Written by Kay Ng at The Motley Fool Canada
With information we can access through the internet easily at our fingertips, it has never been easier to learn how to start investing in stocks. Here are some tips to help you get started.
Investing, not trading
New investors might think of investing in stocks as trading in and out of stocks for quick profits. That requires short-term price volatility to cooperate, which we cannot control. In fact, it can be an easy way to lose money if new investors are thinking about taking profits quickly, especially if they plan to sell stocks within a day of buying them.
When investing in stocks, we’re buying pieces or becoming a part-owner of businesses. By doing so, we’re sharing the risks and profits that the companies bring. In the long run, if the businesses do well, the underlying stocks will rise as well. If the stocks pay dividends, they’ll likely increase their dividends.
For example, investors who have sat on Royal Bank of Canada (TSX:RY)(NYSE:RY) shares for about 15 years have enjoyed a long-term return of about 9.4% per year while earning 149% more in dividend income than the U.S. market. However, whenever there’s increased economic uncertainty, bank stocks like RBC would fall significantly. During the pandemic market crash last year, the bank stock corrected about a third from peak to trough. This is the kind of market volatility that investors should be prepared to endure.
A $10,000 investment made in RBC stock about 15 years ago would have gotten the entire investment back in dividends with about $560 left over plus price appreciation.
How to start investing with valuation in mind
It’s a good idea to start investing with valuation in mind. The idea is to buy when stocks are cheap and potentially sell when they trade at fair valuation or are overvalued. What may be confusing to new investors is that the valuation of businesses changes all the time. In the case of RBC, it tends to become more valuable over time, as it becomes more profitable and pays a growing dividend.
However, last year, the leading Canadian bank and its peers had an earnings cut because of higher provisions for credit losses. The lower earnings were reflected in the immediate stock price at the time, but the stock has more than recovered today by making new all-time highs. Notably, the provisions for credit losses are just the banks setting more capital aside to anticipate great loan losses, which, it turns out, wasn’t needed during the pandemic.
The takeaway is that the greater the volatility of a business’s earnings, the greater the change its valuation could be. So, use analyst consensus price targets as a guide and understand the reliability of the earnings of the business in question. RBC is a highly reliable business. Not only has it been profitable for decades, but every year that it had an earnings decline in the last 20 years, its earnings set new record highs in the subsequent year.
Start investing with sure returns, not speculation
You can become a true investor by focusing on investing for sure returns by not speculating. You can start investing in businesses with reliable revenues and profits. Many of these companies pay safe dividends. Here’s how you can start investing in dividend stocks.
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The Motley Fool has no position in any of the stocks mentioned. Fool contributor Kay Ng owns shares of Royal Bank of Canada.