It can be mind-boggling for new investors who are just starting to buy stocks. Stocks are known to be risky investments. To put it in perspective, in the worst-case scenario, if the underlying company goes bankrupt, common stock investors could potentially lose their entire investment. Simultaneously, stock investing could be a very rewarding experience, allowing investors to build generational wealth.
Here are five tips to help new investors avoid mistakes, thereby aiming to preserve capital while making money in the long run.
Image source: Getty Images
Look out for earnings quality
Every business is different. Even within the same industry, some companies make earnings or cash flows that are higher quality and more predictable. For example, as a large and diversified regulated utility in North America, Fortis’s (TSX:FTS) earnings quality is considered to be top notch. As a regulated utility, it’s able to earn predictable returns on its investments. The business even stays defensive during recessions. Unfortunately, because it is a blue-chip stock with high predictability, the stock hardly goes on sale.
FTS and XIU 10-Year Total Return Level data by YCharts
Watch the stock’s valuation
Other than targeting to buy businesses with quality earnings, investors also need to be aware of the valuation they are paying. What’s challenging is that valuation is a moving target. For instance, in a higher interest rate environment, stock valuations have generally declined.
For instance, when there’s a flight to quality, Fortis stock could trade at north of a price-to-earnings (P/E) ratio of 22. At $55.58 per share at writing, the utility stock trades at a P/E of about 18.4. Then, there is its long-term normal P/E, which is about 19.5. Assuming 19.5 as the fair P/E for the company, the stock is considered to be fairly valued right now.
When investors target to buy stocks on the cheap, at low valuations, and potentially sell at full or high valuations, they could potentially better protect their principal and make money.
Earn income from your investments
Other than price appreciation that could come from P/E expansion and earnings growth, shareholders could also earn income from stocks that pay out dividends. In other words, investors can make money from income and price appreciation.
At the recent quotation, Fortis so happens to offer a dividend yield of about 4.2%. It has one of the longest dividend-growth streaks of about half a century! This year, its dividend remains sustainable, with a payout ratio of approximately 75% of adjusted earnings. For your reference, its five-year dividend-growth rate is about 6%. Over the next few years, it also targets dividend growth of 4-6% per year.
Assuming a safe dividend, the dividend yield of a stock increases as the stock price falls. Since stock prices are unpredictable, it makes good sense to target to earn stable (and ideally growing) income from your investments. As noted earlier, in the case of Fortis, its dividend is secure and expected to grow.
Diversify your portfolio
A diversified portfolio could mean buying stocks from different sectors and industries. Extending further, it implies investing across different asset classes, such as cash and cash-like investments, Guaranteed Investment Certificates (GICs), bonds, stocks, real estate, and cryptocurrency. Different asset classes expose your money to different risks. You can also diversify by investing in exchange-traded funds (ETFs). For example, there are funds that expose investors to a basket of bonds with different maturities or a group of high-yield dividend stocks. Maintaining a balanced portfolio across different assets is one way to diversify risk.
Understand your investment horizon
If you expect to use your money within a few months, that amount should stay in cash or cash-like investments like a high-interest savings account. If you expect to make a big purchase, such as a car or down payment for a home, in, say, one to three years, you might lock your savings in GICs.
Stock and real estate investing are long-term investments. As such, investors should be ready to hold with a long-term investment horizon, which will hopefully help you ride through market volatility and make money over the long haul.
Investing is a complicated matter. Seek advice from qualified professionals if you’re not sure where best to place your money.
