Reader Mailbag: “My cash flow is low right now, so I was thinking of trading penny stocks.”

Dear DTA,

I am here for a class project. We are going to be running a stock simulator. I would like to learn how to trade stocks after taking this class. My cash flow is low right now, and so I was thinking of trading penny stocks to begin with. I don’t know much at this point, but I am a very fast learner. I’m looking forward to any help or suggestions you might have. Thank you in advance.

-Vance D.

Hey, Vance. Thanks so much for writing in to us. We hope you’re enjoying the content thus far, and we hope it’s helping with your class project.

I remember doing a similar simulator back in middle school.

While I didn’t know it at the time, I would later come to love stocks and the stock market.

It’s great that you’re taking this opportunity seriously, as it would behoove you to learn as much as possible about investing, as soon as possible.

In light of that, I want to take a little time today to show you a potential path to massive long-term wealth and income.

First, let’s just stop and think for a second.

Can you name any really successful penny stock traders?

Are there any well-known penny stock traders out there who have made massive fortunes by trading penny stocks?

I don’t know of any. And I’ve been actively writing about and engaging in investing for almost eight years.

But I can name a few people who have made massive fortunes by investing in wonderful businesses for the long haul.

Warren Buffett. Peter Lynch. John Templeton. Benjamin Graham. Charlie Munger.

So on and so forth.

It’s a rather straightforward path to great wealth and income.

But it’s perhaps because it’s so straightforward that people must assume that it’s not right, as if only difficult paths are the right paths. It’s almost like people have some complex where they must suffer and stress in life.

I can tell you that I built a real-life stock portfolio that now generates five-figure growing passive income on my behalf, which rendered me financially independent not too long ago.

I started that portfolio while I was still broke back in 2010.

In fact, I was below broke: my liabilities outstripped my assets, meaning I was worth less than zero dollars.

Yet here I am only a few years later, relatively wealthy, and still in my mid-30s. I outline everything I did in my “blueprint” to early retirement.

Moreover, this is no simulator. This is real money. This is real life.

What’s great about this is that everything I did is straightforward, as I followed a tried-and-true recipe that many of the aforementioned legends of investing laid out.

It’s simply a matter of finding great businesses. You then buy stock in these wonderful businesses when their shares are undervalued. And then you hold for the long haul.

One of the best resources for finding wonderful businesses is David Fish’s Dividend Champions, Contenders, and Challengers list, as it contains information on more than 800 US-listed stocks that have all paid out increasing dividends for at least the last five consecutive years.

Every stock on Mr. Fish’s list is a dividend growth stock.

A business that has paid out an increasing dividend for many years is often a wonderful business simply by virtue of the logic and logistics behind paying an increasing dividend.

After all, it’s nigh impossible to pay shareholders an ever-increasing amount of money while simultaneously running a poor business model that isn’t regularly registering ever-higher profit.

Tough to write checks you can’t pay.

And so a lengthy dividend growth track record can be a great initial litmus test for business quality.

If you peruse Mr. Fish’s list, you’ll notice many blue-chip stocks that have become household names.

McDonald’s Corporation (MCD), Microsoft Corporation (MSFT), and Exxon Mobil Corporation (XOM) are just a few companies you’ll find on that list.

Of course, you then want to look at business fundamentals, such as top-line and bottom-line growth, profitability, and the balance sheet. And you also want to make sure there are durable competitive advantages in place.

But once you find a great dividend growth stock, it’s a thing to behold.

These are businesses selling real-life products and/or services to real-life people all over the world.

And they generate real-life growing profit in the process, which then allows them to pay their shareholders real-life growing dividends.

As great as this is, it’s also important to pay the right price, meaning you should invest when the valuation is attractive.

This is an imperative aspect of investing.

See, price and value are not one and the same.

Price is only what something costs.

But value is what something is actually worth.

And buying a dividend growth stock when it’s undervalued can confer major benefits to the long-term investor, as I highlight in my regular weekly series that discusses undervalued high-quality dividend growth stocks.

Sure, you can go out and buy $0.02 stocks.

But how will you know what that 2-cent stock is worth? Is that going to be a wonderful business you want to put your money behind?

It might seem easy to buy a stock when shares are only a couple pennies, but keep in mind that a stock that goes from 2 cents to 1 cent takes half your money with it.

I could have dabbled in penny stocks all this time, but I’ve been too busy buying up equity in some of the best businesses in the world.

I wholeheartedly believe that I wouldn’t be financially independent right now had I been trading penny stocks over the last seven or so years.

Dividend growth investing literally changed my life. And it could change yours, too.

One of the best things about dividend growth investing is that you’re essentially paid to buy stock.

When you buy a dividend growth stock, you’re also buying into a business that rewards its shareholders with a direct source of growing cash flow. Stocks aren’t just stock tickers.

Said another way, you’re buying into a steady stream of growing dividends.

Those growing dividends are a great source of passive income, and this money can one day (when you’re no longer using a simulator) be used to pay real-life bills that you’ll eventually accumulate.

For further reading, I highly recommend fellow contributor Dave Van Knapp’s dividend growth investing lessons, which serve to inform even novice investors what dividend growth investing is and how to successfully use it to grow your own wealth and passive income.

You have some great information at your disposal, Vance.

But it’s up to you to follow through and use these valuable resources to your advantage (both in your simulator and in your life).

I wish you luck and success.

Jason Fieber

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Disclaimer: Jason Fieber is not a licensed financial advisor, tax professional, or stock broker. Please consult with a licensed investment professional before investing any of your money. If your money is not FDIC insured, it may decline in value. To protect the privacy of our readers, any names published in this article are under aliases. In addition, text may be edited, omitted or paraphrased for grammar or length.