There are different types of stocks: dividend stocks, value stocks, growth stocks, turnaround stocks, cyclical stocks, etc. Stocks can belong to more than one category. Stocks can also jump from one category to another.
For example, a growth stock can also be a dividend stock once it starts paying a dividend. For example, Apple Inc. is becoming a dividend-growth stock, having increased dividends for three years in a row.
Before you buy
Before you buy any stock, you should understand what kind of stock it is. Which categories does it belong to? Identifying what kind of stocks you’re buying helps you set expectations for them. You might invest in one stock for income and another for price appreciation (growth). Some stocks deliver both income and price appreciation.
By knowing why you’re buying a stock, you can see whether or not it’s doing what you expected by tracking it periodically, perhaps every quarter or every year. If it doesn’t do what you’d expected, update your notes and decided if you want to continue owning it. If not, you’ll need to think of an exit strategy, such as selling it when it reaches your target price.
Growth investing example
If you buy a stock like Avigilon Corp. (TSX:AVO), you’re expecting price appreciation. After all, it doesn’t pay a dividend, so the only way you can get a return from it is by selling it at a higher price than your cost basis.
It would be useful to set the price target and the time frame of how long you expect to hold it. Unfortunately, with growth stocks, it’s more difficult to decide at what price to sell because if it doesn’t meet growth expectations, the stock price is likely to suffer.
So, for newer investors, it’s better to start dipping into the stock market with value stocks.
Value investing example
It’s best to start with value stocks that are also dividend payers because they tend to be stable performers. Even if the price goes south, the stock should be able to maintain its dividend, so you’ll get a positive return. At least, that should be the case for high-quality businesses. So, look for dividend payers with strong balance sheets that can survive downturns.
For example, Canadian Western Bank (TSX:CWB) is priced at a discount from its historical trading levels. It has normally traded at a multiple of 15 and now trades at a multiple of about 9.5. When oil prices improve, Canadian Western Bank will recover. At about $25, Canadian Western Bank is sitting at a 36% discount from historical levels, so it’s a good example of a value investment.
My time frame for my Canadian Western Bank investment is five years, and my target is a multiple of 15. Currently, that implies just under $40. Earnings are expected to reduce by 4% this fiscal year, but when earnings recover in the future, the fair value estimate of under $40 is going to move upwards as well.
Further, I expect Canadian Western Bank to continue paying me 22 cents per share each quarter. It’s likely that the dividend will grow because the bank has grown dividends for 23 years in a row, implying the business is well run.
In summary
It’s useful to determine if a stock you’re buying is a value investment or a growth investment. Sometimes a stock can be for both income and growth. It also helps to set a time frame and target sale price (if you intend to sell for a gain), so that you don’t sell emotionally when a stock suddenly declines.
Each stock should be treated differently because some may be for trading and others may be core holdings that are high quality that you don’t ever intend to sell.
