Are you looking to make a fortune from the stock market by the time you come to retire? Of course you are.
Your ability to do so may be helped by avoiding the following traps. They may seem obvious but they’re pitfalls that attract investors of all shades and levels of experience.
Don’t get sucked in by low multiples… We all love a bargain and it’s great when you find a share you’re thinking of buying that’s trading at a juicy discount to the broader market. It’s generally considered that a forward P/E ratio of 15 times or below offers good value, and that shares trading on a multiple of under 10 times can be considered a steal.
It’s extremely tempting to dip into the bargain bin now and again, though doing so is more often than not dangerous business and can prove an extremely costly mistake. Whilst it’s possible to pick up many cut-price corkers, many more shares are cheap on paper for extremely good reasons and so should be avoided at all costs.
Let’s have a look at Barclays (LON:BARC). It has long traded on a prospective earnings multiple below 10 times, but this has not prevented its share price falling (around 25% over the past year alone) as concerns over the impact of Brexit on the bank’s operations have grown. Those buying into the business in 2018 have got their fingers burnt and more pain could be to come as the UK economy struggles.
… or big dividend yields either! It’s also easy for investors, and particularly for those just starting out, to be seduced by big dividend yields when hunting for income shares.
Take Centrica (LON:CNA) as an example, a stock that has long offered yields well above the FTSE 100 average. When it raised the dividend to 17p per share in 2013 it was signalling further growth. Yet it slashed the annual payout twice in succession and has failed to raise the dividend since the 12p reward of 2016, due to the profits drops caused by intensifying competition in the energy marketplace.
Its fall from grace as a past dividend champion has caused its share price to tank 55% in five years, and it’s difficult to see Centrica resurrecting its progressive dividend programme as its customer base continues to decline and regulation becomes more and more restrictive.
Slow and steady often wins the race For this reason, I’m happy to ignore the power supplier and its 8.6% yield. The key to income investing is to select shares that are in good shape to deliver sustained dividend growth over a period of five years or above, even if their yields fall comfortably below those of the London Stock Exchange’s big yielders.
Thus a solid earnings outlook, robust near-term dividend coverage, and a strong balance sheet with great cash flows are far more important to me. It’s why I bought 2.1%-yielding Bunzl (LON:BNZL) last autumn, for example, a share that looks in great shape to continue its run of raising the annual dividend each year for a quarter of a century. Focusing chiefly on the size of the near-term yield can prove a disaster for you and your investment portfolio, as many long-term shareholders of Centrica would attest to.
Royston Wild owns shares of Bunzl. The Motley Fool UK has recommended Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019