2 Simple Questions to Identify Outperforming Stocks

Tired of underperforming the markets? Here’s how you could have outperformed by investing in Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) in 2015.

The Motley Fool

It is not everyone’s goal to outperform the market. Still, given the choice, I believe investors would prefer to beat the market than not. Here are a couple of questions you can ask yourself to identify outperforming stocks.

Which sectors or industries are underperforming?

Identify underperforming sectors or industries. Then buy the top companies from the sector.

Here’s an example of how this have worked beautifully for the top Canadian banks, which are the most profitable publicly traded companies in Canada.

Bank stocks underperformed in 2015. Then in 2016, Royal Bank of Canada (TSX:RY)(NYSE:RY) shares rallied about 22%. The same thing happened to shares of Toronto-Dominion Bank (TSX:TD)(NYSE:TD).

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) shares were even more amazing, as they climbed a whopping 33%! (In 2015, Bank of Nova Scotia fell harder, allowing the shares to make a stronger comeback.)

So, never count out underperforming stocks. They can make an amazing comeback as long as the profits of their underlying businesses are still intact.

win

Which has higher growth?

When considering two companies in the same industry, the one with higher growth will likely outperform the one with lower growth, given that you pay a reasonable multiple for the higher-growth company.

Algonquin Power & Utilities Corp. (TSX:AQN)(NYSE:AQN) and Fortis Inc. (TSX:FTS)(NYSE:FTS) are both utilities. In comparison, the former has delivered higher returns as of late.

Algonquin’s one-year returns were about 24%, of which roughly 5% came from dividends and 19% came from capital appreciation.

Although, roughly a year ago, the utility was trading at a multiple of about 21.8, it was a reasonable multiple for its earnings-per-share (EPS) growth, which was 24% in 2016.

Fortis’s one-year returns were about 18%, of which roughly 4% came from dividends and 14% came from capital appreciation.

A year ago, the utility was trading at a multiple of about 17.5, which was reasonable for its stability and expected moderate growth of 5.75-7% per year for the next few years.

Since Algonquin’s EPS is expected to grow on average by about 11.5% per year for the next few years, the utility should continue to outperform Fortis as an investment.

The difference in compounded returns can add up to make a big difference — the longer you hold, the bigger the difference.

An investment of $10,000 with 12% annualized returns transforms to north of $33,000 in 10 years. If the same amount were invested for an 8% rate of return, it would have grown to only $22,200. That’s a $10,800 difference!

Investor takeaway

Every additional percentage of returns you earn from your portfolio will make a big difference in the long run. So, consider investing in tomorrow’s outperformers when they’re underperforming today!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng owns shares of ALGONQUIN POWER AND UTILITIES CORP. and FORTIS INC.

More on Dividend Stocks

Two seniors float in a pool.
Dividend Stocks

TFSA: How to Earn $1,890 in Annual Tax-Free Income

Plunk these investments into your TFSA to earn passive income and avoid the taxman.

Read more »

Engineers walk through a facility.
Dividend Stocks

1 TSX Stock I Wouldn’t Touch With a 10-Foot Pole

AtkinsRéalis (TSX:ATRL) is one TSX stock I'd never invest in.

Read more »

edit Woman in skates works on laptop
Dividend Stocks

3 No-Brainer Stocks to Buy Under $30

These three stocks all offer a huge deal for investors looking for dividends, as well as growth that will last.

Read more »

You Should Know This
Dividend Stocks

How to Convert a $300 Monthly Investment Into $338 in Monthly Income

If you want a certain amount in monthly passive income, invest a similar amount today and leave the rest to…

Read more »

Increasing yield
Dividend Stocks

3 Income Stocks With Big Yields to Consider in April 2024

If you haven’t yet made your March investments, here are three income stocks to buy the dip and lock in…

Read more »

Senior Man Sitting On Sofa At Home With Pet Labrador Dog
Dividend Stocks

RRSP Investors: Don’t Miss Out on This Contribution Hack!

This hack has so many benefits for you -- not just when you put it in your RRSP but for…

Read more »

A red umbrella stands higher than a crowd of black umbrellas.
Dividend Stocks

Passive Income: 2 Safe Dividend Stocks to Own for the Next 10 Years

Dividend stocks such as Manulife and Fortis can help you generate a stable and recurring passive-income stream.

Read more »

Young woman sat at laptop by a window
Dividend Stocks

3 Dividend Stocks Everyone Should Own for the Long Haul

For investors looking for top-tier dividend stocks to buy and hold for the long term, here are three of my…

Read more »