Investment Iron Law Seven: Mastering Stock Investment#
Choose the right stocks, hold them long-term, and watch their value grow.
The Secret to Liu Qiude’s Fortune#
It is said that Tsai Wan-lin, once Taiwan’s richest man and the world’s fifth wealthiest individual, declared at a Cathay Life Insurance executive meeting, “I don’t just want to be rich; I want those who strive with me to be rich as well. Those of you present with less than ten million in assets, please raise your hands.” The executives remained silent. Not because no one dared to raise their hands, nor because no one possessed such wealth, but because for Cathay Life’s senior management, many boasted fortunes exceeding one hundred million.
Liu Qiude, the current Vice President, who joined Cathay Life in his twenties, became a billionaire by following the right person and investing in the right stock. From the beginning of his career, besides the company’s stock options, he consistently invested any spare cash in buying shares from colleagues looking to sell. When Taiwan faced political or economic crises, and some Cathay employees rushed to sell their holdings, he bought them all. Holding these shares for two to three decades, without ever selling, he effortlessly became a billionaire. He himself couldn’t say exactly how many shares he owned, stating, “I won’t know the exact number of Cathay Life shares until they are all transferred.”
Unsure of His Own Dividend Earnings
In 1981, the average price of a Cathay Life share (1000 shares) was about NT$45,000. After 15 years of stock dividends, by 1996, this had increased to 48.7 shares (see table below). Calculated at a market price of NT$160,000 per share, the market value would be approximately NT$7.795 million, a 171-fold increase in 15 years. This impressive growth doesn’t even include the cash dividends received over the years. With such a staggering rate of return, it’s no wonder Liu Qiude is unsure of his exact share count. He’s likely worth well over a billion, perhaps even ten billion or more.
Cathay Life Insurance 15-Year Stock Dividend and Capital Increase
| Year | Cash Dividend | Stock Dividend | Accumulated Shares (Assuming 1 share purchased in 1981) |
|---|---|---|---|
| 1981 | 3 | - | 1 |
| 1982 | 2 | 0 | 1 |
| 1983 | 1 | 150 | 1.15 |
| 1984 | 1 | 300 | 1.50 |
| 1985 | 1 | 300 | 1.94 |
| 1986 | 1.2 | 300 | 2.53 |
| 1987 | 1 | 300 | 3.28 |
| 1988 | 1 | 400 | 4.60 |
| 1989 | 1 | 500 | 6.90 |
| 1990 | 1 | 500 | 10.35 |
| 1991 | 1.5 | 500 | 15.52 |
| 1992 | 1.2 | 300 | 20.18 |
| 1993 | 0 | 250 | 25.22 |
| 1994 | 1.5 | 400 | 35.31 |
| 1995 | 1.5 | 200 | 42.37 |
| 1996 | 1.5 | 150 | 48.42 |
Source: (Taiwan) Economic Daily News
The Tsai family themselves followed a similar strategy. To maintain control of Cathay Life, they held their shares long-term through investment companies. Tsai Chen-yu, Chairman of First Commercial Bank, pointed out that selling these shares was practically impossible; they had become like real estate. One of the main reasons Tsai Wan-lin became Taiwan’s richest man was his ability to hold Cathay Life stock long-term.
Cathay Life isn’t the only company that has created immense wealth for ordinary white-collar workers. Professional managers at several other large Taiwanese companies also accumulated significant fortunes. According to the Taiwan Stock Exchange, from the end of 1990 to April 30, 1996, the average return on all stocks was 35.41%. During this period, holding United Microelectronics Corporation (UMC) stock would have yielded a return of 726.04%, Acer 421.54%, Tatung 335.88%, China Development Financial Holding Corporation 225.55%, Uni-President Enterprises Corporation 191.30%, and Nan Ya Plastics Corporation 123.77%. These examples demonstrate that long-term investment in blue-chip stocks can lead to substantial gains.
The higher the economic growth rate, the higher the average long-term stock market return.
Why Stocks Offer High Returns#
Why is long-term stock investment profitable? First, I must clarify a key concept that all stock investors should understand. Investing in stocks generates profits primarily because the companies you invest in earn money, which ultimately belongs to the shareholders. Your profit doesn’t rely on other investors losing money.
Stocks represent ownership in a company. Stockholders are shareholders of the enterprise, and they have two inherent rights: the right to share in the company’s profits and the right to distribute remaining assets. If the company is profitable, the profits ultimately go to the shareholders. Similarly, when a company owns assets, those assets ultimately belong to the shareholders. Therefore, investing in profitable or asset-rich companies can, in the long run, not only yield dividends from corporate earnings but also a share of the value when assets are liquidated.
Average Stock Market Return of 17%-18%
The long-term price appreciation of stocks is primarily based on two factors:
(1) Increased corporate profitability leads to higher dividends for shareholders, thus driving up stock prices.
(2) An increase in the value of a company’s assets, such as real estate or investments in other stocks, ultimately benefits shareholders, therefore causing stock prices to rise.
Consequently, if a company’s profitability continues to rise, or the value of its assets, like real estate, continues to appreciate, stock prices will inevitably rise in the long run, and shareholder returns will increase accordingly.
Over the past few decades, Taiwanese companies have experienced stable profit growth and rising real estate prices, resulting in stock market returns far exceeding bank deposit interest rates. Data shows that over the past 25 years, the average annual return on the Taiwan stock market has been around 17%-18%. In Europe, the United States, Japan, and other developed countries, the average annual return over a 10-year period is typically between 12%-17%. Simply put, the higher the economic growth rate, the higher the average long-term stock market return.
According to research by several scholars, the Taiwan Weighted Stock Index, starting at 100 points in 1966, reached 12,682 points over 27 years, before falling back to 2,458 points by the end of 1993. This translates to an average annual return of over 17%. These calculations assume that investors consistently bought stocks whenever they had funds and held them until the present without selling.
The Taiwan Stock Exchange conducted another study showing that if you had invested in the stock market 20 years ago and held your investments until the end of 1994 without trading, your return would have been at least 13.7 times your initial investment, with a maximum potential return of 1,384 times. This demonstrates the impressive potential of the Taiwan stock market.
Learning from the past can inform the future. The Taiwan stock market has historically delivered high long-term returns. Even in recent years, investors who avoided the frenzy of speculative buying and instead opted for diversified, long-term holdings have seen decent returns. Looking ahead, I firmly believe that readers who adhere to the principles of diversification and long-term holding can still achieve substantial results through stock investment.
Stock Investment vs. Real Estate Investment
This book recommends two investment tools with high potential returns: stocks and real estate. Which is better? The answer depends on individual financial circumstances, product knowledge, risk tolerance, and tax situation. There’s no one-size-fits-all solution. However, stock investment offers several advantages over real estate:
Real estate investment requires larger capital, often over NT$1 million, which can be a barrier for young people entering the workforce. Stock investment, on the other hand, can be started with just tens of thousands, or even a few thousand NT dollars.
Long-term stock investment generally incurs lower taxes than real estate. In Taiwan, stock investments are exempt from capital gains tax, with the primary tax being securities transaction tax. Long-term investors who avoid frequent trading pay limited taxes, and capital gains upon selling are tax-free. Real estate investment requires annual property and land taxes, and transaction taxes upon sale.
Stock trading is simpler than real estate transactions. Buying or selling listed stocks requires just a phone call, and payment is made via remittance. Purchased shares are held by a centralized depository, adding to the convenience. Real estate transactions involve complex procedures for transferring ownership, which can be time-consuming. Property management and maintenance can also be demanding.
In conclusion, for investors who diversify and hold long-term, stocks are an excellent investment tool for individuals and families. Unfortunately, most stock investors are unable to withstand the fluctuations of the market and the temptation of short-term gains. Frequent trading often leads to losses due to high transaction costs. This explains why, despite the high average long-term returns of the stock market, few people become wealthy through stock investment.
Can Stocks Maintain High Returns in the Future?
Investors often ask me, “The high average annual returns of over 20% in the past were due to Taiwan’s rapid economic growth over the past two to three decades. Now that Taiwan’s economic growth has slowed, can we still expect such high returns in the future?”
If the question is whether the Taiwan stock market can maintain an average annual return of over 30%, I believe that’s unlikely. A country or region’s stock market return is directly influenced by the profitability of its companies, which is essentially linked to the economic growth rate. Taiwan’s economy is maturing. While the average annual growth rate was around 9% for the past few decades, it’s now around 6%, and this trend is expected to continue.
With a declining economic growth rate, it’s improbable that the stock market will maintain returns above 20%. However, I estimate that future stock returns should remain above 15%. This is based on the observation that in developed economies like the US, Japan, and Europe, long-term stock returns remain between 10%-15% even after their economies mature. Although Taiwan’s economic growth rate may decrease, a 10% growth rate is still impressive compared to other regions, making Taiwanese stocks a worthwhile investment. Furthermore, Taiwan’s increasing financial liberalization is likely to attract foreign investment, which will further boost the stock market’s performance.
Untapped gold mines are plentiful; careful selection leads to boundless profits.
Choosing the Right Stocks#
Generally, stocks can be categorized into four types: listed stocks, over-the-counter (OTC) stocks, unlisted stocks, and mutual funds. Each type has distinct characteristics that investors should understand to avoid regrets.
Varying Returns, Liquidity, and Security
Listed stocks are traded on the Taiwan Stock Exchange. They offer high long-term average returns, good liquidity, transparent financial and business operations, centralized trading with fair market pricing, low taxes for long-term investors (exempt from capital gains tax), and dividends eligible for tax exemptions. Listed stocks offer greater security than unlisted stocks. I recommend that readers with long-term savings consider diversifying their investments in listed stocks and holding them long-term.
OTC stocks are traded on the over-the-counter market through negotiated pricing. The trading mechanism is similar to listed stocks, but with lower trading volume and liquidity. Generally, the listing requirements for OTC stocks are less stringent than for listed stocks, with lower requirements for capital and profitability, resulting in lower security. One disadvantage of OTC stocks is that their dividends are not eligible for tax exemptions.
Unlisted stocks are not traded on either the stock exchange or the OTC market. They have lower liquidity, no fair market price, lack transparent financial and business operations, and are not subject to regulatory oversight by the Securities and Futures Bureau (SFB) and the stock exchange, resulting in higher risk and lower security. Their dividends are also ineligible for tax exemptions. While unlisted stocks offer higher potential returns and the possibility of discovering hidden gems, their lack of oversight makes them risky. I recommend focusing on listed stocks, which are sufficient for building wealth. Invest in unlisted stocks only if you have a thorough understanding of the company, its valuation, and trust in its management.
The Best Tool for Beginner Stock Investors
Mutual funds, or investment trust funds, pool money from small investors, entrusting it to professional investment management companies. Investment experts manage these funds with a diversified approach, and the returns belong to the original investors. Mutual funds are classified into open-end and closed-end funds based on their issuance and trading methods.
Open-end funds allow investors to buy and sell shares at any time based on the net asset value. The total amount of the fund fluctuates as investors buy and sell shares. Closed-end funds have a fixed number of shares. Investors wishing to purchase these funds must buy from existing shareholders. Similarly, existing shareholders must sell their shares on the open market; they cannot redeem them from the issuing company. Funds traded on the stock exchange are closed-end funds, and their transaction tax is only 1%.
Mutual funds are professionally managed by experts and offer diversification, generally providing good returns. However, their long-term average returns may be lower than the overall market due to management fees, custodian fees, transaction fees, and other expenses. Because of their smaller investment units and lower risk compared to listed stocks, mutual funds are an ideal investment tool for beginners. To avoid long-term fees, I recommend index funds, such as the Formosa Fund or CTBC Financial ETF 0050, which offer better long-term returns.
This book primarily recommends investing in listed stocks due to their stable long-term average returns. Unless you have specific reasons for investing in other types of stocks, you should allocate most of your funds to listed stocks or stock mutual funds. The most important reason is that long-term investment in listed stocks is sufficient for building wealth.
Margin Trading is Unsuitable for Listed Stock Investment
Some investors ask, “If the long-term return on stocks is higher than the margin interest rate, shouldn’t margin trading accelerate wealth accumulation?” Theoretically, yes. If you can diversify and hold listed stocks long-term, margin trading can leverage financial leverage to accelerate wealth growth. However, in practice, most people who use margin trading for stock investment lose money.
Why? The reason is simple. It’s the same reason why many investors lose money in the stock market despite its high long-term average returns. Daily stock price fluctuations tempt investors to chase short-term gains. They become driven by greed and fear, leading to frequent trading, often buying high and selling low, which ultimately results in losses.
This behavior is already prevalent with fully funded stock purchases. Margin trading exacerbates the problem. The leverage magnifies the gains and losses, further tempting investors to chase short-term profits while increasing the psychological pressure. This leads to even more frequent trading and ultimately greater losses.
My research on margin trading balances for listed stocks shows that margin balances are lower when stock prices are low. When prices rise significantly, investors begin using margin, with margin balances peaking when stock prices are high. This indicates that investors are often hesitant to use margin when they should, and aggressively use it when they shouldn’t, when prices are already high. In short, margin trading for listed stocks often leads to mistakes and should generally be avoided.