3 Factors for High Returns and Reduced Risk

Investing is not just about high returns. However, there are ways to get higher returns with less risk. Here’s an example with Wells Fargo & Co (NYSE:WFC).

Kay Ng

Kay began investing in dividend stocks around 2008 via the concept of value investing. Since then, she has expanded into growth investing, including in small caps. Her passion for investing has only grown over the years! After graduating from UBC with a BSc in Computer Science, she took university courses in financial markets, finance, and financial accounting. She has contributed her works to Motley Fool, Sure Dividend, and Seeking Alpha.

Published June 21, 2016 11:14 am EDT

People invest in stocks instead of putting their money in a savings account in order to get higher returns. However, higher returns come with higher risk.

That said, there are ways to reduce your risk in investing. Look for quality dividend stocks that are priced at a discount.

Dividend

Dividend stocks add a safety net when you invest. These companies have the tendency and the ability to pay dividends.

View it as if you’re getting some of your money back when you receive dividends. For example, if you buy $1,000 worth of shares of a company and receive $40 in dividends in the first year (equivalent to a yield of 4%), it’s as if you have only $960 of invested capital after the first year.

Discount

Buying companies at a discount adds a second safety net. Always aim to pay less for more. The less you pay for a company, the more value you get. Ultimately, the result is a higher return. You’d also get a higher income if the company pays a dividend.

Quality

Quality companies are financially strong and have competitive advantages.

Wells Fargo & Co (NYSE: WFC) is a quality company that pays a dividend. Now is an opportunity to buy it at a discount.

Wells Fargo has an S&P credit rating of A and is one of the largest banks in the United States. Additionally, it’s trading at about 11.4 times its earnings, while its 10-year normal multiple is 13.2.

Using that multiple, its fair value would be about US$54 per share, indicating the shares are discounted by 13%.

At about US$47 per share, it yields 3.2%. Its quarterly dividend is US$0.38 per share, equating an annual payout of US$1.52 per share. Its payout ratio is only 37%, similar to its competitor JPMorgan Chase & Co.’s payout ratio of 34%.

On the other hand, the Big Five Canadian banks’ payout ratios are roughly 50%. So, Wells Fargo should have better dividend-growth prospects over time, but it requires regulatory approval, as overseeing the dividend payouts of the U.S. banks is one of the measures to prevent the financial crisis from happening again.

Nonetheless, Wells Fargo’s payout ratio is low. So, it has a great margin of safety for its 3.2% yield.

Conclusion

By focusing on quality dividend companies such as Wells Fargo when they are discounted, investors can get more value at a cheaper price, start off with a higher yield, and ultimately get higher returns.

Since Wells Fargo pays U.S. dividends, investors should hold it in an RRSP to get the full dividend without getting the 15% withholding tax.