Common Sense Advice For Investing In The Stock Market
Given the poor performance of the stock market in 2008, its time to go back to the investment basics and make sure you don’t forget the important stuff.
1. Only invest in companies that pay a decent dividend (at least 3%) and that have a long history of increasing their dividend.
You should consider share buybacks when measuring the dividend yield. This criteria achieves several goals. Its narrows your possible choices substantially, providing you an investment “universe” that’s more manageable.
It also automatically prevents you from buying stocks that are speculative or overpriced. If the company is cooking the books, it cannot maintain its dividend. Companies like AOL or MCI Worldcomm were reporting record profits during the Tech bubble (and so was Enron during a later period) when in fact, they were booking large losses. Since they weren’t paying out any dividends they were able to get away with the fraud for a lot longer than otherwise possible.
Investing in dividend-paying companies greatly reduces the odds that your account will ever show a loss. Earning 3% a year isn’t much, but it adds up, especially if the company continues to increase its dividend. After a year or two, even if the share price dips, you’ll probably still show a gain, thanks to the dividend.
2. Out of the companies that are paying a good dividend, only buy companies whose businesses you’re able to easily understand and that you judge to have a solid competitive advantage.
To increase your understanding, read the company’s 10K (annual report) filed with the SEC. You can get a copy online for free at the companies website or the SEC’s website. If you’re not willing to spend an hour or two reading a company’s 10K, are you really ready to invest 4%-6% of your life savings in its stock? It’s surprising that investors will readily pile money into companies that they don’t understand, and that they make no effort to understand.
Note, I’m not talking about trading here. I’m talking about investing – buying a position and keeping it for years.
3. Only buy stocks when they are very attractively priced, i.e. when there’s a substantial margin of safety in the stock.
Benjamin Graham (The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel) was a huge proponent of Margin of Safety (Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor
This step makes it nearly impossible for you to lose money investing and will ensure you garner the benefits of compounding, because your entry price will be small relative to the company’s assets and future earnings.
It’s very hard for anyone to beat the compound returns of high-quality common stocks held for the long term. If you will follow these three simple rules – good dividends, understandable businesses with competitive advantages, and buying only at very safe prices – you can achieve world-class investment results.
Now if I could only follow this advice!
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December 29th, 2008 at 7:08 pm
That’s some sound advice to enter positions. 2008 taught dividend investors that they should sell immediately after a dividend cut instead of hoping that the situation would turn around. 2008 also taught investors not to chase high yield stocks without understanding why the yields were so high.
Another thing learned is not to concentrate your portfolio in a few stocks, but to diversify diversify diversify and dollar cost average.
December 30th, 2008 at 8:33 am
I am about to dump a few thousand into HTE for some decent passive income. What do you think?
December 30th, 2008 at 10:52 am
Ben,
I think you should at least read the 10K and last 10Q so you have a good idea of what you’re investing in and what some of the risk factors are.
December 30th, 2008 at 8:42 pm
Sounds like sound advice
January 1st, 2009 at 12:33 pm
Good read. I plan to implement dividend investing in my goal to be financially free by 25.
January 3rd, 2009 at 3:42 am
Thanks for the advice. Hope the information provided would be of some help to the individual who would like to trade in the stock market.
January 3rd, 2009 at 11:02 pm
Ben,
Regarding HTE. In the medium-term HTE should be a great investment. I just averaged into over 3K of HTE shares myself. Many factors make it a VG medium term investment in my view including:1) monthly distributions (better than quarterly), 2) high effective yield, 3) oil prices likely to rise, thus share price likely to rise, 4) US dollar likely to decline vs. Can. dollar thus effectively increasing value of yield, etc. However there are also some potential risks including: 1) Tax laws in Canada are scheduled to change on these CanRoys in about 2011 making them less attractive (thus one has to consider getting out of HET within a few years..there are many articles on this on the web…although HET claims to have build up tax stategy that may protect it for a few more years after 2011), 2)CanRoys may be brought out by operating oil companies before the tax changes, thus eliminating the distributions..but may also result in decent capital gain on shares if this happens, 3) HET has only “confirmed” current distribution rate through Feb/09…thus it may reduce distributions after this…but my view this is not that likely if oil prices recover at all which is a pretty good bet in my opinion.
In short, there are some pretty good reasons why HET is a pretty fair bet in the medium term, but there are also some real risks in the longer term. Thus in my view this is probably not a great LD hold and will require some close monitering and probably an exit within a few years. Nevertheless it probably is a pretty good buy at this time.
Just my thoughts and why I am willing to invest in it, at least for a year or two anyway.
January 4th, 2009 at 8:20 am
[...] If you are into the stock market, this common sense advice might help you this [...]
January 8th, 2009 at 2:14 pm
This is some good advice. I was looking to sell a few stocks and buy some divident producing ones..