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Let’s say you were around on VJ day, September 2, 1945, which was the day that Japan formally surrendered at the end of World War II. For the month of September 1945, the Dow Jones Industrial Average was at $180. Sixty years later in September 2005, the DJIA was $4,789. That is an increase of over 2600% over 60 years.

The problem is that the increase in the DJIA was not a straight line; it went up and down the entire time. If you could not wait for 60 years but only had 40 years, the price in September 1985 was $1,329, which is only a bit better than 700% for the four decades. If you only could wait 20 years, the price in September 1965 was $931, which was a bit better than a 500% increase.

How does this compare to interest earned in a bank? If you put $180 into a bank account and it earns 8.22% compounded daily for 20 years, then you will have about $931 (the same value as the DJIA that year). For 40 years, the $180 invested at 5% would result in your $1,329. The 60 year mark would turn your $180 into $4792 at 5.47%. This shows that the timing of your buying and selling can have a dramatic impact on the return of that investment.

“Buy and hold” may be good, but it does not necessarily mean that the longer you hold your investment, the wealthier you will become! This is due to the erratic nature of the stock market. You need a system that can maximize the return during the peaks and minimize the risk on the valleys. Five to eight percent returns seem quite small, especially for something as high-risk as the stock market.

Five to eight percent returns are probably adequate for a bank, but this is not a safe, FDIC-insured bank. This is a highly-volatile holding that can decline in value quite rapidly. Conservative banks can pay a lower interest rate because the saver can be assured that the rate of return is safe. In the stock market, your only stability comes from your understanding of what is happening to your investment.

You need a system that allows you to evaluate companies, buy into those companies that are good investments, and then transfer that money to other companies when the investment is better elsewhere. That system is described in my book, The Confident Investor. You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in ebook formats for Nook, Kindle, and iPad.

I probably could have titled this article, “Why I am concerned with companies that give dividends” since I feel these subjects are intertwined. When a company gives a dividend but doesn’t have a large sum of money going into corporate R&D, I am very concerned about the long-term health of that company. A company dividend is basically saying that the managers of the company cannot think of anything better to do with the money than to give it back to the shareholders. While I have nothing against getting a check from my portfolio companies, I don’t want that check to starve future product development that could make the company even more profit in the future.

It isn’t difficult to measure R&D but it is sometimes difficult to measure its effectiveness. To measure R&D, you should use one or both of the following techniques.

• PRR (Price to Research) – This is the market value of the company divided by its research-and-development expenditure over the last twelve months. Look for companies with PRRs between five and 10 and avoid companies with PRRs greater than 15. By looking for low PRRs, investors should be able to spot companies that are redirecting current profits into R&D, thereby better ensuring long-term future returns.
• Price/Growth Flow Model – Price/growth flow attempts to identify companies that are producing solid current earnings while simultaneously investing a lot of money into R&D. To calculate the growth flow, simply take the R&D of the last 12 months and divide it by the shares outstanding to get R&D per share. Add this to the company’s EPS and divide by the share price.

It is far more difficult to look at the effectiveness of R&D. One way, is to calculate the percentage of sales that come from products introduced over the preceding three years. For the calculation, investors need annual sales information for specific new products and this can sometimes be difficult to find. Sometimes, the investor simply has to read the annual report and take note of the CEO or Chairman comments on new product introductions – a lack of conversation often means a lack of products.

Finally, be careful to not overly reward high R&D industries. For example, the pharmaceutical industry spends a huge amount in R&D due to the nature of its market. Just like P/E analysis that I explain in my book, The Confident Investor, R&D spending needs to be compared among its peer group.

If you are amazed at the high dividend given by a company, take a look at their PRR or Price/Growth Flow.  How does that compare to its peer group?  If it is not keeping up then that dividend could actually be starving the long-term potential of the company.