Dividend Stock Investing: The Sure Way To Passive Income w/ Nick McCullum

Hey guys, hope you're doing well. I am recording this podcast for you because I know there's a lot of interest in the conversation of what the heck is going to happen in the stock market. We've seen some crazy volatility and is this a buying opportunity or is this a time to get out? I know there's a lot of confusion about this. I have one subscription that I pay for on this topic and it's from sure Dividend, which is a newsletter that analyzes dividend paying stocks. I love dividend paying stocks. I have it as one of the foundations of my portfolio and my investment strategy because there's passive income, there's growth possibilities, and it makes for some interesting companies that you find. And so we talk about this with the founder of share of sure dividend, Nick McCollum. And we recorded this inside the 1% where we have been talking about what stocks we're tracking and what's going to happen in the market. Not going to lie, we kind of nailed it. So far we have kind of nailed this market and all the craziness of it. But for now, I just want to share with you this interview with Nick because we talk about some specific companies that we're tracking and and what we think is going on in the overall economy and with specific stocks and companies that we like. My standard disclaimer is I'm an idiot on the Internet. Don't listen to anything that I say. This is for entertainment purposes only. But I think you will be entertained hearing how we analyze companies and the market in a crazy time like this. So I hope this spawns some curiosity and some creativity and some further research for you because I know that this is a zany time to be an entrepreneur and investor and I hope that this brings you some clarity. Enjoy. It takes one free person to create change. This is the show for them. We are the creators of the Free world. This is capitalism.com and we are the 1%.

Hey friends, what's going on? Before we jump into today's episode, I have a pure, unadulterated ask my book. 12 months to 1 million is dropping right now. You can grab it over@capitalism.com book if you're in the position to buy a group of copies for your team, for your podcast listeners, for your YouTube audience. There's a section over there to do bulk orders with, opportunities for me to come speak at your event or be on your podcast. I'm so proud of what we have done here and this is gonna make a meaningful, lasting, life altering impact on your followers, on your students, on your family, on your friends. Please go grab a copy over at Amazon or if you're in the position to buy a bulk order, go over to capitalism.com book if I've ever brought you value in the past, please buy this book for a friend. If you're starting a business, this is the clear path to building a seven figure business. I'm so proud and so confident that it's gonna have an absolutely radical effect on your life and your family. Capitalism.com book thank you so much for all your support over the years, all of your success stories, all of your hard work. This book is for you. Hello everyone, this is Ryan Daniel Moran. I am joined by Nick McCollum. This is really exciting for me. It's pretty rare that I get to chat with somebody that I'm unfamiliar, I've never met before, I'm unfamiliar with, but I've been following their work for a long time. And that's Nick. Nick is the editor and co founder of sure Dividend, which is one of the newsletters that I pay to subscribe to. I look forward to it every month and it kind of helps set my framework and some of the things that I track and add to my watch list. So Nick, thanks for hanging out with us. Welcome to capitalism.com yeah, thanks for having me.

I'm excited to be here.

Yeah, we're excited to have you, Nick. First of all, I'm a subscriber of sure Dividend and one of the things that is always interesting to me is to see what companies you're tracking and that you tracked in the past and you're updating the list and your analysis every month. And I can say I have never looked more forward to a dividend list than I have in the last than the last week because there's all, all these companies that are on sale right now. So I'm just curious from your perspective with the landscape of things right now and for as long as you've been tracking a dividend paying stocks, would you call things on sale right now or are we still in tumultuous times? How would you analyze the dividend arena right now?

Yeah, so I mean if you just compare the prices of assets right now to where they were a few months ago, then things are definitely cheaper and if you were to rewind even two weeks, then things were very, very cheap compared to where they have been over the more medium term. Now the big question as to whether they're cheap relative to I would say their forward looking Fundamentals is how quickly we can move past the whole coronavirus thing. It looks like cases in places like New York and all the other widely affected areas are starting to come down. But if you look back towards past pandemics, there's always kind of tended to be a second bounce in cases. So things are definitely cheap compared to where they were previously. But whether or not they're cheap relative to their fundamentals totally depends on how quickly we can move past the coronavirus pandemic.

Now a question that comes up a lot in that context is when the market was at its highs nearing 30,000, many people thought that we were overvalued at that time. And so when you're looking at dividends, where do you think we are in kind of the, the, the overall cycle or when you're buying a dividend paying company, does that even matter?

Yeah. So valuation always matters. And the, the question of whether or not things are overvalued right now, or I guess whether they were overvalued when we were near 30,000, it kind of depends on what point of view you'd like to take. If you look back at rolling valuations, take it on price to earnings or price to book or EV to enterprise value or whichever valuation metric kind of floats your boat. Everything's been trending upward over any kind of rolling timeframe you look at. So if you do like rolling 1 year valuations or rolling 2 year, 5 year, 10 year valuations, things have always been trending upwards. Now there's kind of two reasonable theories as to why that might be. The first is that interest rates have just kind of secularly come down over the long term. The long bond right now is basically near zero if you do it on an inflation adjusted basis. And low interest rates cause the prices of assets to increase because it's easier for people to borrow money to buy those assets, which drives the prices up just because of supply and demand. So interest rates being low is one theory as to why valuations have come up. Another theory is just that there has been more of a concentration in large cap, high quality businesses that have good metrics when it comes to things like return on assets, return on capital, all of the things that an investor wants. So if you look at some of the largest companies in like the S and P right now, for example, it would be your, Microsoft's, your Apples, companies that aren't going to trade at the same kind of dirt cheap valuation as like an industrial manufacturing company because they don't have the same boom and bust characteristics. So if you subscribe to one of those two beliefs, then you might be able to talk your way into thinking that the market was not overvalued at 30,000. But if you're just a pure numerical driven investor who invests based on evidence, then there's no question that Dow 30,000 was a high valuation relative to where Dow has traded in the past.

And so where do you think what is a fair evaluate like a fair market valuation for where we should be right now?

Well, I mean again it depends on your point of view. If you just look at historical averages, I don't know the number for the Dow, it's a little more tech heavy, so it's probably a bit higher than this. But for the S and P, I think it's median price to earnings ratio since inception is around 16. The Dow is probably a little higher than that. But anywhere in that mid teens range would be like long term historical fair value and now that number would be higher. If you want to just consider say the last 20 years or the last 10 or five years.

Yeah, that makes sense. So Nick, when you're making your list of companies that you're adding to the newsletter every month, how are you, what, what criteria are you usually basing it on?

Yeah, so the way that our newsletters perform their security selection is it's kind of a multi step process. It all starts with we have a team of research analysts who each are responsible for covering a basket of securities. And in those research reports that they publish for the securities in their universe, they have to come up with an expected return framework for the next five years. So basically using some conservative assumptions, they have to estimate, here's what we think this company is likely to deliver over a medium term time frame. And once we have those return estimates, we compile those into a database and then those are mixed with various safety metrics to come out with the stocks that we believe are in the safest bucket that have the highest expected returns. Now there's a lot that goes into that, so I'm happy to dive into any specific part in more detail if you'd like.

Well that sounds all fancy and makes me glad there's people like that in the world that can run those kind of numbers. So just for full disclosure, I'm curious, have you ever been absolutely certain about a security and then been wrong?

Yeah, I would say so. Fortunately that has not generally been the case for as long as we've been using our current selection criteria, which I believe is about two years now. Prior to that we did have one company and I'll just, you know, it's in our newsletter. So in full disclosure, I'll say the company's name. Owens and Miner was a company that we believed had a strong outlook. But the company had basically recently completed two large acquisitions that were associated with strong forecasts about how they believed the acquisitions were going to perform. And they, to make matters worse, they funded those acquisitions with debt. So when the acquisitions underperform, they failed to, you know, they had been basically in a cash crunch where they couldn't meet their dividend payment and their interest payments so they had to cut their dividend. And that was basically like a worst case scenario from our end because we, our newsletters are designed to help people build portfolios that generate rising dividend income over time. And a dividend cut is basically the exact opposite of what we'd ever hoped to accomplish.

Yeah. So if you have never heard my analysis of dividends that my. The reason why I feel compelled to have Nick on and the reason why dividend paying stock is one of the foundations of my investment strategy is because over the very long term you have a couple different sources of compounding interest. You have the compounding interest of this, the dividend being raised, of them raising the amount that they're paying investors every quarter or every year. And you also have the compounding interest of those dividend payments buying more stock over time. So you have a double compounding interest. That happens. And a lot of times people will write off dividend paying stock as having a minimal return compared to the rest of the market because a dividend might only pay a 4% dividend, but when you factor the compounding returns over 10, 20, 30 years, they're astronomical. And I've yet to find find anything that, that matches that type of a return which, which has, has been my analysis. Nick, I'm curious. Why do you prefer or favor a dividend paying strategy versus other ways of investing in stocks?

Yeah. So dividend investing has definitely like seemed to surge in popularity over the last 10 or 20 years, but it's definitely not a new phenomenon. Benjamin Graham, who many people know as the father of value investing, said famously in his book Security Analysis, the prime purpose of a business corporation is to pay rising dividends over time. So paying increasing dividend payments has been something that people have looked at for a long time and it's not just about the dollar income that you generate, although that definitely has benefits, especially when it comes to retirement. If you have stocks that pay dividends, you won't have to Sell any stocks to fund your lifestyle, assuming your portfolio is big enough. So there's obviously that benefit, which is kind of clear up front. But there's also, I would say three separate reasons why we believe that dividend paying stocks tend to outperform over time. The first one is that in order for a stock to pay dividends, and especially for it to pay rising dividends over time, it has to actually have cash. So a company that doesn't have cash can't pay dividends. And this naturally excludes what we would consider to be the two riskiest buckets of stocks, which would be pre revenue startup businesses and then separately businesses that are about to go through bankruptcy. So dividend peg stocks kind of naturally excludes both of those, which is great. The second reason is that company management teams generally have more cash than they know what to do with. At least in a successful company like a Coca Cola or a Johnson and Johnson or any of the types of companies that share dividend tends to cover. So if you force the company to pay out some of that cash as dividend payments, you're kind of making management double down on its best opportunities because it doesn't have enough cash to pursue like the mediocre opportunity end of the spectrum. So dividends force capital allocators to really only focus on the best opportunities available to them. And then thirdly, dividend paying stocks just show that a company's management team and its board of directors, they're shareholder friendly. They care about the shareholders that own their company. So if they're making the shareholder friendly decision of paying dividends, of literally distributing their profits out to the shareholders, then it's likely that they're also making similarly shareholder friendly decisions behind closed doors that we don't get to see as much. So there's lots of reasons to like dividend paying stocks, but I would say those are like the three that we think about the most.

Yeah, that makes sense. So Nick, I'm curious when you're looking, when I, when I read the Shirt Evident newsletter, there's sometimes ones on there that make me go, that I, that I want to ask you about. But before I go there, I wanted. There's been a lot of Talk inside the 1% community about oil companies. And because oil companies got absolutely trounced with, with coronavirus news, they pay really healthy dividends. But there's also some fear in the marketplace right now. I also know that a lot of them are, some of them are paying their dividends with debt. But there have been consistent dividend aristocrats meaning they've raised their dividend every year for at least 25 years. So when we're talking about something like an Exxon or a Chevron. Nick, what is your analysis of oil companies right now?

Sure. So let me preface this by just saying that we have like a dedicated oil analyst who's about 50 times smarter about this type of thing than I am. I'm definitely not an oil expert, but I can kind of give you like the, the 50,000 foot view on a couple oil companies that we cover. And then if anyone who's watching this is curious about more detail, you can just email me@nickernevidend.com I'll send you our detailed research written by are oil specialists. So with that said, there's two oil companies that are dividend aristocrats, like you said, that have paid rising dividends for a quarter century and that's ExxonMobil ticker XOM and Chevron ticker CVX. So those two companies are kind of considered to be the best of breed. ExxonMobil's got a double A credit rating from S and P and I think Chevron's got a AAA plus, although I'd have to double check that. But they have strong enough balance sheets that oil could stay very depressed for a long time and they could still fund their dividend with debt. Now obviously that is not ideal because they are deteriorating the quality of their balance sheet over time. That's not something that can last forever. But I would say if you're owning stocks for dividends and you believe you have a secular view that oil is going to increase in price back to its historical norms, then those two companies are paying dividends in the high single digits right now, giving you a tax advantage yield that you can't seem to match elsewhere generally. So outside of those two companies, the oil and gas sector is kind of notoriously barbelled where you have like the super majors on one side, your Exxons, your chevrons, your totals, etc. And then on the other end of the spectrum you have all of these very small players that are considered to be very poorly managed. You know, generally, especially in the oil and gas services industry, outside of like your Schlumberger and Halliburton, there's a lot of small players in that industry that have horrible balance sheets and generally just are poor, poor allocators of capital. So my view on energy stocks is that if you're going to invest in energy, you think oil is going to increase in price, then kind of try to stick to the high quality sector or the high quality, I guess, spectrum of the sector and avoid the really small players, even though some of them are probably paying double digit dividends. There is no double digit dividend in the world that is sustainably safe forever.

So that's interesting because a question was posted. It simply asks how high is too high of a dividend yield? If such a thing exists, at what point are you triggering a red flag? Does such a thing exist, Nick?

Yeah. So if you just look at kind of the mathematics behind dividend yield, you can kind of calculate a company's dividend yield by multiplying its valuation multiples like its price, earnings times its dividend payout ratio. So if you think about those two things, the lower a company's price to earnings ratio, the higher its dividend yield will be. So cheaper stocks have higher yields, what that means, and then separately, the higher a company's payout ratio is, the higher its dividend yield will be. So there's really only one situation in which a company will reach a double digit dividend yield. Its valuation has to be really low and its payer ratio has to be really high. Now, payout ratios are a reflection of how much capital a company wants to return to its shareholders. And price to earnings multiples are kind of a reflection of the market sentiment around the future prospects for that stock. So generally, if a stock is cheap, it's cheap for a reason. And that reason is because people think that something is bad is going to happen to it, or that it's going to underperform, its business is going to deteriorate, something like that, there's a negative view about the stock. So if you can find a negative stock with a high payer ratio and you have some kind of strong evidence that the market sentiment on it is wrong and that things are going to be much better for this company than what the market believes, then sure, high dividend yields are not a bad thing. But what you strongly have to keep in mind is that usually if the market has a strong view that's driving a stock's price down, it's usually right. And the problem with being a contrarian is that as a contrarian, you're usually going to be wrong, kind of by definition. So, right, I would say generally any stock that's trading at a 6% plus dividend yield is most of those stocks in that universe are kind of junky. You have to be do some strong due diligence to make sure that the stocks in that universe are paying sustainable dividends and that there's not going to be something horrible happen to their business or their dividend in the near future.

So let's combine those last two questions here for a second because Chevron and Exxon Both went over 6% at their lows during the most recent pullback. But it sounded like you just expressed some optimism in those two companies specifically. So is that a freak scenario or is there something else that I need to understand?

Yeah, I think.

There'S a lot that goes into the movements of oil stocks and more so than I would say any other sector because they're highly correlated to this outside commodity, just like WTI crude oil. Right. So.

I would guess that there may have been a bit of overreaction to the downside when oil kind of fell off a cliff. And if oil rebounds, I'm sure those stocks will rebound correspondingly. So your view?

Yeah, yeah. I mean, if you could have bottom ticked that you would, you would have made some money for sure. The problem is, you know, no one can. The problem with calling a bottom is that usually you'll just miss it because they go so quick. You know, you only stay at the bottom for an instant.

But yeah, I would say in terms of what factors go into how high of a dividend is too high of a dividend in terms of yield anyway, the factors I would consider would be like.

How strong is this company's balance sheet? Could it afford to pay higher than what it's earning for a temporary period of time? And then separately, how shareholder friendly do you really think this company's management team is? If you have a company like Johnson and Johnson, for example, that company's shareholder meeting is kind of famous for how candid they are with their shareholders. They have been paying a steadily increasing dividend for 50 some years now. And if Johnson and Johnson's payout ratio ticked above 100%, I don't think you would see many people questioning the safety of its dividend just based on its history and its management team.

That's interesting. I want to ask you about some of the specific companies that have been on the watch list for sure Dividend. And just, just for my. My standard disclosure is I'm an idiot on the Internet. You shouldn't listen to anything that I say. This is for entertainment purposes only. But this is fun to talk about what companies you might want to add to your watch list so that you can do your own research. And some of what you have done in your research Nick and your team has done has guided me to find Some interesting things. And so there's a couple companies that I just love that were introduced to me on True Dividend. And then there's a couple that are head scratchers for me that I want to ask you about. Maybe I can understand your analysis a little bit better if I, if I, if I bring up the companies that I would have not found or considered investing in. So there's two companies that you've had on your list for a couple months now, and they're bank of the Ozarks and Walgreens. And these are two companies that have both been just beat up mercilessly lately in terms of their valuation. And yet, especially with bank of the Ozarks, have, in my assessment, such strong fundamentals that I'm curious why so many people overlook them. So I was hoping you could give your analysis of those two companies and why they're attractive to you and also why the rest of the market is overlooking them for an extended period of time.

Yeah. So I will happily dig into both of those stocks. But before I do, I just have to say two things. The first thing is that I'm going to go forward, assuming that you've read our disclaimer. So you can find that at www.suredividend.com forward/disclaimer.

Don't do anything we say is, yeah, basically this is our own research, and we're two dudes who are just talking and shooting the shit about dividend stocks. Do your own research, please.

Yeah, I mean, basically we exist to try to help people, but we're not financial advisors. So please read that disclaimer and don't sue us.

The second thing I have to say is that I am, I have a long position in Walgreens in my personal portfolio. So I'm going to tell you about our research on the stock. So don't assume I'm doing it just to pump the stock or anything. I'm just telling you what's publicly available to our subscribers. So with that out of the way, I'll dig into bank of the Ozarks first. So bank of the Ozarks, or it recently changed its name to bank ozk. They are basically a regional bank kind of situated near the Ozarks in the Midwest. And what they kind of specialize in is construction lending. So they have a big construction loan portfolio in New York City, a big construction loan portfolio in California, and then they would have all the other services that a regional bank would have to. They would have commercial deposit accounts, mortgages, lines of credit, all of Those sorts of things, credit cards. So bank of the Ozark has been hammered. They're kind of trading at a single digit P E now for like years, it seems like. And the valuation just doesn't make sense if you compare their valuation to a similar basket of other regional banks that trade across the country. So why is that? The reason why that is is because people.

At least pessimistic people, they look at Bank Ozk and they see this construction loan portfolio and they say, hey, if the economy really takes a hit, construction activity is going to stop. And we kind of have two concerns about that. A, maybe they're not going to be able to underwrite any new construction loans because no one's going to be funding new projects and that's going to kind of hit their earnings growth. And then B, maybe the people that are kind of the counterparties on their existing construction loan portfolio will stop making their payments and they'll have to, you know, present these big credit loss loan or credit loan losses on their income statement. So that's kind of the, the concern around Bank Oz K. And then on the positive side, that bank has been run by the same kind of what I would call like an outsider CEO, a very skilled CEO who's a strong capital allocator. There's a book about These types of CEOs called the outsiders by William Thorndike. And it's about Warren Buffett and those types of amazing CEOs. So we would consider him to be somewhat of an outsider CEO because he's been running this bank for decades now to some pretty phenomenal return returns. They've done double digit percent CAGRs, basically perennially. So I believe his name is Glenn, Glenn Gleason. And if you look at his track record as a CEO working in just the financial services industry and underwriting loans in the construction space, he's, you know, he's navigated worse construction crisis than we've seen now. He, you know, they made money through 2007-2009, which very few banks can say. So, you know, I would say just based on their leadership team, we think the concerns around their construction loan portfolio are probably overblown. So that's the thesis on Banco ZK Got it.

Cool. Makes sense.

And then on Walgreens. So Walgreens kind of has two business lines. They have pharmaceutical distribution and you know, just retail sales, like convenience stores and those sorts of things. And Walgreens I would say has just been. Their stock price has just been punished severely because of fears that the government is going to take some sort of action surrounding pharmaceutical prices. They take a cut of every pharmaceutical sale. So lower pharmaceutical prices means that their cut would probably be squeezed as well. So that's been a huge negative sentiment change around their stock. And then separately, there's been also concerns around.

Kind of their ability to succeed in an e commerce first world. And that was so about two years ago. I think it was late 2017, early 2018, although I may have the date slightly wrong. Amazon acquired a company called Pillpack. And Pill Pack was basically they made those bubble packs for people who need to take multiple pills every day and they would ship them right to your house. So they were kind of like the Amazon of drugs. And everyone said, wow, Amazon just bought this pill pack and now they have like their foot in the door for pharmaceutical distributions and Walgreens is screwed. They're going to go bankrupt. So that was like three years ago. Their stock fell off a cliff. And I have not heard a single other news headline about Pillpack ever since. And Walgreens stock has not recovered. So that's basically the thesis on Walgreens. We think the fears around pharmaceutical prices and around the electronic situation of real drugs or pharmaceuticals are probably quite overblown.

Yeah. And okay, so in your assessment, the, the, the lower valuation has been overblown because of one piece of news from a few years ago. And the payout ratio and the dividend, dividend yield are healthy enough to be able to manage that kind of what you think is a mismatch. Is there anything else that goes into that analysis as a company? For Walgreens?

Yeah, I mean, for any company. We would also look at the other standard things like what is their free cash flow conversion look like? So there are many companies whose free cash flow differs materially from their, from their earnings because they might have like, high capital expenditures or because of a bunch of other accounting idiosyncrasies. So for Walgreens, I would say all of their financial metrics look pretty strong. Their balance sheet is healthy, their free cash flow conversion is good, and perhaps most importantly, their dividend pay ratio is like well below where we would consider it to be safe.

Okay, got it. So one that was a real head scratcher for me, particularly in the last newsletter was, I think this was a new one. On the list was Foot Locker. And I'm looking at this and I'm going, why in the world is anyone buying Footlocker in the year 2020? I don't even know anyone who shops there. And no one is going to be going to malls and retail stores right now, which is the only place that I know Foot Locker has a presence. So why is a company that to me is as old hat as Foot Locker interesting to you and the rest of the team?

Yeah, so it's interesting. I'm not surprised that you found Footlocker to be a head scratcher because we had, you know, some strong internal discussion before we recommended it for the first time, I believe. Footlocker was first introduced into our newsletter in summer of 2019. And when I first saw it, I kind of had the same questions you did because our system, as you can tell, is kind of very systematic. It's very rules based. So it's not like I'm going through a list of stocks in like the Moody's manual and trying to pick which one I like best. They turn up from screeners primarily, and then we, we vet them according to various exclusion criteria. So when I first saw Footlocker, I basically had the same questions you did. And if you really dig into this company's annual reports and its financial statements, what, what immediately comes to light is that Footlocker has done a much better job than most retailers of transitioning to like, what we call an omnichannel model. So they have lots of capabilities where you can order shoes online and then pick them up at the store, or you can order them online and then get them shipped to your house and try them on. And if they don't fit, you can ship them back. And they've actually done this in a fairly unique way where many retailers, like take an Amazon, for example, if you want to buy something on Amazon, you just go to Amazon.com and everyone kind of knows that because Amazon is the big behemoth in the space. But for Footlocker, they would have a different website for every country. So they might have, you know, Taiwan Shoes.com, i don't know if that's a real website, but that's like an example and that's like a Footlocker property that Footlocker uses to sell shoes online to people in Taiwan. And then they've optimized all these websites with SEO and other things. So if you actually look at Footlocker's e commerce growth, it's been very, very impressive. And like most retailers, their brick and mortar presence is not really growing right now, but they've more than made up for it with this very, very strong E commerce presence.

Really? That's really interesting.

Yeah, you can actually, if you're curious, you can go into their annual report and they kind of break down all of their web properties in a very transparent manner. It's quite cool.

Yeah, that. That is really cool. What other companies came on your radar newly in the last two to three months because prices in the, you know, the paper values of so many companies came down. Were there any other new companies that kind of came to your attention during this?

Yeah, that's a good question.

To be honest with you, you're kind of asking at a bad time because I just came off two weeks of vacation where we published our two newsletters. But, you know, in general, I would say a few companies that have stood out as performing very well through this and we think are going to be like minimally impacted from a financial point of view. Walmart has done extremely well. Costco has done extremely well. And anyone who has been to a Walmart or a Costco in the last month or so can kind of attest that their traffic has been just absolutely absurd. So those two companies stand out. And then basically any company that has plenty of cash on its balance sheet is probably going to do well because the economy is going to shut down. A lot of companies are going to go cash flow negative for a short period of time. So if you're just looking around for other opportunities, I would just say make sure it's got at least a few quarters of cash on its balance sheet because it is going to be tight for a while. I mean, if you just look at any of the airline or cruise line companies, for example, a lot of those are going to report negative revenue in Q2. Not negative earnings, negative revenue, because their refunds are going to outweigh how many ticket sales they have. Yeah, there is no financial analyst in the world who last year, when planning for Q2, 2020, said, oh, I'm going to bake in this small probability that we'll have negative revenue. This is just a complete black swan. And because of that, you really just have to make sure the companies that you're buying have lots of cash on hand.

Do you feel tempted at a time like this to buy airlines or cruise companies that are going to get taken through the wringer for the next couple of months, knowing that they have really well, they've historically had great dividends. I mean, I think carnival hit like 25% at one point. Obviously that's not the case now because they've cut their dividend and they won't have any. Have any money to distribute. But also with airlines, you're seeing Delta over, you know, into really healthy Attractive territories, but they may have negative revenue for a couple months. Do you feel tempted to try and buy some of these companies at the bottom, or do you avoid them altogether because of uncertainty?

Yeah, so Warren Buffett has this concept that he calls like the too hard pile, where if some ideas like too hard for him to work through, he just kind of puts it aside and doesn't waste any time thinking about it. I would say that for me personally, airlines are kind of in the too hard pile. Not because they're complicated as businesses or anything like that, but I'm not sure that anyone outside of DC can really reasonably predict what the government's gonna do because the government could just let them go bankrupt and wipe out all the equity holders. And if you're like a pure capitalist and you really believe in capitalism, that's probably what should happen. Now, there is a bit of a socialist bent where what happens to the employees of those companies if they get wiped out? And there's all kinds of things that go into thinking through this, but I would say whether or not to buy airline stocks right now, it's not a stock market decision. It's like a public policy decision where you just have to really be sure that you understand what's going to happen at the government level.

That's interesting because I would, I'd argue that from a pure capitalist perspective, the government should have never interfered in airlines business in the first place, like they caused the shutdown. So at some level they also have a responsibility for making it right. Which is very weird for my free market brain, but it's like the government broke it. And so I feel like the government should also buy it in one way or the other.

So.

But what I'm basically hearing you say, Nick, is that regardless of the, of the, the fundamentals of the company, there's so much uncertainty in how the government could manage the airlines or affect their business that figuring out the answer to that question puts it into the too hard pile for you. Is that a fair summary?

Yeah, exactly. I mean, I spend my time reading about stocks, not about public policy. Although it is certainly interesting, it's not a. It's not within my circle of competence enough to really make a decision in terms of whether or not to buy airlines.

Yeah. So like, and I agree with you completely, there's like the sense of, when I, if I look at a Delta Airlines, like the company fundamentals are still fantastic, but I wasn't factoring in negative revenue for a couple of months. The government might keep things very, you know, it might prevent international travel for several quarters. And so are you seeing the same thing as me, that all the fundamentals look really solid, but there's just this big question of uncertainty.

Yeah, exactly. I mean, before this all happened, a lot of people thought that the airlines had kind of consolidated enough that the industry had rationalized and that it was going to be like attractive grounds for hunting for investment opportunities moving forward. I mean, Warren Buffett was literally in that camp. He bought all the airlines and he's been selling them off. I mean, for God knows why, but he has. So it's really hard to say, like, is the industry, has it rationalized? And this was just like a black swan that would have wrecked any travel industry or are the airlines the same old boom and bust industry that they've always been? Who knows?

Yeah, it's difficult to predict. Obviously you started to go down a certain route and I cut you off. It was. But I want to speak to the person who is, is listening to this and being like this is. This sounds really complicated and hard. I was just curious where you are finding the cash on hand and the calculation of can a company weather a few quarters or a few months of negative profit? Where are you finding that and how do you calculate that?

Yeah, so it would really come down to, I would say two categories, cash in and cash out. So there's going to be no cash in and instead what you'll just do is you'll say how much cash is on the balance sheet and then from that you'll need to figure out how much cash is leaving the business every quarter. So to do that I would say go to the statement of cash flows and go to the operating cash flow section, which should be the first statement on this, the first section on the statement of cash flows. And then from that section, basically cross out every positive cash flow and then add up all the negative cash flows and that's how much leaving is leaving every quarter.

Yeah, you're basically looking at expenses and subtracting that from the overall balance sheet. Is that correct?

Yeah. I mean, take the cash and equivalents from the balance sheet divided by how much cash is leaving the business every quarter. And that's your Runway. You know, if you get two, then you have two quarters of Runway. If you get five, then you have five quarters of Runway. Obviously, the longer the better, but man, it's going to be tight for some of these businesses.

Yeah, I understand. So for just to put that into layman's terms for any of you who are scratching your heads right now, you can find the financial reports for any publicly traded company. You can find their balance sheets and their operating expenses, and it's very, very easy to find. And what Nick is saying is that he looks at the cash on hand inside of the balance sheet and then he's looking at what the total expenses are for the company and simply doing basic math where he is subtracting what the company could lose as a result of having no revenue for a few months or even a few quarters, and then subtracting that from the free cat from the cash that the company has on hand. And that's all publicly reported. So, Nick, part of my assessment coming into this has been I am running away from companies that have a lot of debt and I'm running two companies that have a lot of cash on hand to weather a storm. Do you agree with that approach as kind of a, a base level analysis of a company?

Yeah, absolutely. Especially right now when revenue is going to be tight for most businesses.

Yeah. And what do you, do you have, have you seen anything like this before? Can you compare any of this contraction to 2007, 8 or anything like this? Or are we, is this a completely different event?

Well, I mean, there are certainly some similarities. Anytime stocks decline precipitously, you're always going to be able to make comparisons and there's always going to be people everywhere who are comparing this to, you know, anything from 2007, 2008, all the way back to like the 1918 Spanish flu. So I would say compared to 2008, the one thing that seems to be different about this, or I mean, not the one thing, but the biggest thing I would say is that in 2008, it was kind of like a crisis on Wall street that spilled out over to Main Street. So a lot of people started losing their jobs and they said, why am I losing my jobs? This is so bizarre. But in this case, this is really like a Main street crisis, like a crisis of the people that seem to take a long time to spill over to Wall Street. And I would actually argue even today, stocks have seemed to underreact to how bad this will be to the average American. So right now, you know, GDP is probably going to be down 30, 40% in Q2, and stocks are not down that much. They may have been peaked to trough, but right now they're certainly not down that much. So I know stocks are a leading indicator and people may be buying stocks again in anticipation that things are going to get better. But it seems to be the progression of this crisis seems to be backwards compared to where it was 13 years ago in our last financial crisis.

Yeah, I agree with that. And just to make sure I understand what you're saying is that it seems like there was an over correction at the beginning. And then it seems like the optimism is ahead of Main Street. Like this is really gonna hurt Main street in like a month, maybe a little bit longer, maybe, maybe even three months. But that Wall street seems to be looking past it and they might end up being surprised by how hard this hits Main Street. Is that kind of what you're saying?

Yeah, yeah. I mean, to put it differently, I would say this seemed to have hit Main street first, whereas last time it hit Wall street first, and then the layoffs to Main street came later.

I see, I see. So we had, we had that big market tank at the beginning, and then you had all the hard economic times. This is almost the opposite where Wall street is reacting and overreacting. But at least as of the last few days, we've been kind of nor like recovering, but we might have an economic downturn. That is the ripple effects that will hit Wall street later. Am I understanding?

Yeah, that's correct. Another thing actually, now that I think about it, is that is noticeably different is the speed of government intervention. So all the reading that I've done about 2007, 2008, the government was a little slow to act. And when they did act, it wasn't in very big magnitude. So I think In April of 2008, the government sent out like one single $600 stimulus check to all Americans. And then the bottom was like March of 2009, like you know, 11 months later. So that was like a big leg this time, at least so far. The government acted immediately, we hit the bottom, and we started to rebound because there doesn't seem to be an end to how many trillions of dollars that the government is willing to inject into the economy to keep this from bankrupting everyone.

Yeah, I hear you. Let me ask you, Nick, what do you think of.

Dividend paying companies that are not aristocrats Reits and.

Those types of income plays, how does that work into your analysis or your portfolio, if at all?

Yeah. So.

I guess there's a number of ways you think about it. I guess the most important thing is that if you look at any of the aristocrats, or what we call like a dividend king with 50 years of dividend increases, their historical returns over long periods of time have been amazing. So it would have been great to buy a dividend king 50 years ago and get 50 years of dividend increases. But the problem is 50 years ago, that company wasn't a dividend king, it just started paying a dividend. So.

That'S kind of the big question is how do you identify those companies that aren't yet aristocrats but will be someday? And there's a lot of kind of just business analysis that needs to go in that you need a company that has high returns on capital and plenty of room to incrementally invest that capital at that same high rate of return. I mean, if you think about Walmart in 1970, they didn't have a capital allocation strategy. Their strategy was like three words, open more stores. If you can find like the Walmart of the 1970, and you pair that with a management team that really wants to return a lot of the excess capital to shareholders, that's kind of like the strategy to finding the next dividend aristocrat. Now, we do a lot of thinking about that, but the truth is there is no easy 1, 2, 3 step to find them. Because there's a lot that can go wrong between now and 25 years from now when that company might be a dividend aristocrat in terms of how we actually assess those companies. We don't actually use dividend history as like something to measure, like prospective returns. Instead, dividend history just goes into our dividend safety calculation. So all else being equal, we would consider a company that has a long dividend history to be safer than a company with a short dividend history.

Yeah. Do you have any red flags of companies or sectors that you absolutely avoid, no matter what?

We don't. I would say we're relatively sector agnostic. We do so in our newsletter. We recommend 10 stocks every month and we recommend no more than three stocks from any individual sector. That generally is not a constraint that we have to change anything in response to, except for with respect to the financial sector, we tend to have a lot of financial stocks come up in our screeners. So we usually have to discard a couple of financial stocks every newsletter because we too many of them turn up in the screener. But aside from that, I would say there are certain industries that are just a little more cyclical than others. And we don't like cyclicality. All else being equal, you know, the industrial sector, the manufacturing sector, the construction sector, and we talked about this earlier, but the energy sector, those are kind of the examples of cyclical industries that we see as a little bit less attractive, but not enough to exclude them entirely.

Forgive me if I'm misremembering, but I think Caterpillar has been on the list in the past, but that would be an industrial or construction stock, so why does that get an exception?

So Caterpillar just kind of has enough scale in that industry that if you're a farmer or a construction worker and you go out to buy, you know, a new piece of equipment, there's all kinds of these smaller brands. But there's a really good chance that you'll go with Caterpillar just because it's a name you recognize and trust. So they kind of have like a brand advantage. And then they've also paired that with a really robust financing and servicing segment that is a little less cyclical. The financing segment would be more cyclical than the service segment. But even in a bad economy where people stop buying new equipment, their existing equipment still needs to get serviced. And Caterpillar has done an excellent job of pairing their equipment sales with these long term service contracts that are a little less, I guess, weak to recessions, if that makes sense.

Yeah, it does. Nick, what do you suggest to investors during this time, during all this volatility, all this craziness? How are you approaching this and how are you discussing it internally in terms of the mindset that investors should have right now?

Yeah, I mean, the easiest recommendation I can give is just three words. Just keep buying. I mean, we've always recommended to our readers that you need to build a robust systematized investment strategy that you're comfortable with, like through thick and thin, and then stick to that strategy over time.

It's not very, you know, it's not very glamorous. But my recommendations would basically be the same as if you would have asked me a year ago. Just keep buying. And, you know, stick to the strategy.

Is sticking to the strategy and buying more of the companies that you believe in that are now on sale.

Yeah, yeah, exactly. And I mean, if you can really swing it, this would be a great time to try to jack up your savings rate a little bit. I know a lot of people are kind of stuck at home right now. We're not going out to restaurants as much. We may have a little bit more income, assuming that you haven't been laid off or anything. So it might be a good time to, you know, increase your contributions a little bit if you have the capacity to do so.

Yeah, and, and you, you said Warren Buffett is selling airlines. God knows why. And I, I realize now that what you're saying is it seems strange to. That Warren Buffett would go against kind of his own rule, which is to keep buying companies that are on sale. His favorite. Some of his favorite companies are on sale right now. Why is he selling? Do you have any analysis on that?

Yeah, I mean, this is like a whole conspiracy theory rabbit hole that I actually, I went pretty deep down this last week trying to find, figure out why the heck is Buffett selling his airlines. But there's like, a couple different ways you can spin it. The most obvious one is just like, okay, so Buffett made a mistake. He shouldn't have bought the airlines, and now he's selling them. So that's like, option one. Option two is that he is about to close on, like, an absolutely massive acquisition and just needs to raise a bit of cash. And the airlines were kind of just like some of the larger, more liquid opportunities. And Buffett is in most of his stocks. He's sitting on huge unrealized gains in the airlines. He would be sitting on unrealized losses. So he might be trying to sell some of his realized gains along with some of his airlines to get kind of like, to a capital gains net of zero so he doesn't have to pay any tax, if that makes sense. So, yeah, the second option is just he's selling airlines to raise cash for a big acquisition. A third option is that.

So Buffett owned more than 10% of all of his airlines, which means that every time he buys or sells them, he has to file a certain form with the SEC called a Form 4, which is just. It's called the changes in beneficial ownership. And you have to file that form if you're like the CEO or if you're on the board of directors or if you own more than 10% of the stock, like Buffett does. So he sold down his stocks below the 10% threshold. And we can confirm that because he had to file a Form 4. And then once he got below that 10% threshold, he no longer has to file anything. So some people have wondered if he filed down to below the 10% threshold so that he could buy up all the daily volume for like, a couple of weeks until he gets back to, like, you know, 50% ownership of one of them. And then he can just do, like, a hostile takeover and take one internal so that that option three is kind of like from the conspiracy theory world. But that is one other potential possibility.

So, so in other words, he had that that conspiracy would be that he needed to get out of the the range in which he had to disclose everything so that he could play the Volatility. The volatility part confused me, but so that he could plan for a takeover of one of the airlines and bring it internal to Berkshire Hathaway.

Yeah, I can give like a bit more color there. So once he gets below. I mean, this is all very hypothetical. I personally don't think that this is very likely, but it's interesting to think about nonetheless. If he gets below that 10% threshold, once you get back above the 10% threshold again, I think there's like a three week period after which you have to file your first form four. So the theory is he sells until he gets down below 10% and then he starts buying aggressively for three weeks. He could probably bid up, I don't know, like 40% of their stock or something at that point, based on the calculations I saw. So he gobbles up as much stock as he can.

I see.

And then his next form four will say, hey, I just bought, you know, 20% more, 30 more of this company. And here's my form for it to say. I think there is an argument to be made that he could probably get sued for like market manipulation if that was the case. But he's probably got better lawyers than Nick McCollum, so I'm sure.

Okay, got it. Now that makes more sense. So basically he could exit and then take advantage of the buy at a very low valuation.

Because he didn't have to disclose his involvement right away.

That's exactly.

That's interesting.

Exactly.

So your overall recommendation to investors is to stay the course, to continue to buy up income producing companies that have healthy balance sheets, good companies at good prices, good companies that can weather the storm, good companies that have enough cash to be able to weather this and to continue to follow that strategy if and when, until and when we get through this and go back to a normal expectation of growth. So my final question to you is, do you think that there's a time that we will. Do you think we're going to return to normal or are we in times where there's a new normal?

Yeah, I mean, I will say, you know, I strongly believe we're going to come out of this relatively unscathed. And the truth is, if we don't, and it's kind of some kind of permanent pandemic in the world, we're not going to be caring about which stocks we bought. We're going to wish we had bought guns and ammo, truthfully. But I will say, in general, like, things that are going to change, I think we're going to have A more robust health care system is going to be just big supplies of masks and health care equipment everywhere that we didn't have before. But I don't think things are going to be really that different. I think that if we look back at other financial crises, you know, was 2011 that much different than 2006? You know, before the financial crisis versus after? I don't really think so. And I would say just my general non financial recommendation to everyone who asks about this is that it's really, really easy to kind of talk yourself into a position of anxiety surrounding coronavirus things. So, you know, at the end of the day, take advantage of this time at home to really do the things that are the most important. You know, spend some time with your family, keep up on your fitness and you know, just try to enjoy life while you can. Because you know, at the end of the day we're going to work through this and things are going to go back to normal before we know it.

I want to end things on one more good question that was asked. When is a good time to sell a dividend paying stock and is there one? If you intend to hold it for 10, 20, 30 years, do you have a time that you would consider selling?

Yeah. So we sell stocks, I would say, based on two criterias. And these are pretty firm rules. So we don't really make exceptions to the issue rules. The first one is if a company cuts its dividend, then that's kind of an automatic sell for us because like I mentioned, it's. We're in the business of building portfolios for people that generate rising dividend income over time. So if a company's selling or if it's cutting its dividend, then it's kind of a dud and we're done with it. Now with that said, we might not sell it right away because a lot of times when a company sells a stock, the stock plummets and then kind of recovers pretty quickly thereafter. So it might not be an automatic sell or it is an automatic sell, but maybe not an immediate sell. So we would kind of put that in a pending sell bucket to be revisited later. And then the second time we would sell a stock is when we believe that it's just on pace to deliver returns well below the S&P 500. If that's the case and it's so easy to just sell that stock and buy Spy, ETF or whatever other vehicle that you'd like to, you know, capture the returns of the S&P 500, then we would Just say, sell that overvalued stock and, you know, buy one of our other newsletter recommendations instead.

Yeah, I mean, I'll throw one more at you. I've had, I've had this scenario happen, like with, this happened with Target for me recently where I had been an owner in Target for years and years and years, and then it came out with a new earnings report that just shot it up to the moon, you know, shot it up to like $110 a share. And I sat there and went, that's a lot of dividends. I mean, there's a lot of dividends that, that were, that just grew in terms of this company's valuation. And so I took that off the table and, you know, can use that cash to buy something else that I'm. I expect to have higher returns in the, in the midterm.

Yeah, I mean, that is exactly kind of what we recommend. A lot of times the stock market kind of, I would say in general, the stock market underreacts to good news and overreacts to bad news. But there are rare cases where like some modestly good news will come out and a stock will absolutely surge. And especially if you're in a non taxable account where you won't get taxed on that capital gain, that's definitely a good time to sell and kind of revisit other opportunities.

Yeah. Well, Nick, I'm a fan of your work over at sure Dividend. Full disclosure, I am a paid subscriber over there, everybody. So I'm a little bit biased and my opinions are colored, but I really like the work that they do with over there. So, Nick, I look forward to the report every month. Keep doing what you're doing. And thanks for hanging out with us@capitalism.com.

Yeah, my pleasure, Ryan. Thanks again for having me.

Hey, team. If you enjoyed today's podcast, please let me know on Twitter or Instagram. I'm Ryan Moran on Twitter and RyanDaniel Moran over on Instagram. And if you're looking to start a business or you know, somebody who's starting a new journey during this crazy time, you're wondering, what am I going to do next? You're wondering, what do I do with my time? You're wondering, wondering, where's the world going? My new book, 12 months to 1 million is going to give you the clear plan to pick a winning product, to build a seven figure business, and to become a successful entrepreneur. This is for those of you who want to live life on your own terms. For those of you who are struggling with a lack of clarity who are wondering what am I going to do next? Who are wondering what's the path to building a successful business so that I live life on my own terms, I can call my own shots, and I don't have to go back to work after all of this crap craziness is over. If you're the type of person who has to be an entrepreneur, then you've got to read this book. You can get on Amazon, or if you're in a position to order multiple copies, you can book that over@capitalism.com book I'm so proud of this. So proud of this community for all that it has done. Thank you so much. I hope you love the book.