Stock markets are thrashing around like fish out of water, which can make it a confusing time for investors. That is not helped by the polarity of views from pundits. One minute they claim that aggressive interest rate rises are good because they are instrumental to tame inflation. In the next minute, they claim that rate hikes are bad because they could plunge the global economy into recession.
It is little wonder that shares are volatile. In times of severe stock-market confusion, it can be useful to have guardrails to keep us on the straight and narrow. Let’s not forget that the price of shares can be as much a function of market sentiment as it is of company fundamentals. It is, therefore, important to remain level-headed at all times. Here’s how we can stay sane when others are losing their mind.
- Don’t check your shares too frequently. Checking prices daily when you’re investing for many years is a bit like planting a seed and inspecting it every hour. With share markets in a state of flux, noise gets mistaken for signal and over-trading may ensue. The easy way to rein in too-frequent trading is to remove the temptation in the first place.
- Make a plan and adjust it infrequently. Investing is like starting a garden: Clumsy results stem from buying whatever catches our eye at our local nursery. Gardens need a plan, and a proper investing plan considers where our dividend shares, non-dividend shares, funds, bonds, and anything else fit in relation to each other. Knowing what we need and what we don’t helps us to pounce on the most suitable deals – and not just any deal.
- Don’t anchor on the price you paid for a share. It’s arbitrary to everyone but us.
- Do adjust our dividend cover to the riskiness of the business. Coverage of 1.5 times or below may be acceptable for a typically safe business, while 2 times or higher is prudent for companies with less predictable earnings. Better still, calculate the dividend cover using free cash flow and not the reported accounting income, as the latter contains ‘accrual’ accounts that give a dirty picture of true cash profitability.
- Consider growing yields, even if they seem small at the moment. A 2 per cent yield becomes a 5 per cent yield in 5 years if it grows at 20 per cent per annum, assuming a constant share price. Fortunately, share prices of companies with rapid payout growth can often move higher. It’s quite a victory to end up with both a higher dividend and a higher share price a few years hence.
- Forget ‘flavour of the month’ shares. There is a big danger that we buy shares of companies just because everyone is talking about them. If everyone is talking about them, the ‘stories’ behind these companies are likely to be well known. Their share prices are likely to be high, too. The time to buy is when companies are out of favour because that is when the shares are likely to be languishing at attractive prices.
- Don’t focus on yield alone. It can be a mistake to go for the highest-yielding shares, especially those that yield significantly more than the market average. Remember, there is no free lunch in investing, and don’t be greedy. Instead, look for companies that may not have super-high yields, but instead have reliable yields that do not depend on strong economic growth.
- Take time to read company reports. The number we should focus on is free cash flow. This is the cash left over in the business after all costs and capital expenditure. What we want is a business that has substantial free cash flow compared to the amount paid out in dividends.
- You can reinvest your dividends elsewhere. If we feel another share in our portfolio is better priced, we may divert one company’s payout towards topping up a position in another.
- Understand that successful investing involves exploiting the emotional weaknesses of other market participants. Try and become comfortable with this concept, which is less predatory than it sounds. If a share is indeed overly cheap, it’s often because other investors may be panicking, or lack the fortitude to hold through share-price gyrations. So, let other investors’ shortcomings be our gain. But don’t immediately assume that because a share has fallen it has become a better buy. Evaluate the business with as fresh a perspective as possible so that we don’t throw good money after bad.
We live in trying times. But the principles of good investing still apply. Stay within those guardrails and we shouldn’t go too far wrong.
Note: An earlier version of this article appeared in The Business Times.
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Disclaimer: David Kuo does not own shares in any of the companies mentioned.