It is an unfortunate tendency that, during times of normal and superior economic conditions, too many people becoming entranced with the get-rich-quick type schemes and not enough interest is paid to making conservative investment decisions that will truly reveal their usefulness during the next downturn in the economy.
There are two things that are more important to investing than anything else: liquidity, and the ownership of some assets somewhere that will generate income somewhere in the most adverse of conditions.
Imagine, for a moment, that you were a farmer in the 1920s. By 1925, crop prices had risen so much that people were talking about quitting school to farm because 300-500 acres of farmland were generating profits of $20,000. For comparison, the average schoolteacher earned $3,328 per year in 1925. If the Book of Ecclesiastes is right that there is a season for everything, then this was the season for farmers to stockpile surplus capital to buy some type of cash-generating asset that would still be giving them income when the next batch of hard times arrived.
One of the best insights that changed the life of baseball player Ty Cobb was that people were buying bottles of Coca-Cola for a nickel regardless of their own economic circumstances. Even in the Stumpf biography of Cobb’s life, Stumpf admits to Cobb’s brilliance in recognizing that even unemployed men wouldn’t think twice about grabbing a soda. The insight seems simple, but the wealth that resulted from that insight was staggering.
What is a farmer in 1925 used $15,000 of that enormous salary to load up on shares of Coca-Cola? Essentially, they chose to live on a lifestyle that still spent 70% more than a schoolteacher while taking full advantage of the opportunity to stockpile something for a rainy day. At the time, Coca-Cola was yielding 4.2%.
When the world fell apart during The Great Depression, Coca-Cola raised its dividend 115% between 1925 and 1930. In fact, Coca-Cola actually grew earnings by 3% per share between 1929 and 1930, which was incredibly impressive given that the United States experienced 8% deflation that year. The purchasing power gains were more like 11% since many of us reading this haven’t truly lived through a period in which deflation has been felt.
That means that, will no dividend reinvestment, Coca-Cola was yielding 9.03% in 1930 based on the amount of money that you invested in 1925. If we use the $15,000 original investment figure, we are talking about $1,395 in income that was being passively generated that year from the sale of soda pop across the country. From Coca-Cola dividends alone, they were generating more than twice what a schoolteacher was earning in 1930. All of that was funded by maintaining one’s lifestyle during a feast harvesting season.
Incidentally, that is what happened in Quincy, Florida when a bunch of farmers loaded up on Coca-Cola stock upon the advice of Mr. Pat Munroe. Those farmers sailed survived The Great Depression and got richer as they gobbled up cheap farmland and farm equipment while everyone else was selling collateral and their modest ownership interests to keep food on the table.
Meanwhile, in my home state of Missouri, most farmers couldn’t get their hands on any loans to keep their farms intact because crop prices had declined by 75% and they had already collateralized their farm equipment to the gills in previously existing debt. Also, there was a drought. And when banks tried to foreclose upon the farms because the famers couldn’t make payments, the Missouri Federation of Farmers would show up to intimidate and assault anyone who tried to purchase the foreclosed properties while the rural sheriffs looked the other way.
There are a lot of people out there who work in cyclical industries and experience years in which their incomes rise dramatically while also enduring years in which their incomes dry up or even turn to losses. If that describes your economic situation, you should feel a shove rather than a nudge about using the surplus from the good years to establish meaningful positions in investments like Coca-Cola, PepsiCo, Procter & Gamble, and Colgate-Palmolive. Those are the types of businesses that will still be giving you steady sources of cash even when during the bad years when your income declines.
Conservative investing is all about preparation. It means recognizing that the moments when cash is available is not a license to pick up the latest adult toy to wheel out of the dealership. It is a chance to buy something that generates reliable income to protect you and your family so that the next recession that inflicts a “7 out of 10” amount of pain on your country only hits you with a 2 or 3 instead.
And though this is the part where the art side of investing kicks in, it is also important to invest money in a way that fills in the gaps created by your primary occupation. Recently, I used the analogy of owning stock in both the umbrella and sunscreen companies as a way to make sure that you’re selling something in almost all-weather conditions.
Well, if your primary occupation makes income in the sunblock industries, it can make sense to make initial investments in the umbrella industries as you build your wealth so that your risks become non-correlated. Tenured professors might load up on cyclicals like Honeywell, General Electric, and United Technologies because the volatility isn’t an issue because their job is guaranteed. But if you work in the construction industry, it makes more sense to take the money during the good times to purchase shares in Hershey because people still eat Reese’s peanut butter cups even if the unemployment rate goes up three points.
Benjamin Franklin recommended looking at the people who prosper on the terms that you’d like to prosper, and then emulate their behavior so that you can get the same results. If the process executes well for them, it should execute well for you too if you get the diagnosis right. Wouldn’t you rather be a farmer in Quincy, Florida during the Great Depression that is not only surviving, but prospering during the worst conditions that the United States has ever known? Well, observe the behavior that separated them from the Missouri Farmers that had to resort to violence against lien claimants to survive.
The difference lay in the preparation. During the feast years, the Quincy farmers took the surplus cash and invested it in dividend-generating, non-cyclical companies that sold products people bought when times were terrible. That’s how you invest well. Identify businesses that always make money, and buy ownership interests in them during the good times when the times are good. If you need that money during the next recession, you can uncheck the dividend reinvest box and receive the cash proceeds to keep you afloat.
Muhammad Ali used to say that he won his boxing matches in the six months before the fight through his preparation in the gym. A successful investing life is less about what you do during an economic storm—though not selling low is important!—and more about what you do in the years that precede the economic stressors of your life.
Originally posted 2017-06-27 06:00:28.