With dividend reinvestment, the 5- and 10-year Canadian stock market returns are about 7.6% and 8.3% per year, respectively. If you have been making lower than this rate of return in your stock portfolio, it would be a good exercise to determine ways to improve your investing returns. Here are some tips that might trigger some ideas of improvement for you.
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Buy strong businesses
Strong businesses that have competitive advantages often have solid balance sheets reflected in investment-grade credit ratings. As well, these companies probably have a track record of growing their earnings or cash flow per share, which isn’t necessarily dependent on share buybacks.
Constellation Software (TSX: CSU) is indisputably a strong business, which also has high returns on equity. For example, its five-year return on equity was about 46%. Management has been an excellent capital allocator, as suggested by the tech company’s high five-year return on invested capital of about 26%.
The top tech stock’s 5- and 10-year rate of return are approximately 26.6% and 35.9%, respectively, which outrageously beat the market returns in the same period! These returns were supported by earnings-per-share (EPS) growth. Its 10-year adjusted EPS growth rate was roughly 23.3%, which suggests that on top of the earnings growth, its high returns were also helped by valuation expansion.
Buy dividend stocks
Dividend stocks can provide dividend income — reliable and regular returns irrespective of market movements — to investors. If you’re eyeing reliable dividend income, you should seek sustainable payout ratios and stocks that pay out decent dividend yields. The more volatile the earnings or cash flow could be for the business, the lower the payout ratio you should seek for the stock. The more resilient the earnings, the higher the payout ratio could be (to an extent).
For example, cyclical Magna International’s payout ratio could range from about 20% to 40% of adjusted earnings because its profits can oscillate quite drastically through a business cycle. In contrast, regulated utilities generally have predictable earnings and growth, which is why Fortis stock’s payout ratio is about 76% of its adjusted earnings.
Currently, the best one-year guaranteed investment certificate (GIC) rate is 5.5%. So, you might require dividend stocks to provide a dividend yield of at least 4% in today’s market environment. However, you should also consider the total returns potential of a stock. For instance, CSU stock’s long-term total returns have been superb but it only pays a tiny dividend.
Take note of cyclical stocks
Stocks that are sensitive to the economic cycle may be harder to grasp because these business’ earnings and cash flows are more unpredictable. For example, from the 2020 pandemic low, Nutrien (TSX: NTR) stock appreciated about 250% in a little more than two years. However, from the peak in 2022, the fertilizers and agricultural chemicals stock has declined about 40%. The goal is to buy at a cyclical low and sell at a cyclical high, but it’s easier said than done. Without understanding the intricacies of the industry, it might be difficult for new investors to invest in such cyclical stocks and withstand the volatility.
