Investing: Part 2

The second obstacle to successful investing is knowing when to buy a stock.  The truth is there is no such thing.  All one can do is to assess the company, industry, and the economic climate at the time of investing and predict what the future looks like for that company.  Assessing is nothing but an estimate which is the toughest skill to become successful at. But, thankfully you are reading this publication and we will list a few factors to look for when it comes to putting ones money to work.

Type of asset:  Avoid any mutual fund, ETF or any other investment vehicle created by Bay Street. These instruments rarely outperform the stock market and are designed to generate excessive commissions at the expense of your returns.  Stick to individual securities. 

History of profitability:  One can waste his or hers life savings trying to find a successful start-up that will become the next Microsoft.  Therefore, it is almost always preferable to invest in a company that is mature and has a lengthy history of increasing profitability. Even if the stock does very little, the risk of losing some of one’s capital decreases significantly.

Dividend Yield & History:  Dividends often account for more than half of a stocks return over time.  This is why the dividend yield is so important.  For example, a company with a lengthy history of paying a 2% dividend will return ones investment in 50 years, assuming there are no dividend increases.  Similarly, a share that offers a 4% yield will return the investors’ money in 25 years.  Again, this assumes there are no dividend increases.  A dividend increase will decrease the time needed to recoup ones invested capital.  Therefore, one should always look at the dividend history of a company and favor companies that have a history of increasing the dividend.

Valuation:  We use the dividend yield and price-to-earnings ratio (P/E).  If the dividend yield is below its long term average and the P/E high, it usually means the stock is overvalued and one should wait on the sidelines for both to revert to their long term averages.  Obviously, one wants to invest in the company when both are below the long-term norms.

Cashflow: Cash comes into the business (cash inflows), mostly through sales of goods or services and flows out (cash outflows) to pay for costs such as raw materials, transport, labour, and power. The difference between the two is called the net cash flow. This is either positive or negative. A positive cash flow occurs when a business receives more money than it is spending. This enables it to pay its bills on time.  A company can have a loss; however, if it is still generating a positive cash flow that is most likely sustainable, the stock is worth a look.  A perfect example is (for paying subscribers only)  were it released negative earnings for many quarters but continued to generate a positive cash flow and bank $100m quarterly.  Further investigation into the company found that the majority of losses where paper losses derived from the write-down of assets and amortization.  In this scenario, a stock is worth the gamble as long as the company can maintain a competitive advantage in an industry that has a positive outlook.

Industry outlook:  Does the industry have a long-term horizon?  This is important because the majority of wealth is realized by the law of compound returns over time.  Specifically, if a company can grow its earnings over time, the share price will most likely follow.  For example, if $10,000 is invested in a stock that generates a 15% annual return, it will grow to $20,000, then $40,000, and $80,000 after 15 years.  Most stock markets are lucky to average 7% annually. 

Economic outlook:  This is pretty much self-explanatory.

Our system of buying, holding and, collecting dividends is the easiest and cheapest way to invest.  It is also a method that generates returns that outperforms 99% of investment professionals.  But at some point in the future these shares will have to be sold. 

...to be continued