If you're looking to start purchasing stocks, your first step should be to pick a strategy. This will help you identify companies with strong financials and good standing to invest in. The strategy itself, will direct the kinds of opportunities that you should be on the look out for. In today's post, we're going to be breaking down two popular strategies for long term investors.
Whether you plan to invest for the long term or to build up your income, it makes sense to invest in stocks. The average growth rate in the stock market beats savings accounts by a long shot. If you plan and diversify well, you're pretty well shielded from the occasional market crash over the long term.
So let's start dinging a little deeper into what these strategies are, shall we?
Firstly, a stock picking strategy focuses on identifying and holding dividend shares, is what we'd call a dividend strategy.Dividend shares are instruments that pay out a significant portion of their earnings to share holders every quarter.The primary benefit to investors is that they are able to earn a continuous stream of passive income without much effort involved. There is also the extremely delightful option of dividend re-investments, which we'll touch on later.
As a dividend seeker, you'll be on the look out for Dividend Aristocrats. In Canada, these are companies that havegrown their dividends for at least five consecutive years. They are considered among some of the best income investments. When a company earns profit every quarter, they have to use that money to fund future projects and pay back creditors. Anything that's left over will typically be paid as dividends. Hence, a consistent commitment to dividend growth is often a sign to investors that the company has high profitability, strong operations and good management. Canadian examples include Enbridge, TD Bank and RBC, all of which are listed on the TSX.
However this is not always the case. When you're picking companies, be on the look out for those high dividend payouts that aren't backed up by growing revenues, operating profits or acquisitions. It's a tactic that newer companies use, by paying out higher dividends to lure investors. Ultimately, the company may not be able to sustain such high payout ratios.
On the other hand, growth strategy focuses on identifying smaller companies that are expanding rapidly. These companies care about scaling up, growing their operations and establishing a foot hold in their industry. Most often, dividends and sometimes even profitability can take a back seat. The primary benefit to shareholders, will be to profit from the surge in share prices as the company begins to establish a presence and mature. With young companies, it's not uncommon for investors to double or triple their investments in a span of a few years - sometimes even months.
But all that juicy growth does come at a cost. Usually these companies have staggering debt levels and reducing their debt or lowering expenses isn't yet a priority. Because of this, the chances of a takeover or bankruptcy are high. Share prices can fall dramatically in value, reacting to changes to the industry, management or with the introduction of a new competitor. These may catch investors off guard and lead to losses.
As a growth seeker, you are looking for young companies with a strong competitive edge. Often, investors need to look beyond just the financial statements. Most of these companies may not even be profitable in their early stages and won't be for several more years.With growth investing, there is much to be said about identifying the right opportunity. Some important indicators to consider are:
- the viability of the business model and how scalable it is
- if the business idea will revolutionizethe industry
- the track record of the management team
- the number of competitors in the market
- historical and projected growth in revenues
- if debt levels are manageable at current revenues
This is not an exhaustive list, but it should give you an idea of the kind of analysis that is required. And once you've found the right pick, jump in and pray for the odds to be ever in your favor!
Either way, both dividend and growth stocks can offer tremendous opportunities for long term growth and capital appreciation. But you need to spend time doing your due diligence on the companies first.
I know that's a lot to take in, so here is a quick reference guide on each of the strategies highlighting the differences between the two.
This should help you identify stocks that meet the criteria you're looking for. Additionally, it provides some insight into which strategy is better suited to your income levels, current and future needs.
So how you do you pick a strategy?Well, the primary choice is based on the kind of outcome that you're looking for.
If you're an investor in your 50s or older, your primary concern may be setting yourself up for retirement in a few years. You'll want to add a supplementary source of income to replace the income you will lose in a few years. In this case, you should focus more on a dividend strategy. The bulk of your investments will go into acquiring shares of blue chip stocks - reputable companies that have a long history of performing well and paying out high dividends. Pick companies across a variety of sectors so that bubbles and crashes in individual sectors can't hurt your income too much.
If you're a younger investor with a long term outlook, you can afford to take more risk and can wait out the ups and downs of a volatile market. You can opt for the dividend or growth strategy depending on your need for additional income. I would recommend a blend of the two, with an added focus on dividend reinvestment. Many companies will give you the option to reinvest your earned dividends by purchasing additional shares, instead of paying you cash. I think it's a great option, and use this where possible. Essentially, I'm increasing the number of shares that I own over time, without having to put in any extra money.
Additionally, Canadian investors can start to grow their investments tax free in their Tax Free Savings Accounts (TFSA). The dividends and capital gains on investments are shielded from taxes, as long as they stay within the account. The benefits are amplified over time, and are a great motivator to start investing early.
For more on investments, you can read our
Investor 101 series. As always, if you have questions or would like to hear about any other topics, leave a comment down below and I'll either reply or address it in an upcoming blog.Happy investing!
Disclosure-Some products and services linked, may be affiliate links. If you click on those affiliate links and make a purchase within in certain period, I may earn a small commission. This commission is paid by the retailers or service providers at no additional cost to you.While the products recommended have been tested by the writer, these reviews are based on their experiences. Readers are advised to do their own research prior to engaging in any product or service agreement.
