Did you see Charlie Munger’s quote on Benjamin Graham during his recent fireside with the Wall Street Journal?

I don’t love Ben Graham and his ideas the way Warren does. You have to understand, to Warren — who discovered him at such a young age and then went to work for him — Ben Graham’s insights changed his whole life, and he spent much of his early years worshiping the master at close range.  But I have to say, Ben Graham had a lot to learn as an investor.  His ideas of how to value companies were all shaped by how the Great Crash and the Depression almost destroyed him, and he was always a little afraid of what the market can do. It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay.

I think Ben Graham wasn’t nearly as good an investor as Warren is or even as good as I am.  Buying those cheap, cigar-butt stocks [companies with limited potential growth selling at a fraction of what they would be worth in a takeover or liquidation] was a snare and a delusion, and it would never work with the kinds of sums of money we have. You can’t do it with billions of dollars or even many millions of dollars.  But he was a very good writer and a very good teacher and a brilliant man, one of the only intellectuals – probably the only intellectual — in the investing business at the time.

One of the things about Benjamin Graham’s writings—particularly his mid-career writings about maximizing returns—is that an individual  investment gets treated as a very ephemeral act; you buy your stock for $20 that you think is worth $35, and you sell when it approaches $35. That’s as far as that idea gets you. As a matter of personal preference, I want my good ideas to last a long time, and I want to reap as much benefit from a single decision as possible.

The early style of investing advocated by Graham is hard to pull because it requires a series of successful decisions: (1) you have to find the right company to purchase, at the right price, then (2) you have to make another decision about the right time to sell, and once you do that, you’re (3) back to Step #1 again as you have to take the cash and find something new that’s on sale. To succeed at that style of investing, you need to have constantly new and correct insights.

But it’s more than just convenience—if the Graham approach was more difficult but led to the best results, it might be worth getting over any psychological hang-ups and sucking it up because modifying our behavior would lead to greater rewards. But the hidden insight that was in Munger’s comment was this: if you spend your time searching for a company growing profits per share at 11%, 13%, 15%, or whatever the is the best you can find with high conviction, you only have to get one decision right—the buy at an appropriate price part, and your job is complete.

This conversation topic often gets distorted in investment discussions with questions like, “Is buy-and-hold investing a good strategy?” The question is incomplete until you start discussing what company it is that you are buying and holding. What is nice to know is that, if you decent amount of money to invest, you only have to get one company right in your entire life to have it made (see Munger’s classic comment ‘The bad news is that the first $100,000 is a bitch; the good news is that you only have to get rich once”).

Imagine if you did your homework and saw that Becton Dickinson was growing at rate north of 10% over just about every five-year rolling period dating back to the 1960s. If you study this stuff intensely, they’re one of the few companies that can be heralded as a “baby Johnson & Johnson.” Heck, Becton Dickinson has been raising its dividend every year since 1965, and if you focus on companies with lengthy dividend streaks as the basis for making investments, Becton Dickinson would have turned up on your radar screen at some point in the past decades, as it has been raising its dividend payout since 1965. From 2004 through 2014, its earnings continued to grow at a rate of 11.5%. Every $1 invested in Becton Dickinson on its 25^th anniversary of consecutive dividend increases in 1990 would have seen each dollar grow into $18.29 today, and that is the result of you took the dividends as cash each year and spent them however you saw fit.

And if you didn’t do your homework, but had a keen eye for a business with an unassailable moat and chose to purchase Disney stock in the 1980s (say you had bad timing and bought in 1987 before the Black Monday crash), you still would have seen each $1 invested grow into over $26 in the next quarter of a century. Even in the past decade, since becoming a mega-sized corporation, Disney has still grown profits annually at a rate of 15%.

Are there difficult periods, even with a company of Disney’s caliber? Sure. The dividend sat still at $0.35 from 2008 through 2010. During the Recession, its profits declined from $2.26 to $1.82. The price fell from $35 to $15. If you had initiated your position in Disney in 2007, you saw a $10,000 investment become worth less than $5,000 as a result of your timing. It’s an acquired skill to deal with that situation intelligently, and realize that scrounging additional funds to buy Disney selling at the unbelievably low price of 11x earnings is a sign of an opportunity, rather than a burden, emerging.

That’s why I write so extensively about Visa on this site because it is the best stock I have ever found at growing fast internally, with revenues increasing at 18% annually and earnings increasing at 18.5% annually over the past five years. It carries no doubt, and its profit growth is one of the most impressive things I’ve studied. In 2006, Visa made $455 million in net profit. By the end of 2014, it’s expected to be $5.5 billion. That’s because its net profit margins are 43%. It collects fees based on how much money people spend, and that is an automatic, inherent inflation hedge. Its emerging markets operations are growing at 30% annually, while U.S. operations are growing at 8.5%.

Stylistically, the appeal of Munger’s approach is that you make one decision, and the benefits are ongoing. If you stuff your portfolio with the likes of Becton Dickinson, Disney, and Visa, you put yourself in the position to reap long-term returns at a rate north of 10%, and the ongoing effort is minimal, especially compared to the buy-a-discounted-stock-sell-at-fair-value-then-repeat approach that Graham advised in his early life writings.

If you’ve been reading personal finance articles for a while, you’ve probably come across the different studies that compare one’s overall sense of happiness in relation to the amount of household income that they are able to generate. You may have seen Malcolm Gladwell’s figure about how the slope of money buying happiness is the greatest around the $75,000 mark, and then money is able to buy happiness at a much slower and slower pace after that.

I never paid a whole lot of attention to those types of studies because I’ve always had the gut intuition that money is a super big deal when it comes to the basics (shelter, transportation, food, etc.) and once you have those basics covered and a little walking around money in your pocket, then the quality of your relationships with others as well as sense of personal satisfaction and accomplishment with how you are choosing to fill your days would take precedent.

In terms of critiquing those types of “money buys happiness” studies, there are usually two problems with their methodology that prevent me from taking them seriously.

First of all, they focus on the quality of life based on the amount of money that your household makes, rather than adjusting for household spending. From a happiness evaluation perspective, there is a whole lot of difference between making $150,000 per year and spending nearly $150,000 per year compared to make $150,000 per year while spending $65,000 per year. I would think that what you do with your money, as well as how much of you spend, would have an effect on personal happiness just as much as how much is coming in.

The Charles Dickens character Mr. Micawber offered this pithy saying for happiness as it relates to finances: “Annual income twenty pounds, annual expenditure nineteen pounds, nineteen shillings, and six pence. Result: Happiness. Annual income twenty pounds, annual expenditure twenty pounds and six pence. Result: Misery.” Yet, it doesn’t look like Micawber’s wisdom travelled across the pond into the methodologies of American researchers, as the focus remains stubbornly on the amount of money generated to determine happiness without paying attention to the expense side of the equation in their analysis.

My other concern about those financial happiness studies is that they don’t adjust for the type of job that is creating the money, and how that could affect one’s happiness. Back in my undergraduate days, I had to write the check for the band that was playing at my fraternity on a Saturday night because the treasurer was out of town. When I was paying the band, I asked one of the guitarists if he was a musician permanently or if he had to do something else with his time. He volunteered that he made about $2k per month, and added that he loved it because he got free beer, a free place to stay, and would get to know a different woman every other weekend. The quality and personal satisfaction of his life making $24k per year is going to be a whole lot different than someone in his 60s scrubbing toilets at a large grocery story making the same amount.

Somehow, I would like to see these income happiness studies combined with those other academic studies that argue in favor of men and women owning their own businesses being the ones that experience the greatest amount of happiness. Does someone who makes $40k but owns her own business lead a happier life than someone who makes $100k per year but is considered a minion at his work? Does doing work where you are creating an irreplaceable product make you feel indispensable and therefore valuable compared to employment where you feel like another cog in the machine, and if not you, someone else will be doing that exact same work? My theory would be that the amount of autonomy that you have while you work (whether it is because you are an owner or are so good at your job that you are to your own devices) plays into your overall happiness levels, but these kinds of distinctions aren’t addressed in any of the happiness studies I’ve seen.

For me, it comes back to the intuitive basics. It’s about closing the gap between who you are right now and what your potential could be. It’s about creating close personal relationships where you honestly know that certain people give a damn about where you will be in ten years. It’s about filling your days where something gets created rather than merely being a placeholder, biding time. Unless you’re about to lose your house or have to wait until the Friday paycheck to eat, money will always play a secondary factor in determining overall happiness compared to relationships, realizing potential, and feeling as if you are creating something valuable.

One of the most important metrics that investors use when evaluating the merits of a company’s business success is the growth in earnings per share that a company has experienced or is expected to experience over a period of time. It’s become such an important measure, however, that it often gets gamed so that American companies avoid reporting a sudden drop in earnings. One method to accomplish that task: companies take on debt to repurchase stock and boost earnings per share to bolster the appearance of organic growth when none it exists.

The investors—read: owners—of the companies are not blameless in this regard, as we come to expect quarterly growth and hey, there are business news programs that need stories to fill up the airwaves, so a small part of the problem can be attributed to the culture that we’ve created where we expect perpetually forward motion that ignores the timeless reality of business cycles in which a company’s business results disappoint us in about three years out of every ten.

To illustrate the two extremes to which balance sheet considerations get ignored, let’s compare Anheuser-Busch against Berkshire Hathaway. Both companies are among the few dozen most profitable in the world, operate some of the most vast distribution networks and own individual brand-names that will outlive us, and have made anyone who has held either stock for any fifteen-year increment much better off than had they not done so.

I have little doubt that owners of both companies will continue to grow wealth in the coming years, decades even. But that does not mean that both shares are equally attractive. It would be much wiser, in my opinion, to initiate a position in Berkshire Hathaway today at $139 than Anheuser-Busch Inbev at $107.  And you have to look beyond the mere changes in profits per share to see why.

Anheuser-Busch Inbev carries $49 billion in debt, as a result of many acquisitions, with half of that coming to fund Inbev’s takeover of Anheuser-Busch in 2008. Over $41 billion of that consists of long-term debt. No, that is not something that dooms Anheuser-Busch from being a successful investment. But, when interest rates rise and Anheuser-Busch refinances (as AT&T, IBM, and other companies with high debt loads do in the course of their ordinary business), the amount profits that will need to go towards paying off its past than driving returns for its future will grow, and this is the kind of thing that sets a company up for 5-8% annual returns rather than 8-11% annual returns—my opinion would revise upward if the debt load went down to the $20-$25 billion range, interest rates for the debt were below 5% (and presumably, Anheuser-Busch would have a higher annual profit engine by that time as well).

Berkshire Hathaway, meanwhile, is sitting on a cash load that represents enormous untapped energy. I don’t think people realize how truly enormous Berkshire is—it has over $500 billion in assets—and a market cap well over $300 billion. Heck, it’s bigger than General Electric now, as Charlie Munger recently pointed out in astonishment. And here’s the other thing: Warren Buffett is sitting on $49 billion in cash. That’s it. That’s the coiled spring, which can be turned into a permanent increase in earnings fairly quickly—think another Heinz acquisition, or something even larger.

You saw recently that Buffett is dipping his toes into auto dealerships, but I would expect that he won’t make a large move until you start to see a broad market selloff. That’s my guess, based on his and Munger’s historical style. It’s a credit to Buffett, and an underappreciated aspect of those who analyze him, how much he prepares to strike. Success isn’t just recognizing that something is cheap, but also positioning yourself to have cash on hand to do something about it.

What’s the old Mark Twain line? A man who can read and chooses not to do so has no advantage over the man who cannot read. The investment equivalent of that would be this: if you recognize that General Electric at $6, Wells Fargo at $8, Procter & Gamble at $40, Altria at $20, Aflac at $15, Coca-Cola at $20, is a deal-of-the-generation, your insight doesn’t mean anything until you transfer the cash and press the buy button. If you don’t do that, you just wasted your own intelligence. In a worst-case scenario, you lowered the ceiling of your life’s potential, as some dreams require significant capital, and you forewent an opportunity to build.

That’s what I find so wild about what Buffett is doing right now; he’s building up a cash cushion which will be turned into a significant addition to the Berkshire Hathaway earnings base at some point, and it’s not correctly priced into the stock right now. Just walk through it: Berkshire Hathaway is worth about $338 billion. It is sitting on $49 billion in cash. It is rare—outside the halls of Microsoft or Apple, which also carry tens of billions of dollars in cash, but operate in the fast-moving tech industry—to find a company carrying 14.5% of its worth in cold, hard cash.

For illustrative purposes, if Berkshire wanted to pay out its cash to shareholders—it would look like this. You’d buy a share of the stock at $139, and you would receive a one-time dividend of $20.15. That wouldn’t actually happen because Buffett likes to carry large amounts of cash on hand not only for opportunistic investments but also as a buffer against larger-than-expected catastrophes that demand insurance payouts, but the point is illustrative of the coiled spring energy that Buffett is sitting on.

People, including yours truly, get caught up in the red herrings about Berkshire—will it ever pay a dividend, will it survive after Buffett—but this often pays inadequate tribute to what he has put together at Berkshire. Berkshire is sitting on more cash than the total economic activity—not profits, not revenues, but total economic activity—conducted in St. Louis, MO over the course of the summer. The total assets are over half-a-trillion dollars. And it’s crazy to think about what Berkshire will become when Buffett deploys some of that $49 billion during the next recession, and then we check in to see what blooms out of it five years later. I would not count Berkshire Hathaway out of the running to become the world’s first trillion-dollar company.

On Wednesday, Warren Buffett appeared on CNBC’s Squawk Box, and on that day, the prices of most American stocks were down a token amount in the 2-3% range (but enough to propel commentators into action). As you’d imagine, Warren Buffett got asked the obligatory question: “What, if anything, are you buying or selling?”

Buffett framed his response by noting that the appeal of buying companies grows for him as prices decline, and he did treat the modest selloff as an opportunity to buy. When pressed further, he provided a hint that he was buying a company that is a household name, and would not specify whether he was adding to an existing holding or initiating a new position.

If I had to speculate?

I would guess that Buffett is buying up more shares of Exxon stock.

The basis for that speculation would be two-fold: First, Buffett has said in the past when he is initiating positions in new companies, as the universe is wide. Heck, he even played a game daring the anchors to guess what his previous investment was, offering only the hint “Hal.” They couldn’t figure it out, until he came back and noted what happens when you move down one letter on each: “H-A-L” becomes “I-B-M.”

But the universe of stocks that he already owns is much smaller, and therefore more guessable, so I would expect Buffett to be more reluctant to note that he is adding to something he already owns, unless he planned to fully disclose it at the time.

That leads me to think that he is probably adding more Exxon to the portfolio. In his letter to shareholders earlier this year, Buffett noted that Berkshire purchased 0.9% of the oil giant, ExxonMobil. The total investment amount was $3.737 billion, and the total shares purchased amounted to 41,129,643 shares. Breaking it down an additional step, Buffett thought it made sense to purchase long-term shares of ExxonMobil last year at a price of $90.85.

Right now, after this most recent slide oil stocks especially, Exxon has come down to the $92, $93, $94 range. Even rounding up, comparing $90.85 to $94 is only a 3.46% increase. Heck, Exxon’s repurchased that much stock alone in the past year, leading me to believe that Buffett sees an intrinsic value increase for the year of at least 3.46%, and is using this opportunity to add some more stock.

I’ve been looking through the book Private Empire again, which tells the story of how Exxon wields more political power than the government in some third-world countries, and because of its size and scope, necessarily became a pioneer in some of the fields of financial engineering and setting incentives.

As an example, Exxon was the first company among the “if you’re a long-term dividend investor, you own this” crowd to start repurchasing stock annually as a corporate policy, after seeing Henry Singleton’s success at Teledyne and after the SEC loosened the rules in 1982 so that stock repurchasing no longer was legally ambiguous with market manipulation.

In Exxon’s case, it was a masterstroke of genius. The company was approaching a size where it could no longer grow profits at a 10% clip, but it could grow profits at a 5-8% clip and retire 3-5% of its stock, depending on the year and the capital investment opportunities available at the time. By deciding to permanently retire 3-5% of its outstanding stock each year, it created a situation where the company could have lower organic growth yet still deliver returns to investors that aligned with historical expectations.

It’s not that the stock buyback itself is magical per se, but rather, it interacts well with two other things: (1) Exxon’s core business operations generate enormous cash profits, with only 25-33% devoted to the dividend in a given year, and (2) Exxon Mobil rarely gets overvalued, and is in fact frequently undervalued, so that the company is creating value when they retire company stock that is selling less than what the company is worth.

The other thing that Exxon does especially well is restrict the ability of company executives and directors to sell the stock after they work for the company—Exxon makes you hold it for a while (though I’m currently unsure of the specifics). The point of it was to encourage management teams to seek out long-life oil fields that would be in operations for decades, and if you knew you were stuck with the stock until 2024 rather than 2014, you would be more inclined to seek permanent value rather than short-term profit bumps.

Exxon Mobil is a culture. It’s a system. It’s a collection of assets so vast that it has 25.2 billion barrels of oil and oil equivalents which are currently being replaced at a rate of 120% (so that amount of harvestable assets under Exxon’s control continues to grow). Those distribution networks span 48 countries. That’s why I’ve written extensively about dripping the stock: you get a 3-5% buyback, some organic growth, oh, and some kind of dividend payment has been every year since 1882. It’s one of those ten pillars that you stick right there next to Coca-Cola, Nestle, Procter & Gamble, Colgate-Palmolive, Berkshire Hathaway, General Electric, Johnson & Johnson, Chevron, and Unilever.

Considering that Buffett was okay buying Exxon last year at $90, it wouldn’t surprise me in the least if he felt comfortable buying it today around $93. The main reason why he wouldn’t do so is because (1) he found a greater opportunity that showed up elsewhere, and/or (2) he expects greater opportunities ahead and is being patient. But given that he said in the interview that he is thinking in terms of fifty-year horizons, I can’t help but guess that he is thinking about Exxon: it has the history, culture, assets, and likely trajectory to fit the bill.

In the last article I wrote here, I speculated that Buffett might be currently purchasing shares of ExxonMobil when I noted that the current price of the stock is only 3-4% higher than where it was when Buffett purchased 0.9% of the entire company last year. I connected the bridge when I said that surely the actual internal value of what the company should be worth has at least increased by 3-4% over that time.

A thoughtful reader challenged that assertion, effectively saying—hey, we don’t have clear evidence that Exxon is actually doing better this year compared to last. He noted that Exxon made $2.10 in the first quarter of this year, and made $2.12 in the first quarter of last year. Then he noted that the $2.05 per share that Exxon reported in profits during the second quarter had been artificially boosted because Exxon sold some assets in countries that define due process as “pay us kickbacks or we’ll nationalize your assets”, so the real figure should be somewhat lower. Last year, Exxon made $1.55 in the second quarter.

My response:  Allright, so if you want to do year-over-year comparisons that remove one-time items, it would look something like this:

2013 Exxon: $2.12 in the first quarter + $1.55 in the second quarter = $3.67 in first-half 2013 earnings.

2014 Exxon: $2.10 in the first quarter + $2.05 in the second quarter – $0.25 in asset sales = $3.90 in first-half 2014 earnings.

When you compare Exxon’s half-year comparison between 2013 and 2014, even adjusting for asset sales, you will see that profits are up 6.26%. Considering we are in a normal operating environment for the energy sector, I felt confident noting that Exxon has probably increased around 3-4% in value since Warren Buffett originally started purchasing the stock.

That said, I don’t think year-to-year comparisons are the best way to judge Exxon stock. Energy profits fluctuate wildly, and we shouldn’t apply the standards we expect from non-cyclical companies to those that are in the industrial or energy sectors because the price of basic commodities are always in flux. Coca-Cola doesn’t have to worry about lowering its prices of soda 20% next year, so year-to-year comparisons pack some meaning. With energy companies, you have to judge over 5-10 year periods. You have to adjust for those fluctuations by looking at growing production, growing reserves, and in Exxon’s case, the effects of an ongoing stock buyback program.

I mean, imagine the yo-yo treatment you would give yourself if you tried to analyze Exxon’s profits on a year-to-year basis: Exxon’s net profits grew from $25 billion in 2004 to $45 billion in 2008, before dropping to $19 billion in 2009, rebounding to $30 billion in 2010, and then expected to be around $34 billion in 2014. You have to keep your eye on the growth from $25 billion in 2004 to $34 billion in 2014, and not get caught up in the annual fluctuations that happen in between, especially considering that even in the worst of 2009, Exxon’s dividend payment still only amounted to 43% of profits.

The other thing is the immense buyback: In 2004, Exxon had 6.4 billion shares outstanding. Now, the company is only divided into 4.2 billion pieces. Boy, does that matter—Exxon the business grew 36% in total over the past ten years, but each share that you owned grew its profits from $3.89 to $8.00 over that ten-year time frame. That’s 105% growth in profits over the past ten years when you take into account the stock buyback in addition to the growth of the business—and I didn’t even touch on the dividends.

Even if Exxon’s profits did go down a little bit, its actual value as an enterprise could have grown. How would this have been possible? For one, the profit declines were mostly the result of lower oil, oil refining, and chemical prices, and a slight downtick in production as a result of modest asset sales. The company is growing its reserves at a 1.2x existing production rate each year (so that it has accumulated more oil to drill in the past twelve months than it has actually drilled), the company is split into 3% fewer pieces so that when profits do climb again you’ll have a higher claim, and there are projects expected to grow production at a 3-4% rate that are coming live during the 2015-2017 stretch.

But enough of this—it feels dirty talking about Exxon on such a short-term basis. I mean, this is a stock that would have compounded a $100,000 invested in 1984 into $5.5 million today, even if you spent every dividend check—all 120 of them which grew each year—along the way.

It only happens three or four times in your life, making it a Haley’s Comet sort of thing, but you do receive the once in a generation opportunity to both (1) buy a high-quality company and (2) do so at a period when the company is severely, deeply, truly on sale. Although the opportunities when you get to take advantage of both conditions simultaneously are rare, the good news this: the happy consequences of taking advantage of such an opportunity can last a lifetime.

One such reader, Kevin, wrote in to me and shares his story with taking advantage of General Electric, and gave me permission to share his story as long as I kept the details loose. It was in 2009, and General Electric had cut its legendary dividend from $0.31 to $0.10 per share. But Kevin had an important insight—even in 2009, General Electric made $11.4 billion in net profit. No one talks about that; the focus is always on the collapse of GE Capital, the dividend cut from $0.31 to $0.10 per share, and the collapsing share price from $38.50 per share in 2008 to $5.70 per share in 2009. For retirees, those results were terrible—a violation of General Electric’s informal covenant with mom and pop American investors as the bluest of the blue chips dating back to the 1890s. But for long-term investors with a value bent, it was a once in a lifetime opportunity to ready, aim, fire. Kevin struck, and purchased 2,000 shares of General Electric at the very depressed price of $12.30 per share.

At the time he made his decision in 2009, General Electric was paying out $0.10 per share for a dividend total of $200 getting sent his way every ninety days. Very nice, but the story was just beginning.

The beat was just getting started. First, he collected $0.46 per share in total dividends (2010), $0.61 per share in total dividends (2011), $0.70 per share in total dividends (2012), and then $0.79 per share in total dividends (2013). Over the course of 2014, he should collect $0.88 in total GE dividends.

Someone who looks at Kevin’s $24,600 investment might just think, “Okay, cool, you doubled your money or so in about five years. Well done.” First of all, it’s a little bit more than that. Not only did he benefit from a share price shift from $12.30 to somewhere around the $26-$27 mark, but he also benefited from $3.44 in total cash dividends that got paid out from 2010 through the end of 2014. That’s $6,880 in total dividend payouts, which compared to the $24,600 invested, is a little like getting 28% of your money back. If GE were to repeat its financial crisis experience (something I find unlikely given it discarded its nasty real estate loans, bolstered its Tier 1 Capital Ratio by about 80%, and is preparing to spin off Synchrony Financial in the next year or so), Kevin wouldn’t be nearly as affected as the headlines would lead you to believe, as he has already extracted a quarter of his total investment back in the form of cash profits returned to him by GE.

But let’s look at things going forward. General Electric is now paying out $0.22 quarterly, and that’s probably going to be growing by at least 8% annually for the next few years as that matches the growth rate of its large industrial businesses. That yield-on-cost figure is already 7.15%, and that is without any dividends getting reinvested, and stands to improve substantially with time. If you figure that the GE dividend will double every seven years, those $1,760 annual checks could turn into $3,520 checks in 2021, and then $7,040 per year in 2028, and then per year in $14,080 in 2035.

And it’s not just a waiting game; right now, in the present moment, he is getting $146 per month to spend as he wishes. Investing is not a game of always doing without. Once you get a nice pool of capital into a well-selected security pumping out dividends, you get to receive a nice little check every ninety days while you are also participating in the wealth-building process at the same time. That’s why this site is here; it’s tremendously important lesson to pick up to make your life easier and free of financial stress if this comes to mean something to you in a deep, very real, and substantial way.

I love reader stories. It’s great to set aside some cash from what you worked hard to earn. It’s great to study an excellent business, and then combine your knowledge with action so that you buy one when the time is right. It’s great to prepare and engage in long-term planning that is achieved through the often forgotten art of delayed gratification.

Contrary to what some people think, the quest for passive income is not about being a lazy bum. It’s about freeing yourself from the notion that the only way to make money is to sell your time in the form of labor so that “some other guy” gets rich. This site exists so that you can be that “some other guy”, or gal, as it may be.

I’ve been trying to work my way through reader questions that also would be good material for inclusion on this stock, and I reached an intelligent question from a reader that wanted to know why I don’t write about small-cap index investing on this site all that often, given what he called the proof of their permanent superiority as investments. The “proof” he was referring to is this: According to research conducted by Ibottson & Associates measuring the 1926 through 2013 time period, an indexed collection of small American companies delivered returns of 12% per year. A similarly indexed collection of large American firms delivered annual returns of 10% per year over that same time frame.

When I’ve discussed this topic before, I mentioned that within the top tier of large American firms, you can doably get results that equal the 12% figure cited by the small-cap basket.

But there is another thing I should point out but did not previously do so because I was unaware: The superior performance generated by small-cap stocks happened in short, concentrated bursts. There were five years that were highly, highly important for you to be invested in small-cap stocks if you sought to benefit from significant outperformance. You had to be invested from October 1990-October 1991, when small-cap stocks delivered returns of 51%. You had to be invested October 2002-October 2003, when small-cap stocks returned a little over 60%. You had to be invested October 1966-October 1967, when small-caps delivered returns of 75%. You had to be there March 2009-March 2010, when returns were over 90%. And then there is April 1942 through April 1943, when small-cap returned just shy of 150%. And then the big cahuna: From June 1932 through June 1933, when the small-caps returned 315%.

The years 1990, 2002, 1966, 2009, 1942, and 1933 had a tremendously outsized impact on the performance of small-cap companies. If you missed those six years and were around for the other 87, you saw your 12% annual returns become less than 7%. In particular the Depression year of 1932 and the War year of 1942 loom large in our understanding of the historical data. It’s not that it doesn’t count; after all, the sharp declines that preceded those comeback years count, but it’s important to recognize how it happens: It’s not, oh, small-cap stocks swim along nicely at 12% per year. Rather, revenue declines send small-cap indices down sharply, and the slightest pickup in revenues during a deep recession leads to a very fast comeback.

To use an example that actually takes into account the pre-eminent small-cap index fund, let’s take a peek at the Vanguard Small-Cap Index Fund. Since its inception in 1960, it has net returns of slightly above 10% when you take into account the long-term fees. Fifty-four years is going to be an entire investment lifetime or more for many of your reading this, and you’d be looking two percentage points less than what the advertised rate of return would be for small-cap stocks. It’s a reminder of how we’re creature of the time period we choose. Over the past thirty years, the Vanguard Small-Cap Index Fund has returned 8%. That’s a four percentage point slide from the 1926-2013 figure.

That’s why I choose to focus my writing on what makes intuitive sense—if you find companies growing earnings in the 8-12% range (and occasionally, you find gems like Visa that do better than that), and you get a dividend thrown into the returns, you can have somewhat clear expectations about what you’re going to achieve. Just blindly adopting the strategy of investing in small-cap index funds rely on the measuring period: Is it near a century—okay, then you’re looking around the 12% range. If you’re looking at 50+ years, you’re looking at 10-11%. If you look at the past thirty, you’re looking at 8%. It’s entirely possible that 1984-2014 is the entirety of someone’s investing life, and small-cap stocks would have performed four percentage points below historical expectations. This isn’t a dig at small-cap index funds; they have a valuable role to play in terms of diversification, and all things be told, they do quite well. But I also want to be as clear in my understanding as possible, and that means recognizing the outsized role that six years in the past 80+ had towards affecting the long-term Ibottson data.

You know how Charlie Munger talks about having a “too hard” pile into which he puts the moral and legal dilemmas that he cannot properly solve because the values that you have to prioritize over the other is too difficult to judge? “Too hard” is where I keep finding myself returning when I try to think about how the law should be *ideally* when it comes to gifts and will changes that someone makes on the brink of death.

This topic caught my attention when I was reading a June piece in The New York Times titled “When A Will Divides An Estate, And Also Divides A Family”. The narrative is told from the point of view of Kate (last name not provided in the article), who found herself in this situation: her dad died prematurely, and her grandmother intended to equally divide her estate among all her children at death (there were five children, counting Kate’s deceased father). In 2007, Kate’s grandma created a will equally dividing the estate among all five kids so that the share ascribed to Kate’s father would be divided between Kate and her siblings.

In 2012, she signed another will reaffirming what she created in 2007. Then, Kate’s grandma did something that makes life interesting, and for some people, terrible. A week before she died, she changed her will, cutting out the “share” proscribed to Kate’s father that would have gone to her and her siblings. Although she was suffering from Alzheimer’s, she passed a cognitive test shortly before altering her will (the article drops innuendo but does not explicitly define the suasion of the grandmother’s daughters in getting the will changed).

If I were handed the crown and made King of Estates & Trusts for the day, I have no idea what type of rule I’d want to see made the law of the land.

On the one hand, the right to freely dispose of your assets as you see fit is one of the most cherished and culturally ingrained traditions in the American system, which largely separates us from our European peers that have strict rules on disinheriting bloodlines. Not only does it have a strong basis in traditional, but it appeals to freedom and moral rightness as well: You earned the money, or at the very least came into possession of it, and possession/production of assets should give you a right to direct the proceeds as you see fit. If you have that right, why shouldn’t you be allowed to change your mind? And plus, wills are an uncomfortable topic—people don’t usually wake up in October and say, “Do I want to watch the World Series today or plan out the sequence of events following my death?”—and can be delayed until the last possible moment, when the prospect of death becomes more than mere contemplation.

On the other hand, you are also at your weakest emotionally and physically right before your death, oftentimes. This creates fertile soil for unclear thinking and moral persuasion from those who stand to benefit from your estate in a way that cannot be fully captured and proven by a law. Should you lucid thoughts and intentions from age 35 to 85 suddenly be cast aside by an entirely different thought you have at age 86, when you’re still meeting the threshold of lucidity but are not thinking as clearly as you once did?

My traditional impulse towards a libertarian answer to everything—you have the money, you always have the right to be the final director of it—is tempered by the practical reality that your ability to direct your assets in a way that truly reflects your lifetime intent could be lost in your final moments of life if your mind is in a deteriorated state that could still meet legal thresholds for a capacity to make a binding contract/document.

I think a lot of people could use the reminder that the best way to ensure that your money goes where you intend is to get in the habit of making gifts while you are living. By the time you are in your 60s and 70s, you are going to know where you fall on the “Less Than Enough”, “Enough”, “More Than Enough” spectrum. If you’re well into the “More Than Enough” category, then making gifts consistent with legal maximums each year could be a nice reminder that the best way to realize your intent for something is to do it yourself. Also, some states let you create a trust in which you could use the income generated to pay for, say, your health care needs before fully transitioning to a beneficiary who is not you at the time of death. Still, other states permit what amounts to irrevocable wills, in which each spouse creates a will that comes with the contractual obligation that it won’t be changed after one of them dies. That protection isn’t perfect because the surviving spouse can do a whole lot to deplete an estate after the other one dies. My guess is that the lack of truly satisfactory, ironclad solutions that don’t come with significant drawbacks, plus the unpleasant nature of the topic, is why it doesn’t get full attention in finance circles—and reinforces my impulse that the best way to take care of business is to do it yourself while you are alive because no one knows how to realize your intent than you do while you’re of sound mind.

I was thinking about the GT Advanced Technologies announcement earlier this week when my mind drifted to some of the truly excellent businesses that have been able to deliver growth this past decade without adding debt to make investments or repurchase stock. That’s not necessarily a bad thing—if your company can take on debt at 1%, 2%, 3%, or 4% interest rates, and if the stock is trading at a price that is less than what it would fairly be worth, it can make long-term shareholders richer than they’d otherwise be if you didn’t do the buyback.

However, I’ve always had a soft spot for companies that are able to deliver high long-term growth without taking on debt—it provides clear evidence that you’re dealing with a company that possesses strong natural growth tendencies when the growth happens without any financial engineering. In the case of T. Rowe Price, there is a lot to like: (1) the company has no outstanding debt, (2) it has no pension obligations (this surprised me), (3) no preferred stock outstanding, and (4) $3.4 billion in corporate cash on hand.

From what I can tell, it’s a company that doesn’t get mentioned much by other dividend writers. I suspect the reason for this is threefold:

First of all, the starting dividend yield tends to hover around the 1.0% to 2.5% mark. Especially during the 1990s when the dividend yield was closer to 1%, there wasn’t much initial appeal to income investors on an introductory basis: Specifically, why would an income investor buy T. Rowe Price yielding 1.3% when he could buy a 30 Year U.S. Treasury Bond yielding 6.89%, as was the case in January 2000?

Secondly, some individual investors have a somewhat hostile attitude towards the mutual fund industry, particularly when they find examples of funds charging 1-2% to deliver returns that lag a basic S&P 500 Index Fund.

And thirdly, there is a small element of cyclicality to the company’s profits—because the company relies on fees generated from assets under management, the company’s profits tend to go down when the economy goes down. For example, T. Rowe Price saw its corporate profits fall from $2.40 per share in 2007 to $1.65 in 2009. Though, to T. Rowe Price’s credit, they manage their dividend policy effectively during good years so they can give larger than expected dividend increases during bad years, as the dividend payout went from $0.68 in 2007 to $1.00 per share in 2009.

Let’s examine the counterpoints to these concerns:

The current dividend yield offered by T. Rowe Price is 2.3%, which is pretty close to the high of 2.5% it achieved throughout the 2009 calendar year. Furthermore, it has a dividend growth rate that offsets its low starting yield—the longer you hang around, the better the amount of income you receive on your initial investment. Over the past ten years—the dividend payment has gone from $0.40 per share annualized in 2004 to $1.76 in 2014. The midpoint of the stock’s 2004 price for the calendar year was around $25 per share; if you did not reinvest the dividends and chose to spend them along the way, your invested principle went from yielding 1.6% in 2004 to 7.04% in 2014.

It took ten years to get there, but you received an additional prize for your years of patience: The price increased from $25 to $75 over these last ten years. Every dollar invested now represents three dollars of market value. Not only have you acquired an ownership position in a business that is increasing its cash payouts to owners at a double-digit rate, but you also acquire a large capital gain for when you decide to sell that sweetens the process for those who take the route of delayed gratification that is inherent in the “low dividend yield but high growth rate of dividend payout” universe.

For those who feel unusual contemplating an investment in the mutual fund industry, it’s important as an investor to recognize when your own perceptions are out of step with the rest of society. At the very least, it’s a successful investor and human attribute to have the self-awareness to recognize when your viewpoints are shared by broader society in general and when they are not. You don’t want to go through life like the Yale professor who was shocked that Nixon beat McGovern because “she didn’t know anyone who voted for Nixon.” Otherwise, you set yourself up to receive the undesirable consequences of misjudgment when you act upon a reality that does not exist.

The fact is, there are many 401(k)’s administered by T. Rowe Price or consist of T. Rowe Price funds, and there are a lot of people in the world who make a lot of money by doing what they love, but don’t have the passion to develop the skillset necessary to make individual investment selections. In the past two years alone, T. Rowe Price has seen its assets under management increase from $576 billion to $692 billion.

Even at the low point of the 2009 recession, the firm still made $433 million in total profits. When a finance firm remains profitable during the second-worst financial crisis in the past century, it strikes me as a solid long-term candidate for investment. You may disagree, and you will make a lot of money if you stick to Johnson & Johnson, Colgate-Palmolive, and Nestle, which virtually never experience more than moderate declines in annual profit—each January, you can usually review the past year and see that your shares are generating more profit than the year before.

That being said, T. Rowe Price does offer some countervailing advantages for those of you who choose to accept the occasional fluctuations in reported profits. The dividend at T. Rowe Price is well managed; it has increased for 27 years straight, due in no small part to the management decision to keep the payout in the 25-40% of profit range during prosperous years, so that, when the 2008-2009 type of situation emerges, shareholders can continue to receive an increasing stream of cash (which, if reinvested, is one of those wealth-creating acts that you realize years later).

Furthermore, in exchange for tolerating about two downward spikes in profits per generation, you receive a better growth rate over the full business cycle. Specifically, in the past ten years, T. Rowe Price shareholders have seen earnings increase at a clip of 15.5% per year, and that is because corporate profits have grown from over $300 million to over $1 billion in the past ten years.

I would think that investors buying today would probably do very well paying $75 per share, though, like everything else, it’s not on sale. It wouldn’t be historically cheap until it hit the low $60s, based on current profits (though, as the company becomes more profitable, the price at which T. Rowe Price becomes a steal also increases). It seems to fall into that category of excellent satellite holdings. Once a person builds up a position of two or so dozen top-tier quality firms, T. Rowe Price becomes an attractive investment consideration when you ask yourself the question, “Okay, what’s next?”

If you frequently read articles about personal finance, every columnist, pundit, and article writer will list as abstract advice that you must practice diversification. At some point, though, diversification became such a buzzword that it became devoid of meaning and no longer discussed diligently.

For instance, I view diversification as a sliding scale in which owning diversified cash-generating streams become more important as you age and take on permanent obligations that carry significant fixed costs (kids, mortgage, etc.). Furthermore, the consequences of failure need to be taken into account as well—an eighty year-old woman losing 40% of her net worth is going to have much more significant lifestyle ramifications than a twenty-five year old dealing with the same percentage loss. That’s why I’d react much more differently to a single thirty-something telling me that he has 35% of his wealth in Visa stock compared to a retiree telling me the same thing.

When you are trying to build wealth—that is, turn $200 dividend checks into $1,000 dividend checks, and then turn $1,000 dividend checks into $10,000 dividend checks—it is okay to be more aggressive and make big bets, provided you understand the probability of loss and can make peace with that. It’s intelligent risk-taking with a purpose: you have a clear idea of the substantial differences in lifestyle between generating $45,000 in dividend income compared to $4,000 in annual dividend income, and the probability of the failure that comes with focused investing is a necessary risk to accomplishing your goal.

However, once you’ve made it, which I loosely define as having a portfolio that generates $30,000-$45,000 (in which simply reinvesting the dividends adds $1,000+ to your annual income without even assuming any dividend growth, rental income growth, or something of that sort), your orientation towards investing should change. That’s the point when wealth preservation should start to be a primary consideration over wealth creation—your attitude towards beverages should be “give me Coca-Cola, PepsiCo, and Dr. Pepper,” your attitude towards healthcare should be, “Give me Johnson & Johnson, Merck, Bristol-Myers Squibb, GlaxoSmithKline, Abbvie, and Abbott Laboratories.” Your attitude towards energy should be, “Give me Exxon, Chevron, Conoco, Total SA, Royal Dutch, and BP.” Your attitude towards food should be, “Give me Nestle, Kraft, Mondelez, and General Mills.” Your attitude towards brewing should be, “Give me Anheuser-Busch, Brown Forman, Diageo, and Heineken.”

And across the sectors it goes. You should be entering fortress mode, in which case the focus should be on acquiring the forty or fifty highest quality names in business rather than worrying about the academic concern of trying to beat the S&P 500 by a point or two. NO, you’re in a position to have an awesome life as long as you don’t make a big bet and fail—the interest of not being stupid should replace the interest of trying to be particularly clever.

It’s probably easy to read something like this and agree in the abstract, “Of course, if you have $2,000,000, you shouldn’t put it all in stock X.” It’s harder if you’re in the moment. It’s harder if you’ve put all of your money into a business you started, and you successfully grew sales to $200,000 then $800,000 and then $1.6 million. You can always see that next avenue of growth ahead, and unless you’re the kind of person who takes long walks to come up with deliberate life strategies, it can be hard to know when to draw a line in the sand and say, “It’s time to diversify even if it means less future growth.”

You don’t want to be like the Stroh brewing family.

In 1980, Stroh’s became the third largest brewing business in the United States when Bernhard’s great great grandson Peter Stroh became CEO and purchased F&M Schaefer and Joseph Schlitz Brewing. The family’s new fortune saw them make the Forbes list of the richest families in the country, worth $700 million in 1988.

But then something went wrong.

Family members confessed to Forbes that acquiring Schlitz, a beer company with six plants to Stroh’s one, overwhelmed the business and they didn’t have the marketing prowess to keep so many different brands up with rivals Anheuser Busch and Miller.

According to Forbes, Peter Stroh continued his disastrous acquisition spree among other moves but still the company failed…

By 1999, the company was worried it wouldn’t even be able to make the interest payments on its debt, so it sold itself for scraps, brand by brand.

Miller Brewing bought some, while Pabst bought the rest at around $350 million.  Some $250 million went into debt service and employee pension fund liabilities while the remaining $100 million went into a fund for the family, but ran out in 2008.

You had this terrible situation where all of these escalation tendencies started to reinforce each other—Peter Stroh was overwhelmed by the Schlitz purchase, so he sought to make it right by taking out lots of debt to make real estate and biotechnology investments. The problem is: these were desperate beer barrons calling the shots, and when the real estate and biotech investments didn’t produce cash flow, the debt proved ominous. It swallowed up a fortune that was approaching $1 billion.

If you are acquiring something you can’t handle, you: (1) look to outsource the merger to someone who can handle it, and accept the partial loss of power, (2) you spin-off the Schlitz brewing company you just acquired, and even though you’ll get made fun of a bit, shareholders ultimately love receiving another “free” company as a spinoff, so they’ll forgive you, (3) if the first two don’t work, you sell the brewer you had just bought. Yeah, it looks bad and raises questions about your competency, but I’d rather be mocked and have $700 million than be broke and open the local newspaper to see which Shakespeare character I’m being compared to today.

What you shouldn’t do is try to undo your mistake by acquiring businesses outside your core competency, and take on substantial debt to put your family’s wealth that had been built up over the centuries on the line.

This money didn’t have to be blown. There is a point at which you stop investing into the business—even if it’s the family business—and stop so that you can inventory your profits and build a portfolio of blue-chip stocks and government bonds (that offered much better rates than what you’d get today). There aren’t a whole lot of things you can buy with $100 million that you can’t get with $50 million, or that you can get with $500 million that you can’t get with $250 million. Diversification is the premise upon which wealth preservation is built, and generally, those with family businesses that have been historically successful are the least likely of the affluent to appreciate that lesson. Money is a tool to a better life, and once the good life is achieved, the shield rather than the sword should become your weapon of choice.

During the past twelve months, over 6% of this website’s traffic has come from people living in Atlanta, GA or its nearby suburbs. The city of Atlanta holds its own against the other heavyweight generators of this site’s traffic—like the entire states of Texas, New York, and California (though the number of California residents that read this outnumber the Atlanta residents by a bit). That is not a coincidence: From what I can tell, just about every Atlanta reader that finds his or her way to the site does so by googling something about Coca-Cola as an investment, and I’ve been lucky to have many of you stick around.

More interestingly, I’ve been fortunate to trade e-mails with some of you who are sitting on very, very large ownership stakes in Coca-Cola, and spend a lot of your time figuring out what to do with it. When you have a company with 4.4 billion ownership units that has been growing profits for 77 out of the past 82 years (with dividends rising for 51 years straight currently) and combine that with Atlanta’s historical culture of treating “Thou shalt not sell thy Coca-Cola stock” as an 11^th commandment of sorts (or maybe it’s just an extension of the 5^th?), you can’t help but end up with something that produces massive piles of cash.

The mathematics of compounding go crazy—haywire—if you reach a point where your dividend income equals your annual expenditures. This is particularly so if the bulk of your wealth comes from something like Coca-Cola, which has a twenty-year record of giving investors income increases that amount to 9.63%, roughly three times the prevailing rate of inflation in the U.S. If Coca-Cola continues to give investors dividend increases at that historical rate, you’d find yourself in a situation where $60,000 in Coca-Cola income today would become $1,066,155 in annual income thirty years from now. It’s a wildly different scenario from annuity world, pensions, 3% U.S. government bonds, and the other hallmarks of retirement planning that focus on avoiding the occurrence of a $0 bank balance before you die. Someone spending the last thirty years of their life drawing on Coca-Cola dividends could see a doubling, then another doubling, and yet another doubling, of their annual income and die with a $35 million estate just based on their blocks of Coca-Cola ownership alone.

Also, I have happened to personally like the investors I’ve encountered who own stock in The Coca-Cola Company. It’s nice encountering people who have a sense of general contentment about them, which tends to naturally arise in people who have chosen the right spouse, the right career, or in this case, the right permanent investment in life. When you own something that generates profits in over 200 countries, has over 500 brands, generate 30% returns on equity, has been raising its dividend every year since the death of C.S. Lewis, and has distributorship networks so vast that executives at Dr. Pepper reach out and say “hey, you mind if we partner with you to sell our stuff?”, you’re not going to get caught up in whether the price of the stock is $50, $45, $40, or whatever. The shares aren’t for sale.

And if you’re reinvesting your dividends and follow the company closely enough to be aware that it is repurchasing its own stock, then you probably actively are rooting for the price of the stock to go down, so you can acquire even more shares at a discount and your existing shares will become more valuable as each dollar Coca-Cola devotes to its buyback program retires even more stock and ties your ownership interest to a higher profit per share figure.

You should note that I said you should root for the price of the stock to go down in such a situation, not the business fundamentals. I hope profits grow from $2.20 to $2.80 while the price of the stock goes from $44 to the $30s—it is the act of reinvestment and the initiation of new purchase orders in response to this growing spread between business fundamentals and the price of the stock that you become the farmer planting his seeds in increasingly fertile soil.

On another personal note, I am glad that many of you Coca-Cola shareholders that I’ve encountered are thoughtful about ways in which your wealth can be used to help those who, in the words of Warren Buffett, did not win the ovarian lottery and instead find themselves born into situations that are reminiscent of Hosea, Chapter 4: “My people are destroyed by a lack of knowledge.”

It’s wise to think of investing as a two-stage process. The first focus is on reaching financial independence, and taking more-than-reasonable precautions to make sure that condition can last the rest of your life. This is not a manifestation of greed, but rather, the desire to live your life as you see fit and doing things that you want to do rather than have to do. Once that mission is accomplished, you begin to turn your eye outward as you recognize that you can be a tremendous force for good or bad depending on which impulse you choose to follow. In a very real way, a few of you reading this are Coca-Cola princes and princesses as you sit on tens of thousands or even hundreds of thousands of shares in the company’s stock, and every three months, you receive a check in the six figures that can have a profound influence on your community. It’s not my place to tell you which way to allocate it, as I don’t know your value system and preferences. It’s your life, and you get to spend it gradually writing your own obituary as you see fit.

For those of you reading this who own Coca-Cola and find yourself with 70%, 80%, or 90% of your money tied up into the legendary beverage maker’s stock, I understand your concern about diversifying—buying almost anything else reeks of diworsification rather than diversification. However, almost no companies does not mean the same thing as saying there are no other companies out there that could be good candidates for consideration. Why not adopt the practice of putting dividends elsewhere, looking perhaps to Colgate-Palmolive, Nestle, ExxonMobil, Johnson & Johnson? Those are ways to diversify without sacrificing earnings quality or future growth prospects.

Now, for my non-Atlanta readers, who may or may not own Coca-Cola stock: The usual disclaimers apply. It’s an important to find an investment style that fits your own temperament. Heck, I know some of you could never bring themselves to own the same company stock for three years straight. That’s perfectly okay. As the writer Steven Pressfield said, “Our job in this life is not to shape ourselves into some ideal we imagine we ought to be, but to find out who we already are and become it.” (Hat tip to Stiles Mikell Harper III for alerting me to this quote). If long-term investing in the same stock isn’t for you, there are tons of other finance sources you can read. As for me, the appeal rests in making decisions that have long measuring lifes; finding anti-fragile businesses with high permanent returns on capital, establishing an ownership position, and then enjoying the growing cash payments that arrive four times per year thereafter. Those are the potential rewards when you approach the investment altar without a sale price in mind.

In 2011, I saw Johnson & Johnson trading at $61 per share. It was one of the first times I saw one of those buy-and-hold forever stocks trading at an attractive price that offered a margin of safety (the financial crisis wasn’t much applicable to me, because I was a college freshman while all of that was going on, and had things other than investing on my mind). The moment was highly unusual because almost everything I can find (and I’ve felt this way for a while now) falls into one of two categories: (1) A company selling at a discount to long-term value because it is working through problems—think BP, McDonald’s, GlaxoSmithKline, IBM, and a few others, or (2) companies with excellent core economics trading at various ranges of fair value, running the gamut from Exxon to Coca-Cola to Visa.

Astute readers may point out that Johnson & Johnson was in the headlines at the time for its string of product recalls, but that’s something of a red herring because when you actually studied the ongoing profits at Johnson & Johnson, the product recalls were exceptionally small when compared to the scope of Johnson & Johnson’s overall operations. I mean, even during the worst of the headlines, Johnson & Johnson was growing its annual per share profit from  $4.76 to $5.00 and raising its quarterly cash payout to owners from $0.54 to $0.57. These were not choppy waters. And yet, the price languished around the $61 threshold, letting new investors see a starting dividend yield of 3.73% in the world’s best healthcare firm. Once you accept that nothing is guaranteed and we have to think in terms of probabilities, you can’t help but conclude that an investor buying Johnson & Johnson at $61 per share is establishing a starting position on highly, highly favorable terms.

I feel exactly the same way about General Electric right now at $24 per share. It gives you a 3.63% starting dividend yield if you buy today, and seems like to grow the payout by 8-11% in the years ahead. My personal estimates for General Electric’s dividend going forward are something like this:

General Electric dividend=

$0.88 per share in 2014.

$1.00 per share in 2015.

$1.12 per share in 2016.

$1.24 per share in 2017.

$1.40 per share in 2018.

$1.56 per share in 2019.

$1.80 per share in 2020.

$2.00 per share in 2021.

You could possibly collect $11 per share in dividends from 2014-2021, or a little over $10 and some change if you buy at the end of 2014. And that is without dividend reinvestment. If the prices stay low, like they are now, and the company continues to grow, you could see your yield-on-cost rise at a faster rate.

Imagine someone who owns 1,000 shares, purchased at a price of $25 per share, for a total of $25,000. That individual could be collecting $2.12 per share over the next year, and if those dividends get reinvested at an average price of $25, we are talking about $2,120 getting you 84.8 new shares.

That adds a nice little boost to the amount of annual income generated by your initial investment amount. When 2017 approaches, someone who does not elect to reinvest would be receiving 4.96% in annual income based on the amount of money set aside in 2014 to buy the stock at $25. But if you reinvest, those extra 84.8 shares bump your annual collection to 5.38%. And that’s just two years of dividend reinvestment. Once you reach year ten or so, the spread starts to get more dramatic.

Why don’t people do this? The say things like, “Let’s wait and see what happens until after GE spins off Synchrony, and play it by year then.” The problem is that, by the time that happens, the price of the stock will have increased, and you missed in your opportunity to lock in a favorable yield-on-cost. The Bank of America investors that buy in the $7-$14 range are going to be much better off for owning it while the company had been paying a penny per share in dividends than the investor that waits a couple years for 4-5 consecutive dividend increases to start a position. Waiting for that certainty often prevents you from getting shares of a stock at a nice discount.

General Electric has a backlog of over $200 billion. It has oil and gas operations that are growing a little bit above 10% annually. It’s taking all the money created by the share swap of this Synchrony spinoff and committing to repurchasing the equivalent in stock, so that your earnings per share won’t take much of a hit.

This isn’t the same company that it was in 2007—that’s lazy thinking to equate the 2007 General Electric with the 2014 General Electric. The backlog of work is almost twice as big. The troublesome real estate loan portfolio is gone. Of the remaining finance units, there is 75% more capitalization than existed in 2007. With the Alstom deal, General Electric remains on pace to make 70% of its profits “industrial related” rather than “financial servicing related.” The fact that you can initiate a position at 3.6% today is a gift; and the rewards will become more apparent in the coming years, especially for those that reinvest their dividends while the price of the stock is in the $20s and low $30s.

When you look at the stocks sitting there in your portfolio, do you think: (1) I need to diversify more, (2) I need to own higher quality companies, (3) I need higher current income, and/or (4) I need to own companies that have better earnings per share growth rates. If those thoughts dominate when you size up your portfolio, it probably makes sense to pool your dividends together and make opportunistic investments that can alleviate that concern.

Want something higher-quality? Take your dividends and add some Procter & Gamble, Johnson & Johnson, or Coca-Cola to your portfolio.

Need higher current income? Take those dividends and buy GlaxoSmithKline, AT&T, or BP.

Need higher earnings per share growth rates? Take your dividends and purchase shares in Disney, Becton Dickinson, or Visa.

Pooling dividends together and selectively adding to the area you seek to improve is the easiest way to rebalance when you have an aversion to selling anything—particularly the companies that have done well and come to represent a higher overall portion of your portfolio.

On the other hand, imagine a person with a thirty-nine stock portfolio that consisted of: Exxon, Chevron, Conoco, Royal Dutch Shell, BP, General Mills, Kraft, Nestle, McDonald’s, Philip Morris International, Disney, Becton Dickinson, Johnson & Johnson, GlaxoSmithKline, Hershey, Brown-Forman, Anheuser-Busch, Coca-Cola, PepsiCo, Dr. Pepper, Procter & Gamble, IBM, General Electric, Wells Fargo, Emerson Electric, JPMorgan, Aqua America, Southern Company, McCormick, Sysco, AT&T, Visa, Wal-Mart, Clorox, BHP Billiton, Unilever, J.M. Smucker’s, Kellogg, and Campbell’s Soup.

All that person needs to do is stay alive. There’s no need for further diversification. There’s no real need to tweak things. If you’re doing fine financially and don’t need the income to spend, you should just automatically reinvest because it’s unlikely you can improve much upon a portfolio composition like that. You’ve built a great ship, now get out of the way, and let it sail.

But a lot of people aren’t there yet—they might only have ten or so of the stocks owned, and have a long ways to go towards their ideal diversification. In that case, it makes sense taking the dividends and looking elsewhere. For other people, they own a lot of second-tier and third-tier companies, and they want to remove their dividends from them to upgrade the quality of their portfolio as ongoing portfolio maintenance in preparation for the next recession. Still, others may find themselves sticking on an initial portfolio construction of cash cows like AT&T, GlaxoSmithKline, and BP and want to use those generous dividends to fund some higher growth opportunities.

You’ll never get a definitive answer to this question because both sides are right. Someone advocating automatic reinvestment into Coca-Cola is going to say, “How can you improve upon the best company in the world that is growing 8-12% annually, and why on earth wouldn’t you want to arrange your affairs so that you always own more, more, more of such an outstanding business?” Someone on the other side of the debate might say, “I need to take dividends and buy higher-quality companies that are built for the next 25+ years”, and how could you argue with that sentiment?

The way I see it? In the early stages, it makes sense to automatically reinvest. There’s no need to fuss over $5, $10, and $15 dividend checks. Let the positions grow and get your savings rate up. In the middle stage, when your dividend checks are of the “$800 here, $950 there” variety, it makes sense to pool them together as cash and then complete your portfolio as you see fit. Towards the end, when you’ve got three dozen firms sending you dividend checks above what you need to live, it seems wise to take what you need and automatically reinvest from there. There is a point where you own all the companies you want, and the need for constant optimization disappears because even going on autopilot will keep on increasing your wealth beyond your wildest dreams when you first started.

Because I don’t know approximately what the future of phones will hold, I cannot comment intelligently on the long-term future of Apple into 2024 and beyond. However, I can comment on what the U.S. tax system and Apple’s new commitment to financial engineering (through stock buybacks) have done to the company’s balance sheet.

One of the very many peculiarities of our tax system is that companies domiciled in the United States have to pay a repatriation tax to bring money generated outside the U.S. back to American coffers. If a corporation files a form indicating that the money will be kept permanently overseas, then there is no tax. If the money is bought back home, there is a 35% tax applied to the income. If you’re ExxonMobil, this is what the incentive picture looks like to you: You generate $100 million in profits in Brazil. You can (1) bring that money back to the United States to pay dividends, repurchase stock, or drill new oil fields, but you will only have $65 million to deploy after paying the U.S. federal government for the right to transfer that money from Brazilian banks to American banks. OR (2) you can permanently reinvest that $100 million into new Brazilian growth prospects, and Uncle Sam will get 0%.

Because of these distorted incentives, Apple finds itself keeping the large bulk of its cash hoard overseas. You’ll often see headlines touting the fact that Apple has $156 billion in cash sitting on its balance sheet. You would be correct to note that it is a substantial amount. Considering that Apple is a $600 billion company, the cash hoard amounts to 25% of its market valuation. You might look at it and think, “Wow, Apple is trading at $100 per share, and could pay out a one-time dividend of $25 to shareholders, just from the cash on its balance sheet.”

That is absolutely correct at a theoretical level, but the reality is somewhat different. Sure, Apple may be sitting on $156 billion in cash profits, but only $18 billion of that is here in the United States. The other $138 billion is abroad, and would instantly become $90 billion if it was all instantaneously brought back to the United States in one fell swoop. That is why it would be borderline idiotic for Apple to repatriate its cash—it would have to pay the equivalent of FORTY St. Louis Cardinals’ franchises in tax to the U.S. government just for the act of gathering the profits in British, Irish, Korean, French, and Chinese banks and putting them inside U.S. banks instead.

You may have noticed the recent headline claiming that Apple is adding $30 billion to its buyback program. You may also notice that the company pays out a $0.47 quarterly dividend on its 6 billion shares, so that the company is currently on the hook for $11.2 billion in annual payments to shareholders. So the nuts-and-bolts analysis of the company becomes this: All those $11.2 billion dividend payments, all those $30 billion buybacks, and all of Apple’s continued investment inside the United States would have to come from that $18 billion in American cash.

The only alternatives would be to (1) repatriate cash and pay that 35% tax, or (2) take on debt. As you can guess, Apple has chosen door #2. As of this past July, Apple has taken out $31 billion in debt (and makes payments that amount to $2 billion annually on it) to meet its liquidity needs inside the United States. It’s crazy—because of the disincentives created by the tax code, a company with over $150 billion in cash has to take on $30 billion in debt to meet its operational requirements and promises of buybacks, dividends, and American investment.

On the buyback front, Apple has reduced its share count from 6.57 billion to 5.98 billion over the past twenty-four months. Put simply, Apple is retiring around 4.60% of its stock per year. In other words, even if the company’s annual profits remained steady at $37 billion per year, you would still experience 4.60% annual returns if the company remained valued at 16.3x profits as your share of corporate profits increased at a rate of 4.60%. If the company grows profits at 5.40% annually over the next ten years, and maintains buybacks at the same pace, then you will achieve 10% annual returns from price advances in the stock plus you’ll get a dividend to boot.

If you’re a student of these things, you got to love kicking back with the popcorn and watching this sucker play out. On one hand, the phone market is notoriously fickle. Twenty years from now, you know you’ll see people eating a Hershey’s candy bar. But twenty years from now, will people be walking around glued to an Apple phone? It was just seven years ago that Research In Motion’s Blackberry was a thing. On the other hand, $37 billion in annual profits gives you a lot to play with. Retiring 4-5% of the stock each year has been great for long-term shareholders of ExxonMobil, and it’s fair to see traces of that path based on what Apple is doing right now. Long-story short: Apple has $150+ billion in cash, but only $18 billion in America due to tax considerations, and this has forced Apple to borrow $30 billion in debt. The company is retiring around 4-5% of its stock each year, and I’m curious to see how this interacts with the core business performance in the years ahead. Your guess is as good as mine.

All my talk about oil stocks here on the site bring in lots of oil stock investors from the search engines, who woulda thought?

In the past couple of days, I had been talking to a reader that decided to make BP and Royal Dutch Shell the starter positions in her stock portfolio by putting $400 per month into each Royal Dutch Shell and BP since 2011. I didn’t inquire into the specifics, but a very rough calculation that takes into account the capital appreciation of those companies could indicate that she is sitting on about $40,000 worth of stock in the two oil giants that is generating around $1,800 in current income, averaging out to $34 per week that makes its way to her in passive cash.

Although those are only my back-of-the-envelope estimates based on what she said, my point isn’t to get caught up in the specifics but rather to discuss a psychological element that came up in the discussion. She mentioned to me that savings became a lot easier once she started seeing results.

That made a lot of intuitive sense to me. It’s hard finding motivation when you have to put in a lot of effort and delayed gratification just to get that initial quarterly dividend check of $5, $10, or whatever. There’s a lot of reasons why people don’t make income investing part of their life story, but one of the reasons is that the rewards are small at first.

For 99% of the people in this country, coming up with that first $1,000 to invest is quite the hurdle, taking even months or even a year to set aside. And if you only get $30—what’s that, $0.08 per day, when you initially start, it can have a huge deterrent effect from doing anything at all. Dollar-cost-averaging with automatic reinvestment can mitigate this somewhat—you can see those new Exxon shares get purchased with your cash on hand each month, you can see the small sum generated by your Exxon payout that automatically buys another partial share, and then you can see the cash declaration on those shares go up each year.

I think that last point is the key to getting through the early days of investing—when you own a single share of Johnson & Johnson, you’re not just entitled to the $0.70 that the company pays out quarterly now. It’s not just about receiving $2.80 for each share. It’s about the fact that you will own all the dividend income that the share will ever produce as long as (1) you don’t sell it, and (2) you stay alive.

The reader I was talking to mentioned that it’s easy to keep investing once you’ve got something successful going, because it starts to become fun. Turning $1,000 in monthly dividends into $1,100 in monthly dividends is a fun game, because you’ve already accomplished something good in your own right, and it’s easier to pick up a clump of snow from the lawn and attach it to the middle of the snowman than it is take that clump and know that it’s the very beginning of the snowman.

Somewhat paradoxically, once you’ve been saving well for a long time, it’s entirely possible that something could trigger psychologically for you that gets you to start improving your savings rate because the game becomes fun. When you’re sitting on 2,200 shares of Coca-Cola, adding another 20 shares is just feeding the beast, and making a good thing even better.

There’s also the fact that just holding on to a stock for a while starts to build something impressive in its own right—even if you only set aside $1,000 in Chevron twenty years ago, you’d now be sitting on $11,000 worth of the stock and collecting $367 per year just by letting it sit there. Do that every year, and you’ll be pleased by what you see.

When Seth Klarman first began value investing for the Baupost Group, he encountered the frequent Wall Street wisdom that value investing would be dead in a short period of time because (1) the rise of computer trading mixed with (2) a significant influx of new investment professionals would lead to a perfectly efficient market where all new information would be instantly known and accurately priced into the stock.

One of the character traits that makes Seth Klarman such a remarkable investor is that he has an uncanny ability to recognize the situations in which news about a company is instantly known but not necessarily accurately priced into the value of the stock. There are two reasons for this—one, frankly, it’s hard to accurately predict the future cash flows for a majority of American companies once you get beyond soda, cereal, toothpaste, and other products that aren’t subject to technological disruption or big shifts in market share among the competitors.

And two, most people do not have the patience to see an investment thesis through if it takes five to ten years to play out. I often get asked, “How can you possibly gain an edge to become a successful investor if there are thousands of individuals and partnerships with million-dollar budgets that are dedicating fifteen hours a day to making opportunistic investments?”

The answer to that question is two-fold. The first part is about recognizing the truth of what Graham said when he pointed out that getting satisfactory returns is easier than most people think, but getting superior returns is harder than most people think. You don’t have to beat the S&P 500 for investing to be worth your while; all you have to do is earn returns that beat inflation to increase your purchasing power.

What’s a blue-chip stock that has disappointed investors by trailing the S&P 500 over the past twenty years, Dupont? The chemical company has trailed the S&P 500 by two percentage points every year, on average for the past twenty years, and you still would have turned every dollar invested into four dollars; a retirement nest egg of $150,000 in Dupont would be worth $600,000 today. Hardly a disaster that defeats the purpose of investing.

And secondly, as Klarman points out, very few managers possess anything resembling long-term patience. The people we associate with Wall Street compete on a short-term, and relative basis—it’s about beating the other guys on a three-month, six-month, and twelve-month period. There’s a barrier to long-term thinking because, if investment selections do not perform well in the short-term, there is no guarantee that you’ll be there in the long term. It’s the same principle that explains why you don’t see NFL coaches and GMs stocking up on 1^st round draft picks in 2016, 2017, and 2018 via trades because they know if they don’t win now, they won’t be around later to reap the benefits that come with truly long-term planning and delayed gratification.

In other words, when you’re investing on terms of five, ten, and fifteen year increments, you are playing a game that very others are engaged in. Klarman recognized this when he recognized the long-term appeal of Texaco bonds during their bankruptcy proceedings; he was purchasing debt that was secured by oil assets that were certain to prove lucrative because of their place in the bankruptcy claim order, and therefore, he was willing to tolerate the volatility that came with the uncertainty.

We can learn as much about behavior psychology reading Klarman’s Margin of Safety as we can studying the life works of Charlie Munger.

Klarman recognizes that most people’s understanding of volatility goes out the window—totally defenestrated—once an ownership interest declines 30%, 40%, or 50% in value. Very few people develop such a thorough understanding of business that they can tolerate $100,000 turning into $50,000 at a particular moment of time without feeling some type of negative emotion. The default human wiring associates negative volatility with the loss of security, and the loss of security creates a feeling of vulnerability that diminishes happiness.

You move beyond this, and set yourself up for superior long-term returns, when you thoroughly understand the businesses in which you invest. Ideally, you will make decisions based on long-term earnings power, and oftentimes, current profits can indicate that things are better than other actors in the stock market believe.

There is a reason why BP is such a popular investment holding among the readers of this site, especially compared to the investing public at large. Even after selling assets in preparation for a potential gross negligence payout, BP is still on pace to make $14.4 billion in profits this year. What’s a popular stock in the dividend growth community, Colgate-Palmolive? Well, Colgate has not lowered its dividend payment since the 1890s (and even then, it was the initiation of a dividend payout, rather than a cut, that preceded the streak), and makes a little $2 billion in annual profits today. The readers here understand that, despite all the headlines and headaches that have been associated with BP, and even with the asset sales, it still makes 7x as much total profit as Colgate-Palmolive. This company isn’t going anywhere anytime soon.

Value investors can also get a glimpse of what BP will look like once the oil spill litigation is fully resolved, and the price of the stock increases due to the “established certainty” that people seem to love. Ten years ago, BP was roughly the same size that it is now (it made $15 billion in annual profits then, $14 billion now). Back then, the price of the stock traded in the low $60s. And, in the tradition of John Neff, you get to collect a 5.6% initial dividend yield, which he calls the hors d’oeuvres that precede the main meal (e.g. you get cash while you wait until fair value to sell, at which point, you’d get much more cash). And if you choose to reinvest, you will turbo-charge your returns by automatically gobbling up more shares in the $40 range that you will look upon with a special fondness when the stock trades in the $70s and $80s.

That’s why this “you can’t beat Wall Street guys” stuff is such a myth. It would be like men and women that are marathon runners getting intimidated by the fact that they could never win a forty-yard dash. You’re doing the same activity, but playing a different game.

This week, I’ve been working my way through Forrest McDonald’s 1962 book Insull about Samuel Insull, the man who worked as secretary and financial manager under Thomas Edison but also was associated with large wealth destruction that resulted from centralizing electricity—one of his famous techniques was helping companies create large amounts of new issuances in stock to bring new shareholders, saying “if everybody owns the company, nobody owns the company.”

His lack of concern about regulated monopolistic powers meant that he frequently gave advice on how corporate management teams could avoid being hassled by shareholders, and he recommended annual but modest dividend increases and the issuance of new debt or bonds to fund the necessary improvements to ensure permanent job safety—as long as the new management has a new project to tout to shareholders, and if the annual cash payout grows, you can put together a nice career without being called out.

This situation isn’t something I worry about too much because a cursory analysis of a company will let you know when there are problems. Take something like Middlesex Water—it’s a somewhat storied company in that shareholders have been receiving dividend increases for 41 years running. If you have been a super long-term holder of the stock, it’s definitely been nice owning something that has sent you 160 cash payments, which have been bumped up now 41 times along the way.

But I can’t imagine it ever being something that someone would look at and conclude, “This is the best company I could purchase an ownership interest in right now.” Over the past ten years, the annual profits have increased from $8.4 million to $17.4 million.  I bet you’re thinking, hey, doubling your money over the course of ten years isn’t the worst fate.

And here’s where it gets trickier: What is important is not just how much the company grows its profits over the course of a particular period (in this case, ten years), but how much your proportional share of the company’s profits grow over that time frame. In this case, Middlesex Water diluted shareholders by creating 5 million new shares so that it could pay its dividend and invest in new projects simultaneously. In 2004, each dollar the company made in profit had to be broken up into 11.3 million pieces. Now, ten years later, each dollar in profit gets divided into 16.1 million pieces.

Breaking out the math, here’s what happened to someone who owned 100 shares and collected the dividends over the past decade:

In 2004, your 100 shares meant that you owned 100/11,300,000 or 1/113,000 of the entire company, and the water utility generated $73 in profit on your behalf and paid you $66 in cash.

By 2014, due to share dilution, those 100 shares only entitled you to own 100/16,100,000 or 1/161,000 of the company, and the water utility only generated $110 on your behalf while paying out $76 in cash dividends.

See what happened there? The company’s profits doubled, but your proportional share of the profits did not—instead of experiencing a 100% increase in ownership wealth like you might expect over that ten-year frame, you only experienced a 50.6% increase in wealth as earnings per share only increased by 50.6% from $73 to $110. That’s the effect caused by the creation of those 5 million shares.

This, incidentally, is why investors that focus on companies with dividend growth rates in the 8-12% range (which have been going on for a long time) still end up with very good investment returns even if they lack sophisticated accounting skills. Coca-Cola can’t increase dividends by 9% for two decades unless it currently has the cash on hand to support the payment, and management is confident that it can permanently make the payments going forward.

It’s stating the obvious, but it’s nice to remember: you can’t fake a dividend—you either have the cash on hand in the corporate treasury to make the payouts to the owners or you don’t. This fact deters a lot of clever crap from happening.

When you look at Middlesex Water, the dividend payment has only gone up by a penny per year. The ten year annualized dividend growth rate works out to 1.5% annual increases. The low growth rate of the dividend foreshadowed the low growth of the company itself. When you’re managing a company that has raised its dividend for 41 years straight, you’re not going to bite off more than you can chew and give 8% dividend raises when your profits per share are just limping forward.

Perhaps I’m being too hard on Middlesex Water; in the end, it does build wealth, albeit a slow pace. Based on the current fundamentals, I just cannot understand why someone would choose Middlesex Water over Coca-Cola, Visa, Johnson & Johnson, or Colgate-Palmolive. The future growth profile at Middlesex is substantially inferior. You’ve got a business that’s been earning 5% returns on capital each year for over a decade, pays out a dividend around 3-4%, and dilutes shareholders to the tune of 2%, 3%, or 4%, depending on the year. The end result? You compound your wealth at a 4% annual rate over ten years, turning $1,000 into $1,500. Even in the universe of stodgy water utility stocks, there are companies like Aqua America growing profits per share at 8.5% and growing dividends at 7.5%.

In the 2013 letter to shareholders of Berkshire Hathaway, Warren Buffett noted this: “It is important for you to realize that Bank of America is, in effect, our fifth largest equity investment and one we value highly…We can buy 700 million shares of Bank of America at any time prior to September 2021…We are likely to purchase the shares just before expiration of our option.” Even though Buffett’s terms on the deal are much, much better than what any investor could get by going online, typing in the ticker symbol BAC, and clicking the purchase button, the fact that Buffett values the position highly and will likely make Bank of America such a meaningful portion of the Berkshire Hathaway investment portfolio seven years from now indicates positive sentiment about the long-term future of the bank.

The response to this news could be two-fold: Perhaps the best answer is to buy Berkshire Hathaway stock, so you can directly tap into that $7.14 per share strike price for 700,000,000 shares of Bank of America that Buffett had arranged as a special class of warrants. All this means is this: In September 2021, Buffett or whoever is running Berkshire will have an opportunity to pay just under $5 billion (700,000,000 x $7.14) to purchase 700,000,000 shares of Bank of America stock. If the price is above $7.14, the warrants are called “in the money” because that is the point at which purchasing the stock/exercising the option would make you money. If the stock traded at $3 in 2021, the options would expire worthless and Berkshire would get nothing on this component of the deal because why would you exercise the right to pay $7.14 for something that trades at $3? It would be like going to a cashier at Wal-Mart and saying, “I don’t want to pay the $3 price for this ice cream. I have a coupon to get it for $5!”

Now that Bank of America’s dividend is on the mend, the story gets a little more complicated because the special arrangement between Berkshire and Bank of America involves deductions for the dividend payments. So for each dividend above $0.01 that Bank of America pays out (they just raised it to $0.05), the strike price of the warrants lower to compensate for the cash that Bank of America chooses to return to its shareowners. Considering that Bank of America could likely pay considerable dividends between now and 2021, this will affect the strike price significantly.

In the case of Bank of America, here is a brief summary of what is going on: This year, they will make a little over $10 billion in actual profits before you get into its litigation costs (we’ll get there in a minute). $2 billion of those profits come from the management of its customers’ investments (led by the Merrill Lynch division, which may be a lucrative spinoff someday), another $2 billion comes from extensive trading operations that churn stocks all day (contributing to what Charlie Munger calls the greatest waste of human capital he has ever seen), a little over $3 billion of the profits come from what we would consider the old-fashioned banking and loan division, a little over $2 billion comes from global commercial investing (e.g. a manufacturing business that is privately held wants to start inventorying profits and making common stock investments, so Bank of America assists with that), and the remaining $500 million comes from real estate loans (namely, the mortgages that are the legacy of that Countrywide acquisition during the financial crisis).

It is that real estate loan division that has wreaked havoc on investors, explaining why someone who bought $100,000 of Bank of America stock in 2007 would have only $35,000 today. The Countrywide acquisition has now cost Bank of America over $67 billion in legal fines (justly earning its reputation as the worst U.S. acquisition, ever) and forcing Bank of America to raise capital during the crisis, so that the share count from 4 billion to 10 billion.

The reason why Bank of America has been unable to raise its profits, and grow its dividend, in the past six years is because these $60+ billion in fines, fees, restitution, and so on, related to the Countrywide acquisition, have prevented Bank of America from using its banking profits to enrich shareholders—it’s gone out the door in legal judgments instead. Recently, Bank of America management indicated that roughly 90% of the financial crisis litigation has been settled, and only $5-$10 billion in settlements remain.

Over the past few years, many shareholders have sold out, growing weary and worn out by seeing Bank of America’s litigation woes take center stage, quarter after quarter, year after year, since the financial crisis. For prospective shareholders now, we are in about the eighth inning of the litigation settlement ballgame. The crisis is finally fading, and those $10 billion (and growing) annual profits will soon begin to manifest themselves with higher profits, and the rising dividends and stock price that comes with that. The appeal of buying the stock now in the $15 range rather than later is that, once the dividend increases and profits-in-the-clear arrive, the opportunity to buy the stock at a value price will be gone. You have to be a bit like Gretzky and skate to where the puck will be, rather than where it is now.

While I am flattered—and I mean this sincerely but I’m not a good enough internet writer to make the depth of my appreciation jump off the screen—that some of you have written to me asking that I manage some of your money, sadly, that is not something I can nor want to do.

First of all, I mean that literally: I don’t have the proper licensing to start taking on investors.

And secondly, even though I understand that the management of other’s assets “is where the money is” when it comes to the financial services industry, it’s not something I’ve had much of an inclination to do because most people are interested in twelve to twenty-four month returns, and I have little desire to spend my life defensively explaining to others why stock selections aren’t performing better than the S&P 500 Index over the past six months, year, three years, and you get the picture. If I wanted to beat the market over the next ten years or so by owning high-quality blue chips, it could be done: it would be a portfolio loaded with Visa, Becton Dickinson, Disney, and the like, but I’d have no ability to tell you whether those stocks will be winners in 2015, 2016, or 2015 through part of 2016. Being right over a fifteen year period isn’t something that would be enough for most people; they want to see that they are right at every annual benchmark along the way. I couldn’t do that, and I wouldn’t want the hassle.

For instance, if I had been managing money over the past couple of years, I would have bought a significant block of IBM stock. Since 2011, IBM has returned 7.5% annually, while the S&P 500 has returned 18.5%. At this particular 2011-2014 point in time, it does look like a particularly bright decision. The catch, though, is that the P/E expansion experienced by the S&P 500 has been much greater, and will revert to the mean eventually. IBM, meanwhile, has been getting cheaper than usual over that stretch, trading at 12x profits instead of its usual 15-16x profits. Although most people don’t talk about, the business is doing fine fundamentally, growing profits by 9% each over that time. Over the next seven to twelve years, things will work out, but it’s this narrow snapshot of time when a particular decision is underperforming that I wouldn’t want to spend my life having to defend to people.

You saw these all the time—since 1920, Coca-Cola has experienced sixteen declines of 25% or more, and has experienced declines of greater than 40% eight times (I’ll rephrase that: of those sixteen declines of 25% or more, half of them have actually taken the price of the stock down by over 40%). Someone who bought the stock eighty years ago would have compounded at 16.5% over that time frame. Since the early 1970s, Coke has compounded at almost 13%. Since the early 1980s, Coca-Cola has compounded at over 15%. And since 1990, Coca-Cola has compounded at 11%. The evidence of Coca-Cola being a high-quality asset is apparent to everyone that spends time in the financial industry, yet imagine buying right before one of those steep declines.

People are going to think you are stupid because of the timing, even though those reinvested dividends at lower prices are actually turbo-charging the amount of wealth you will end up creating, and over the course of 15-20 years, your thesis about Coca-Cola is going to prove right. If Coca-Cola fell to $25 per share put kept paying its $0.305 dividend, earning $2.20 in total profits, and had no noticeable drop in future expectations, you should be excited about the new reinvestment opportunities it would provide, and the wisdom that you’d get a good deal purchasing the stock at $40-$45 isn’t negated just because a cheaper price comes along (e.g. buying General Electric at $12 per share during the financial crisis was an exceptionally intelligent decision, even though you could also have purchased the stock as low as $6 per share. The intelligence of a decision at a given time is not diminished by the fact that an opportunity to get richer, faster with the same stock later arrives. You look at the price, make an educated guess about future cash flows, and act accordingly if you like what you see).

The people who understand those fundamentals aren’t going to be asking for anyone else to manage their money, and the people who want to let someone else manage it may not appreciate that a superior business that will deliver 10-13% annual returns has been purchased, but at this point in time, the stock price doesn’t reflect what you are going to be getting over a fifteen to twenty-year period. If someone’s heart isn’t into the notion of owning excellent businesses for the long-term, it’s going to be a whole lot of work getting them to stick to the script when you’re getting those steep declines that you see two or three times per generation.

I was reading an investor forum recently where a commenter said that he was contemplating a purchase of shares in Vanguard’s legendary Wellington Fund that has a track record of delivering 8.5% annual returns to investors dating back to 1929, making it one of, if not the, oldest balanced fund in the nation.

He said that he wasn’t going to buy shares because it had trailed the S&P 500 over the past three and five years. For reference, the Vanguard Wellington Fund has returned 12.32% over the past three years and 13.95% annually over the past five, while the S&P 500 has returned 16.58% and 18.83% over those same time periods, respectively.

While it’s always true that you should never make an investment based on past performance alone but you can use it to inform yourself about future performance (for instance, the history of labor problems at Hostess can help explain why Hostess has gone from bankruptcy to bankruptcy while Kraft has built wealth at a 12.5% clip annually for a century. Looking at Little Debbie’s and Oreos in a grocery story aisle may not make the wildly different experience of owning the shares apparent, and a look at history can explain a lot about the future in that situation), you should not rely on performance metrics alone when the economy and the stock market has been rising for five years straight.

Even I would always prefer longer data (ten years vs. five years) over shorter data, it is especially short-sighted to rely on five-year returns right now because it only captures half a business cycle, rather than a full one. Typically, one years out of three will result in stock price declines. But because the 2008-2009 experience was so extreme, it has created conditions that have allowed for prolonged positive stock market performance as stocks have generally moved from undervaluation back to fair valuation and then the slightly modest overvaluation that we see today.

If you are contemplating any potential investment, you have to take the bad years into account as well. If you look back ten years, the S&P 500 has returned 7.78% while the Vanguard Wellington Fund has returned 8.53%. Viewed in that light, it’s easier to understand the purpose of the Vanguard Wellington Fund: it’s not supposed to be a high-flyer that steals the spotlight in good times, but it holds up in poor times and also does satisfactory in good times.

How is this possible?

When you look at its composition, you can see that it consists of 35% high-quality bonds. The purpose of this is to limit the downside volatility when economic conditions worsen and stock prices decline. The bond prices don’t fluctuate as much and they keep pumping out interest to hold up the prices better than some fund that is fully invested in stocks.

Meanwhile, the Vanguard Wellington Fund is prepared for the good times as well by putting the rest of the money (aside from a small cash allocation) to the highest quality stocks in the world, with the largest bets on Wells Fargo, Chevron, Johnson & Johnson, Exxon Mobil, and JP Morgan. The growth of those firms during good times is why the fund’s returns are within hailing distance of S&P 500 funds during prolonged periods of stock price advances and improving economic conditions.

That’s the Vanguard Wellington’s formula for success—diversify, hold a basket of stocks divided among the most powerful companies in the world to provide ballast during times of economic expansion, and keep enough bonds on hand to ensure that the fall isn’t too steep when the next recession inevitably hits. That’s how you stay in business for ninety years and deliver 8-9% annual returns in the process.

None of this should be read as advocacy that you buy the Vanguard Wellington Fund, although it’s probably one of the best buy-and-forget-about-it funds out there, given its low fees of 0.26% annually, its nearly century long track record of delivering 8-9% returns, and its current collection of high-quality assets. But really, my point is more along the lines of how you think about the process. I don’t want you to make any investment decisions based on the performance of an asset over the past five years. The only thing you learn from that fact is that the asset performs well during good times. That sets you up poorly when the next recession and steep decline comes around. You should probably be looking at ten-year performance charts anyway to get an idea of a strategy is playing out, but this is especially true when reviewing the previous five years of performance because they were no bad years included in the data. The skeletons in the closet can only be found if you go back six or seven years.