If you want to learn the best method on how to invest in stocks, you have come to the right place. If I were to describe my style of investing, I would say i’m a value investor that puts company valuations at the forefront of everything before I decide to invest in any company. I don’t play momentum and I don’t jump in and out of stocks(ie daytrade). Anyone thinking they can outsmart the markets and make a quick buck is playing a suckers game. The same goes for people that think they can time the markets or predict where the economy is going.
How to invest in stocks – My golden rules:
NEVER short the index. I short individual stocks instead but only if I really believe in it. The amount of companies I short a year is usually less than 5.
NEVER buy gold! Physical or etf. If you want a safe haven, buy more utilities or reits instead. Why not buy a producing asset?
Consider stocks that are optionable and buy shares in blocks of 100. Selling a put isn’t always necessary if it’s a good entry point but you ALWAYS want to sell using the covered call method. I wrote another article on selling options for income where you can get more information on that.
Trim shares when overvalued, buy more when undervalued. Sounds simple but im not talking about the stock price. If the fundamentals keep rising with the stock, I continue to hold it.
With dividend paying stocks, aim for at least 4% dividend yield(or 4% yield on cost within a year). Avoid anything lower.
Investing is not being an economist or focusing on short term geo-political events but rather making investment decisions on a company by company basis. In fact, when I’m checking the news, I skip the business section and go straight to the sports section. What the fed is doing or who is going to win the next election is not relevant to me when i’m wondering what the next apple product will be or if Tesla will successfully disrupt the auto industry. When I pick stocks to add to my portfolio, there are only two types of companies I invest in.
Companies that pay dividends and fast growing tech companies. When I analyze the dividend paying companies I forecast what my “yield at cost” will be 5-10 years from now. In other words, the current dividend yield is not that important to me. I want to know how fast it’s growing and how well it’s covered to see if it’s sustainable. After all, there’s nothing I hate more than a dividend cut! My target yield at cost with a 5 year horizon is around 7%. If I can’t see the company growing their dividend enough to hit that target, I avoid it or wait for a sell off. If the company doesn’t pay a dividend, the technology sector is the only sector where I make an exception.
I only buy into companies if the valuations make sense, long term fundamentals look promising and the company has a strong business moat. I avoid cyclical businesses and prefer industries with consistent and predictable cash flow. This means I avoid industries like automotive, construction, airlines etc. Instead, I invest in pipelines, reits, technology(mostly software).
I make an exception with technology stocks because in my opinion any business that doesn’t require a lot of CapEx, does’t manage any physical inventory and the only real expense they have are the people that work there, is the best business to be in. That is why I can’t avoid tech stocks. Especially now since we are going through a technology revolution and I want to get a piece of it. Total returns are everything so if they aren’t paying a dividend, they better be growing fast enough for me to forgo getting that dividend check!
Now let’s talk about fundamentals. What do I consider good value when I’m buying shares of a company exactly? There’s a lot of things I consider but the very first thing I look at is the cash flow statement(not net income). The ONLY proof that a company has a proven business model and can operate profitably is if they are producing positive cash flow. I don’t look at net income because it can be misleading. Why? Because the net income accounts for asset depreciation which gets deducted from the net income but NOT the company’s cash flow.
Cash flow is strictly a metric that shows how much money is going in the business or going out. Now that you have a general idea of what a company’s cash flow represents and why it’s important, let’s go back to the original question. What is good value? Well, you should ask yourself this question: For every dollar a company produces in positive cash flow how much would YOU pay for it? Now you can see this leads to more questions. You would probably ask yourself, is that cash flow growing? How fast? Does the company operate using a risky business model that would threaten the company’s profitability? Or does this company have a strong business moat that keeps it safe from competition? So whether you are paying $10 or $100, you don’t know if you are getting good value unless you know the answer to these questions.
So what do I consider a strong business moat?
Quite simply any business that has a strong barrier to entry or has a strong enough brand that’s hard to compete with. On the other side of the coin, there’s the low barrier to entry businesses that are swamped with competition. The first type of business that comes to mind is the transportation business. Trucking specifically. When you are involved in a business that’s all about price, it’s very hard to achieve growth because competition is keeping it that way and profit margins are paper thin.
Unless there is a company operating in this industry that has an unfair advantage over the competition, I don’t bother investing. Then there’s companies like Nike that can increase the value of a pair of shoes just by putting their logo on them. That is the kind of branding power that only a select few companies out there can possess. Another example would be railroads. It’s pretty much impossible for anyone to get into the railroad business today. If you want to, the only way is to become a shareholder of a rail company.
My portfolio set up
My portfolio is divided up into four components. First component making up about 60% of the portfolio are the dividend paying companies that generate income. But the income my portfolio generates doesn’t just come from dividends. The other source of income comes from selling options(both calls and puts). To learn more about producing income selling options, you can see another article I wrote on selling options. The second component is where I get my capital gains from.
As mentioned before, I love the tech sector so I have 30% of my capital allocated to tech stocks. A small section of my portfolio is allocated to high flying small cap stocks that have a lot of runway to be the next multi billion dollar company. The majority of these companies are high risk startups but could potentially be a 10 bagger. These companies represent 5% of my portfolio. The other 5% are short positions.
Generally, I don’t like the idea of shorting companies and would rather put that money towards companies that can generate long term returns. Knowing that shorting companies is risky and the odds are stacked against you, I only do it if I have a strong belief that their fundamentals will continue to deteriorate and have a high chance of going bankrupt. Shorting individual companies is also the best way to hedge against a downturn.