Today, I’d like to play make believe by pretending we’ve just won $100 million with a Powerball ticket.
I only suggest playing the lottery in Fantasy Land, of course. In real life I consider it the world’s most popular voluntary tax. But let’s just say we played, and things went our way.
Our next big question should be how we’re going to invest our windfall.
Oh, you’re worried about taxes? You shouldn’t be. This is Fantasy Land — there are no taxes!
Back to our wonderful dilemma of how to invest the cash.
Sure we could just keep it in cash equivalents. Heck, we should be able to scrape by even if we only make 1 percent a year on our lousy $100 million.
Still that seems rather unfulfilling. So let’s buy a business. I’ll get our new investment banker buddies to line up some candidates for us …
Here Are Three Potential Companies for Us to Invest In!
Company #1. In comes a guy wearing a lab coat. Apparently, he’s an expert in building transistors that will be used in future space shuttles.
All he needs is our money to hire a team of scientists. They’ll spend a couple years developing the product, and hopefully it will earn a patent. Then, once the finished transistor beats out its competition in a government contest, the scientist says we’ll cash out big time when our company’s share price goes to the moon.
Company #2. Our next candidate is dressed in a designer suit. He runs a pretty large chain of clothing stores in the New York metropolitan area. And now he wants to go national with our money.
If the stores catch on, they’ll be bigger than The Gap, he says. Heck, he’s already making pretty good money at his current locations. He just needs funding to scout and acquire new locations and advertise. Also, he wants to fight the existing national chains by setting up some offshore manufacturing facilities. That way we’ll be able to offer clothes at even lower prices.
And, hey, in the best case scenario … The Gap might even just buy the chain if it really catches on!
Company #3. Standing before us is an older man, dressed in a pair of worn khakis and a tattered navy blazer. Turns out that he’s the great-grandson of John Henderson, the creator of Henderson’s World-Famous Chocolates. You know the product … heck, you’ve been eating them since you were a kid.
Apparently, the company is doing just fine by selling its chocolates all over the globe. But the great grandson wants to spend his golden years sailing yachts … NOT thinking about a chocolate empire. So he’ll sell his stake to you at a fair price. The current managers will still run the business, and send your share of the profits every quarter. And as the great grandson points out, Henderson Chocolates hasn’t had a losing year in the last three decades. Even the recession hasn’t really put a big dent in sales.
Now, I Ask You: Which Person Should We Give Our Money To?
Before you answer, let’s review some of the pros and cons of the various businesses …
|Investing in a high-tech area like space exploration might be exciting, but I’d rather more grounded profits from “boring” dividend stocks!|
The transistor opportunity sounds like it could be wildly profitable if everything goes right. We’d be in on the ground floor, and there’s no doubt that a government contract would pay handsomely. Plus, our friends would be really impressed when we tell them we’re funding missions in space!
But I certainly don’t know much about the field. Do you? More importantly, there are a lot of obstacles in the way of success. We’ll probably be waiting a long time to get paid for taking all that risk.
Meanwhile, the clothing business sounds healthy and it’s making money already. Going national could mean nice growth on our initial investment. And there’s the possibility of a buyout down the line.
On the other hand, clothing and fashion are very trend driven, and even the owner says there’s already LOTS of competition in place. Will the stores succeed beyond the New York metro area? And for how long? If the economy slips again, or people suddenly start wearing togas, we might have some serious down years ahead.
As far as the chocolate company … there are clearly some ins and outs of running a large multinational operation that are best left to the executive team. Nor should we expect tremendous growth. But at least we understand the basics of the business as well as the risks.
Even better is the fact that we don’t have to wait for a bunch of milestones to be met or for somebody to come along and buy our shares out from under us.
In fact, this is the kind of cash cow we’d rather just hang onto. Sure, we’ll probably be able to sell at a higher price down the line if we want to … but we’ll also be getting immediate profits sent to us starting RIGHT NOW and probably for as long as we continue holding.
If you’re getting the impression that I like Company #3 the best … you’re right. Heck, what’s not to like?
And here’s the point of our imaginary scenario …
While you probably don’t have $100 million to invest at the moment, you still face these same basic choices when you invest even $1 in the stock market!
Yes, you have far more than three choices when you go out shopping for a stock to buy. There are a tremendous number of businesses in the world … all with varying risk profiles, structures, end markets, and more.
Yet I think it’s fair to lump companies into some basic categories. And that’s what I was trying to do with the three imaginary firms.
Company #1 is like the Nasdaq tech stocks everyone loved so much in the late 1990s — great to brag about, hard to understand for most investors, and very much like playing the lotto unless you do A LOT of research and really understand the firm’s niche. Of course, the profits can be huge.
Company #2 is that so-called “growth” firm that has its greatest years ahead of it, as long as things go according to plan. It’s probably in a cyclical sector … which also means volatile swings. But there’s potential for solid returns if you get the story right.
And Company #3 is what a lot of people dismiss as a boring “value” firm. The kind of company that is going to continue chugging along as it has for decades, spinning off cash, and growing modestly year in and year out. Your friends won’t be impressed, but you stand a very good chance of making money year in and year out.
A bit of an oversimplification? Maybe. I’m not saying it’s simply growth vs. value. I actually think that’s a false dilemma because my favorite companies are BOTH undervalued and growing steadily.
No, the real issue is whether or not you’re buying companies with real, profitable, long-term businesses … companies that are willing to reward you right away with steady income … and companies that are posting sustainable growth without big competitive challenges ahead of them.
I mean, really, why would you risk your hard-earned investment dollars on some fly-by-night company that operates a business you can’t even understand? Especially when you can buy stock in profitable, growing companies you already know and trust.
Right now, with stocks running higher, it’s easy to lose sight of this basic concept. But don’t forget that when you buy a stock, you are literally buying a company. Make sure you understand its business … the risks and rewards … and precisely how you — as an owner — are going to profit (and WHEN).
In the real world you don’t have to just buy one company. So by all means, go ahead and put a little bit of your money into a couple more speculative shares with good prospects as well as some faster-growing companies.
At the same time, I suggest you also make sure the bulk of your stocks will be able to weather the potential economic challenges ahead … and begin paying you non-refundable profits in the form of dividends immediately.
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