Investment Services in Toronto: Stocks
Equities are growth investments, and can include things like real estate, art, antiques and gold. However the most popular equity investments that people rely on for growth are stocks. But stocks can also serve purposes other than growth. In addition to potential capital gains, stocks also have the potential to pay dividends. With GICs and bonds, you are a lender and your reward is interest. With an equity you are an owner, and if your company makes money, your reward is a dividend. Because of the preferential tax treatment for some Canadian source dividends, dividends can play an important role in your portfolio. But as important as dividends may be, it is the potential for growth and capital gains that make stocks a vital part of your portfolio.
What the experts say about stocks
Financial experts have many opinions on many things, but there is one fact on which they will all agree – you need to have stocks in your portfolio to provide the growth you need to stay ahead of inflation and have a secure future over the long-term.
They also agree on the best way to invest in stocks – with a long-term view in mind. Yes, there are “day traders” and “swing traders” and many other “traders” whose success depends on timing the market. How do they do? For the most part, the ones who benefit most from “trading” are the brokers who earn commissions on each trade.
Trading stocks successfully over short run periods is difficult to say the least and there are far more losers than winners. Equities go up and equities go down. That is predictable. To know when they will go up or down is not.
But history has taught us one valuable lesson.
Over the long run, equities do go up and have proven to be the most profitable investment by far. But the key phrase here, the vital strategy for success is “over the long run”.
You saw an earlier example of the disastrous results of missing the "best" days in the market. Here’s another statistic that shows how important is to stay invested rather than be a trader:
From 1975 to 2000 the average annual rate of return on the Dow Jones Industrial Average was 12.3% per year. However, if you missed the best 35 days during this period, the return drops to 6.92%. Imagine. All you have to do is miss 35 days out of 25 years and you miss almost half of the gains.
When you hold stocks for the long run you get all of those key days. If you’re a short-term trader, unless you have a crystal ball working for you, you’re going to miss most of those key days. The simple secret to success is to stay invested.
What kind of stocks should you stay invested in?
That depends on your needs, your goals, your resources, your time horizon and your tolerance for risk. But whatever kind of stocks you want to invest in, you can find them.
If your goal is to preserve your capital and receive an income, there are ultra-safe blue-chip preferred stocks that have paid dividends regularly for years. (Always keep in mind that even though a stock may be ultra-safe, it is still a stock and its value is subject to performance and market forces.)
If your goal is to get rich quick, there are endless speculative opportunities to double and triple your money overnight. But if that’s your goal, you’ll have about the same chance of success at the racetrack or gaming table, where you’ll probably have more fun.
And of course, in between the blue chips and the speculatives, there are thousands and thousands of stocks, covering the full range of risk and return.
With thousands of stocks to invest in, there are two basic investment styles – value oriented and growth oriented. Some investors strictly look for value stocks, others strictly for growth stocks. But most experienced investors practice both styles to some extent.
In today’s market, value stocks are more in favour.
A value stock is one whose price is lower than what its potential indicates it should be. The value investor looks at the relationship between the current price of a stock and its intrinsic value.
To determine a stock's intrinsic value, you evaluate things like current earnings, long-term earning potential, price-to-book ratio, and dividend paying ability. If this evaluation is higher than its current price, the stock could be a good long-term investment opportunity. A common guideline is to compare a company’s P/E or Price/Earnings ratio to other companies in the same sector.
These value distortions or mispriced stocks can happen for a variety of reasons, but emotional reactions of investors is probably one of the most important. Here’s how it happens.
Suppose that a certain company has excellent long-term prospects. But some negative event occurs that poses a short-term difficulty for this company. Many investors, letting their emotions get the best of them, will overreact to the short-term problem and sell their shares. Share prices fall and create the kind of opportunity a value investor with a long-term horizon looks for.
A note of caution. Investing in stocks just because they are cheap is not value investing. Some share values are low because they deserve to be. The trick of course is knowing when the fall in price is called for or when it is an overreaction.
Which is why successful value oriented investors are not only research oriented but have the discipline to ride out stormy periods.
Growth stocks have more potential but . . .
Growth stocks, as the name implies, are stocks whose earnings are either on the rise or are expected to rise. During the late 90’s, just about everyone was a growth investor. Every dip in prices was a buying opportunity. And then the great bull market began to falter. And investors who were buying on dips saw their investments keep going down and down. And you know the rest of that story.
As a result of that dramatic drop, many investors have shunned growth stocks. But this is like throwing the baby out with the bath water. There are still many growth opportunities that deserve examination.
The key for most investors is balance. Value and growth investments are both effective strategies through most stages of the economic cycle, and both should be represented in your portfolio. The extent that each should play is up to you.
Also keep in mind that mutual funds are an excellent way for an investor to participate in the high growth potential of equities with less risk and much less capital, time and effort.
How do you decide when a stock is attractive to purchase?
There are two general ways of determining a stock’s potential as an investment. You can look at the "fundamentals" or you can look at "technical analysis" and of course you can look at both.
Fundamental analysis looks at factors such as earnings, cash flow, debt, strength in its industry, outlook for the industry, general economic factors, interest rates, and so on. If these factors are good, then even if there are short-term setbacks, over the long-run, the stock should do well.
Technical analysis looks at factors like volume of trading, cyclical behaviour, trends, moving averages and many others.
Some investors use both approaches. They use fundamentals to determine the long-term potential of a company and technical analysis to decide when to buy. For example, you may believe that a certain company has great potential over the long-term and will be worth much more in years to come.
However, it could be that the current market for this company’s product is temporarily weak and that as a result, the stock price could fall. Technical analysis could be helpful in determining how far the price might fall and could provide help in indicating a good time to buy.