Login | June 05, 2023

Bad pennies

Ask the Fool

Published: May 30, 2023

Q. Penny stocks are so cheap -- how can I not get rich when I can buy thousands of shares for just $100 or less? -- H.S., Lake City, Florida
A. Penny stocks -- those trading for around $5 per share or less -- have caused many investors to lose lots of money.
The stocks are usually tied to small, unproven and often unprofitable companies. Since they have relatively few shares trading, they can be easily manipulated. In a classic "pump-and-dump" scheme, a scammer buys shares of a penny stock and hypes it online so that people buy and the price goes up; then the scammer sells in a rush, sending shares plummeting and wiping out the gullible investors.
Remember that a stock's price alone tells you little about its value. Sure, you can buy gobs of shares of a $0.10 stock, but there's a decent chance it will become a $0.05 or $0.001 stock instead of soaring and making you money. Meanwhile, even a $200 stock can be undervalued and on its way to doubling, tripling or more.
Both kinds of stocks can rise or fall by the same percentage over a day or year: A 10% increase will turn a $0.10 stock into a $0.11 one, and a $200 stock into a $220 one. If the $200 stock belongs to a growing, established and profitable business, it's likely a much better buy.
Q. What's "EPS"? -- N.D., St. Joseph, Michigan
A. It stands for earnings per share. If you take a company's net income (net profit) over a period such as a quarter and divide that by its number of shares outstanding, you'll arrive at its EPS.
Fool's School
All About Dividends
Dividend stocks can be terrific for all kinds of investors, not just retirees seeking income. Younger dividend investors, for example, can watch as cash appears regularly in their brokerage accounts -- and can spend it on more shares of stock, which will help their portfolios grow more briskly.
Dividend stocks aren't slouches when it comes to performance, either. According to Ned Davis Research and Hartford Funds, between 1973 and 2022, dividend-paying stocks averaged annual gains of 9.2%, while an equal-weighted S&P 500 index averaged only 7.7%.
Stephen Dover of Franklin Templeton has noted that from 1990 through 2021, half the total cumulative return of the S&P 500 index was from dividends received and reinvested. Meanwhile, according to a 2023 report from Wisdom Tree, "Since 1957, dividends have grown by an average of 5.7% per year -- more than 2% above the rate of inflation."
While dividend investing in general can be powerful, not every dividend payer is a great buy. Beware of red flags such as extremely high yields, high payout ratios or trouble at the company or in its industry.
When a stock falls, its dividend yield rises -- so some (but not all) steep yields are tied to companies in trouble. If a dividend payer is in an industry facing serious challenges, its dividend may be in danger. Healthy and growing companies will aim to maintain and even increase their payouts, but struggling ones may reduce, suspend or eliminate theirs.
Finally, there's a company's payout ratio, which is the portion of earnings that it pays out in the form of dividends. (To calculate it, divide the dividend amount over a period such as a quarter or year by the earnings per share over that period.) You don't want to see a company paying out more than it's making, so look for a payout ratio well below 100%.
For best results, favor stocks that have been increasing their dividends regularly for years.
My Smartest Investment
Smart Moves for Retirement
My smartest investment move was increasing my 401(k) contribution rate from 12% of my salary to 14%. (Plus, I get a 6% match from my employer.) I also opened a Roth IRA and filled it with shares of companies such as Walt Disney, Microsoft and Waste Management. -- L., online
The Fool responds: Those are a lot of smart moves!
A 401(k) account, whether of the traditional or Roth variety, can be a powerful investing tool for retirement. Many employers will automatically enroll workers in one, but at relatively low contribution levels, so it's good that you increased yours to an aggressive rate that will let you sock away a lot of money for your future.
Many 401(k) plans offer at least one broad-market index fund in their menu, and that's generally a solid choice for long-term dollars. (Make sure the fees are low; index funds generally charge very low fees, often below 0.2% annually.)
IRAs are also very effective. They have lower annual contribution limits than 401(k)s, but allow you to invest in just about any stock or mutual fund. You did well selecting some dependable blue-chip stocks. Each has a solid track record of growing over decades while rewarding shareholders. Using a Roth IRA is also smart, because if you follow its rules, you get to withdraw money from the account in retirement tax-free!
Foolish Trivia
Name That Company
I was founded in 2010 by a fellow who had started out selling windsurfing and snowboarding equipment. After turning his focus to buying brands and licensing them, he built me into a big business, with annual revenue near $25 billion. My offerings are sold in more than 10,500 stores, and my lifestyle, entertainment and media brands include Reebok, Eddie Bauer, Frye, Tretorn, Nautica, Izod, Brooks Brothers, Barneys New York, Juicy Couture, Lucky Brand, Aeropostale, Forever 21, Nine West and Jones New York. I'm privately held at the moment, so you can't buy shares of me through your brokerage. Who am I?
Last Week's Trivia Answer
I trace my roots back to the 1946 founding of the Tokyo Telecommunications Engineering Corp. My first consumer product was a rice cooker. My pocket-sized transistor radio, launched in 1957, was a global success. I revised my name in 1958 to reflect the Latin word for "sound." I debuted an iconic cassette player in 1979. Today, I'm a conglomerate operating in entertainment (including film and music), electronics (like cameras, televisions and mobile devices) and more. I recently employed more than 100,000 people and had a market value of $110 billion. P.S.: I launched a video game console in 1994. Who am I? (Answer: Sony Group)
The Motley Fool Take
For Rent
United Rentals (NYSE: URI) stock was recently down more than 20% from its all-time high, while sporting a price-to-earnings (P/E) ratio near 13 -- reflecting a good valuation at which to buy United Rentals stock for the long term.
United Rentals -- "the largest equipment rental company in the world" -- claims a 17% market share in North America, renting out everything from warehouse forklifts and excavators to portable offices and restrooms. With its equipment fleet valued near $20 billion, it would be hard for a would-be competitor to build what United Rentals has. Scale like this takes time.
United Rentals' management is opportunistic with its fleet management. When rental demand is high, it tends to keep equipment in use, servicing as needed. When demand is lower or items reach the end of their usefulness for rental, management sells them. The company profits either way.
The company initiated a dividend in 2023 that recently yielded 1.6%. It's also rewarding shareholders by repurchasing stock. Share repurchases are a big reason the stock has been a long-term winner -- it's averaged annual gains of nearly 22% over the past decade.
United Rentals isn't a complicated story. Its services are routinely in demand because they're important for infrastructure. These services generate substantial profits, and management returns profits to shareholders. This lucrative formula is likely to continue in 2023 and beyond.