In our most recent series written by Jamie Cornehlsen, Denver CFA and founder of Capstone, FLOW examines how we seek out investments and make selections based on current market trends and future forecasts. Part three of our series evaluates how increasing risk and investing in high dividend funds can generate an increase in cash flow over time.
Below is my experience in finding an investment whereby I acted as the owner of a business and followed Warren Buffett’s true sense of investing.
As the stock market continued its downward spiral, I went off in pursuit of finding a reasonable investment. I thought about investing in a liquor store. I thought about a venture in the real estate industry.
Both opportunities likely would have delivered optimal returns, but I opted for something different. Instead, I discovered that the recent market decline had opened up the chance to dive in and explore some interesting investments that I had not seen in over four years.
With $150,000 set aside, I was eager…not to invest based on speculation, but rather, for the underlying ability of the business to generate cash flow.
Adopting a Higher Level of Risk for a Greater Return
In my search for investments that would grant financial independence, I decided to skip the liquor store investment and pass on the real estate venture. I knew I was more interested in learning opportunities with higher potential reward in exchange for more effort and risk. As a result, I settled on companies with high yielding dividends, master limited partnerships (MLPs), real estate investment trust (REITS), and closed-end funds (CEF), all of which I knew would provide me with a 10% return.
Ever since I heard Buffett and Munger discuss owning an investment as a business, I have thought about applying this philosophy to my financial choices. In Chapter 8 of The Intelligent Investor, author Benjamin Graham discusses the idea of buying a company with a partner. There may be some days when the partner comes running into your office saying the business is worth half as much as the day before and he wants to sell to you. The very next day, this same partner comes running in saying the business is now worth twice as much and he wants to buy out your share.
In reality, the business does not swing in value by that much. As I indicated in Flow #2, returns are based on three key factors: the cash flow that is generated and paid to you, the amount by which you can increase this payment each year, and finally, the price you are able to sell it for.
Selecting Investments That Work for You
In his book, Graham advocates that people should not partner with this type of person as they are proven to be fickle. Instead, he believes individuals should invest on their own and focus primarily on what the business can provide in cash and how it can increase that amount each year.
For me, detecting an investment that provided the beneficial outcomes I sought came in the form of high dividend yielding companies, master limited partnerships (MLPs), real estate investment trust (REITS), and closed-end funds (CEF). From here, I created a list of 170 investments to further evaluate. My goal was to narrow this down to 20 in order to limit the individual risk of each going out of business. Narrowing down my choices also allowed me to watch my basket closely and follow the progress of each investment.
Now that I knew what my investment would be, it was time to develop the portfolio…