Following Ben Reynold’s popular article on 3 important dividend investing concepts with real life examples, I gave some thought about the important concepts about investing.
“Never lose money.”
This is Warren Buffett’s No. 1 rule: “Never lose money.” and his No. 2 rule is “Never forget rule No. 1.”
By buying and holding great companies which have track records of delivering results, you cannot lose money given your holding period is forever. If you are buying the best of the best companies, why would you ever sell it?
One easy way to tell that a company is great is if it has increased its dividend for many consecutive years. In Canada, the longest dividend growth streak for a publicly-traded company is more than 40 years. Fortis Inc (TSX:FTS) is one of two companies that has achieved that.
Unfortunately, Fortis is fully-valued and trades at a price-to-earnings ratio (P/E) of 20 at about CAD$43 per share. Whenever it yields close to 4%, it’ll be a decent place to buy some shares.
In the U.S., the longest dividend growth streak is more than 50 years!
You can only make money with money
Some people want to use the stock market as a quick way to make money. However, the more money you want to make and the shorter time you want to make it in, the riskier it is.
The focus for people starting to build their wealth should be on their active income. At the start of your stock investing career, your day job will still make you the most money.
Secondly, they should learn to save. Your savings would be the seed money for your first investments. Here’s how to save more money.
Besides, it takes time to learn to invest properly. Other than reading a lot, applying the knowledge is also essential for learning. And there’s a high chance that you’ll make mistakes along the way and lose money. That said, those will be the most valuable lessons to learn from.
It’s not what makes a great stock but what makes a great company
New investors might look for winning stocks. They ask,
“Which stocks will give high capital gains?”, and
“Which stocks will pay high dividend yields?”
A better way to think about it is to ask “What makes a great company?”. Whether that company pays a dividend or not is an afterthought.
Behind each stock is a company. What drives the stock price (and dividend increases) is the company behind the stock.
So, instead of looking for a great stock, look for great companies.
Great companies might not generate high returns immediately. Companies with excellent management have a longer term view. They would invest for the future good of the company (and to create lasting value), in opposed to looking for immediate benefits, push up the stock price, and get an outsized payment as the compensation of being a top management.
“Price is what you pay. Value is what you get.”
Ok, so, I’m sharing another rule from Mr. Buffett. What he means here is that you should never overpay for even the greatest companies.
After all, the more you pay, the lower your returns (and the lower the yield if it pays a dividend). In fact, Mr. Buffett tries to pay for companies at half the price of what they’re worth.
However, those opportunities are rare. It’ll take the whole market to tank (e.g. in the financial crisis of 2008-2009) to find great companies at cheap valuations.
Maybe we will get that buying opportunity soon. It has been 8 years since the last recession.
No stock is equal
Each stock is unique. If one stock returned 10% in a year while another returned 5% in a year, it doesn’t mean the first one is better than the second.
You should look at the quality of the stock. How much more risk did you have to take to get that 10% (versus 5%) return?
For example, Johnson & Johnson (NYSE:JNJ) is a leading healthcare company and is well-known worldwide. There’s no question that J&J is high quality with an S&P credit rating of AAA (the highest standing).
However, it trades at a premium P/E of 18.4 and is only expected to grow its earnings per share (EPS) by 6% a year. (This is exceptional growth for a company of its size.)
Compare J&J to Starbucks Corporation (NASDAQ:SBUX) who’s a leader in its own right. Starbucks trades at a premium P/E of under 30 and is expected to grow its EPS by 18% per year.
So, before buying a stock. Think about its quality, growth expectations, and its valuation. The ideal situation is you find a quality stock with excellent growth expectations given the price it’s trading at.
If you like what you've just read, consider subscribing via the "Subscribe Here" form at the top right so that you will receive an email notification when I publish a new article.Disclosure: At the time of writing, I own shares in Fortis and Starbucks.
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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