty wiring in the economy and sooner or later it will spark and ignite blaze that will, to quote Peter Schiff, “will make the financial crisis of 2008 look like a Sunday school picnic.”
The politicians, if they even realize that there are systemic problems in the economy, simply aren’t willing to endure the short term pain and inconvenience of ripping out the faulty wiring in order to fix the underlying problems. So they will continue to kick the can until the economic house burns down.
The bright side is that this will present an opportunity to rebuild the economy based on a strong foundation as opposed to what we have now, a phony economy based on debt, cheap money and consumption.
There will be winner and losers. I’m very optimistic about the future and I want to be counted amongst the winners.
So where am I putting my money?
My asset allocation falls into three main areas. Value stocks, gold and cash.
Value Stocks
Most people love buying things on sale and getting a great deal, expect when it comes to investing. When it comes to investing people want to buy expensive things and hope they go higher. Value investing takes that same common sense, buying things when they’re on sale and applies it to stocks and other asset classes.
The stock market as a whole is overvalued by a variety of metrics. But there are still good deals out there especially in non-US markets. I don’t doubt that value stocks will also go down in the event of a stock market crash but I think they will go down less and they will recover with more strength.
I share my value stock picks publicly. But I only share if I would buy them today or if I would hold or add to my positions with members of my free email newsletter. I will also let me email subscribers know when I buy or sell a stock first, before I publish that information to this website.
Gold
I don’t think you will get rich buying gold but it could prevent you from getting poor. Under relatively normal circumstances the demand for gold is fairly steady and the supply is fairly steady so for the most part the price of gold will rise with the level of inflation.
Gold is a way to save purchasing power. It’s a way to opt out of the financial system and wait for sanity to return.
If the dollar tanks loses it’s reserve currency status gold will still be valued.
I also think there has been significant effort to suppress the price of gold and depending on how much downward price manipulation there really has been, the price of gold could go up significantly from where it is right now.
If fiat currencies collapse that could very well induce a flight to the safe haven asset of gold that this influx of demand would be very bullish for gold.
Because of the absurd expansion in central bank balance sheets and artificially low interest rates I like gold presents a fantastic value at current prices.
What I write about gold applies to silver–another asset I think will do very well in a downturn. Silver has the added benefit of being an industrial metal that is more widely consumed.
Cash
Long term, like every other fiat currency, I think the dollar will go to zero. So why would I want to hold dollars?
First, I own a month or two of expenses in physical cash in a secure location in case there are capital controls. If there is a panic and people start withdrawing money from the banks the banks might in turn say, you can only withdraw $500 a week or something like that. Withdrawal limits could also be imposed if the US implements negative interest rates and people (very rationally) decide it is better to hold dollars in physical cash so they don’t have to pay interest to their bank for the privilege of loaning their money to the bank.
I reside in the United States and everything is priced in dollars so I need dollars to buy things. If I lived in the eurozone I would hold pounds or euros, if I lived in China I would hold Yuan. If I lived in the socialist paradise of Venezuela I would probably hold dollars (and try to get out).
Secondly, apart from physical cash I also hold dollars in a money market fund as a war chest. If stocks tank I expect there will be bargains to be had. I want to be buying stocks (if they are high quality free cashflow producing companies) when everyone is panicking and selling.
Now I fully expect the United States Federal Reserve to do what it has done in all other crises it has created–it will lower interest rates and buy assets to prop up the markets.
With interest rates already low once they cut rates to zero they will only be able to do things like Quantitative Easing and Negative rates. This is very bearish for the dollar and very bullish for gold.
But in the highly unlikely chance the US Federal Reserve does the right thing and lets the stock market collapse and lets the US government default on it’s debts this could be very bullish for the dollar. So holding some dollars is a hedge against deflation as well as a war chest to draw upon to buy undervalued stocks post crash.
What are some other possibilities?
While the bulk of my holdings are in cash, value stocks and precious metals I also dabble in some other alternative investments.
If there is a dollar crisis or collapse in the faith of central bankers then more people could turn to cryptocurrencies and could see it rise. Demand for cryptocurrencies could also rise for other reasons pushing the price upwards.
While I think blockchain technology is here to stay the value of any one specific cryptocurrency or token could very easily tank to nothing. Cryptocurrencies are very risky and 90% swings (both directions) happen.
You need to have an iron stomach but having between 1-5% of your liquid net work in cryptocurrencies isn’t the most outlandish idea in the world.
I would only speculate on cryptocurrencies with what you can afford to lose and I don’t considering buying cryptocurrencies investing in a technical sense since I am simply betting on the price going up.
I’ve shared with my readers my Group of Six cryptocurrencies that I’ve chosen to own and speculate on.
Options
Net I’ve actually lost money trading options. I traded options while unemployed and failed to remain dispassionate and objective. I was so focused on making money that I opened positions when the conditions were not ideal and took risks I should not have been taking.
I do believe if you are disciplined and follow the appropriate rules, you can do well trading options.
During a stock market crash volatility spikes and selling options could be a good strategy. When the VIX (a volatility index) spiked up in early February I sold a few options and those positions are doing well as volatility has dropped and the market has recovered. Markets don’t move straight up or down for very long so even if the February selloff portends drops to come, the market doesn’t drop as fast as people think in the midst of the drop.
Real Estate
Unlike all the other assets mentioned above I do not and never have owned any real estate.
Lots of people have made lots of money in real estate. I am working to learn more about this asset class and hope to own my own rental property at some point.
What I like about real estate is that it is easy to use leverage and the tax benefits are ridiculous. You can effectively pay no tax on investment property income and borrow a lot of the money you need to get started.
You of course need to know what you’re doing.
My goals for owning real estate involve owning a multi-family apartment building. The key for me is a cashflow positive property. I don’t have any interest in trying to buy and flip, although some people are very successful doing this. There are lots of ways to make money in real estate and I recommend biggerpockets.com to learn about them.
I think cashflow positive real estate will do okay in the event of a crash. If you’re in an area that has stable employment prospects those workers will always need a place to live and have the money to pay for it. Of course real estate won’t “always go up” and there are a lot of risks and headaches associated with managing property (if you don’t outsource property management).
This is part 5 of 5 of what I’ve decided to term The Economic Conflagration series where I discuss the faulty wiring pervasive the global economy:
I like value investing and value stocks. It’s not some aesthetic or subjective reason. As an asset class US value stocks have a history of outperforming other US stock classes.
I like picking individual stocks but I appreciate that is not suitable for everyone. For some folks a passive index asset allocation strategy could be better.
Equally Weighted Large, Mid, and Small Cap Portfolio Performance Since 1972
If one were to have invested $1,000 in the a portfolio consisting of roughly equal allocations of large market capitalization (“Large Cap”) stocks, mid-cap and small cap stocks in January of 1972, it would have grown to $132,330 by January of 2017. The compound annual growth rate (CAGR) of this portfolio was 11.45%. The maximum drawdown around the 2008 financial crisis was 52.70% (stressful).
During this same time, if one were to invest $1,000 in “US Stocks” the CAGR would have been 10.21%, balance on January 2017 would have been $80,008, and the maximum drawdown would have been 50.89%.
Source: portfoliovisualizer.com
What about Growth Stocks?
A portfolio with 1/3 large, 1/3 mid and 1/3 small cap growth stocks would have done even worse than the allocation above. The CAGR since 1972 has been 10%, the maximum drawdown was 58.6% (wow!), and $1,000 would have grown to $73,508.
So growth stocks performed worse.
Source: portfoliovisualizer.com
US Value Stocks have Outperformed
US value stocks have outperformed growth stocks. A portfolio mixed with 1/3 large cap value, 1/3 mid cap value and 1/3 small cap value would have a CAGR of 13.11%.
A $1,000 investment in 1972 would have grown to $258,618. The maximum drawdown would have been slightly higher than straight market cap stocks, at 55.79% (still stressful) but less than the growth stock portfolio.
Source: portfoliovisualizer.com
What it All Means
There are two main takeaways.
Value stocks outperform other stocks classes
A small increase in the CAGR has a large impact if the time horizon is long enough
US value stocks had a lower maximum drawdown than growth stocks
US value stocks have higher maximum drawdown than stocks in general
Source: portfoliovisualizer.com
For more details on this data see the portfoliovisualizer.com FAQ.
I’m a value investor which means I buy stock in profitable companies trading at a discount.
I’ll be tracking the stocks I like over at my Value Stock Picks page.
The information presented here, like all the content on this website, is not investment advice. These are stocks I own (or intend to own) but they might not be suitable for you. The information presented is accurate to the best of my knowledge, but no guarantee of accuracy is made.
Prices are as of 11 January 2017 on market close, unless otherwise noted. Market data is from morningstar.com.
Korea Electric Power Corp (KEP on NYSE)
Price
Market Cap
Shareholder’s Equity
Price to Book
Earnings per Share
Yield
Return on Equity (TTM)
Price to Earnings (TTM)
$18.27
$23.5 bil
$56.3 bil (converted from KRW)
0.4
$8.74 (converted from KRW)
7.63%
12.2%
3.3
Korea Electric Power Corp “KEPCO” is a large cap electric company that transmits and distributes nearly all the electricity in South Korea.
I like this stock because the company pays a very nice yield. They have net income growth the past three years. I also think that people aren’t going to stop using electricity anytime soon, so it is in a good industry. With a price to book of just 0.4 it’s a steal.
It is an ADR, which isn’t my preference. But is is optionable.
I own 100 shares of KEP and have sold a covered call.
Brookfield Property Partners (BPY on NYSE)
Price
Market Cap
Shareholder’s Equity
Price to Book
Earnings per Share
Yield
Return on Equity (TTM)
Price to Earnings (TTM)
$22.17
$5.8 bil
$7.4 bil
0.8
$3.6
5.05%
6.9%
6.6
I would rather own real-estate directly because doing so provides crazy tax benefits. Despite looking into real estate previously I’m not in a position to join the class of landed gentry.
An alternative way to be a part of the real estate market is through a real-state investment trust (REIT).
A REIT is a company that owns, and often operates, income-producing real estate.
Like many other companies Brookfield Property (BPY) has issued stock that can be purchased.
BPY is a REIT that pays a nice 5% dividend and is currently trading at a 20% discount to it’s book value. It’s had modest revenue growth over the past three years and is profitable.
The properties BPY owns operates and invests in are located in North America, Europe, Australia and Brazil.
Unfortunately most of the assets under management are in the US (72%). I would prefer seeing more exposure in Brazil, Australia, and Asia.
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Korea Electric Power Corp “KEPCO” is a large cap electric company that transmits and distributes nearly all the electricity in South Korea.