He says investors should use their common sense to build a world-class portfolio and follow relatively simple and low-risk strategies as some successful investors have used this method to defeat the market.
John Kingham is managing editor of UK Value Investor, an investment newsletter for protective value investors that he started publishing in 2011 after leaving the computer software industry.
With a professional background in insurance software analysis, Kingham’s approach to high yields is based on Benjamin Graham’s philosophy of being systematic and truthful rather than speculative, low risk investment. Cunningham is also the author of a popular investment book,
“Protective Price Investors: A Complete Step-by-Step Guide to Building a High Yield, Low Risk Share Portfolio.”
In his book, Cunningham explains how to short-list stocks for investing with the best combination of quality, value, income and growth. He also advises investors on a thorough qualitative analysis, how to combine investments into easily manageable portfolios to reduce share time and risk and maximize returns.
Cunningham suggests 10 steps investors can follow to invest in high quality trading stocks. Let’s take a look at these steps.
1. Take a long-term view
Cunningham says investors should take a long-term view of any of their investments.
“Long-term means usually take at least five years, and I think it’s a reasonable minimum. Why so long-term? Because the way the stock market generates returns,” he wrote in his book.
Cunningham says if investors focus on the short term, almost all of their profit and loss valuations will come from changes that are unexpected by their nature.
Instead, he said, focusing on the long term means that dividend earnings and growth have become more important than the daily ups and downs of the market, and finding a company that can increase its dividends is much easier than finding a stock. Go next week.
2. Stay diverse
Cingham said that no matter how much investors research a company, they do not know for sure how it will work or what the share price will be in the future. So investors should diversify and put their eggs in different baskets.
Cunningham says there are other factors besides the number of investments that can be as diverse as industry and geography.
“Companies within the same industry are often affected by the same problem, so diversity across multiple industries can reduce the risk of a portfolio. Can also be applied in cases where a local problem (recession, earthquake, epidemic, etc.) will have a small impact if the portfolio generates its revenue from all over the world, “he said.
Cunningham said risk reduction is also important through diversification because investment is a long-term game.
“If your portfolio is relatively low risk because it is well diversified, then you have a good chance of sticking to equities in the long run,” he said.
3. Look for high yield shares
Cunningham says dividend earnings are clearly a very important part of total stock market returns and the obvious way to measure earnings is to dividend yields.
In Cunningham’s view, yields are often misleading, and it is just as important that dividends be sustainable in the long run, and that there is a good chance that they will increase.
“That’s why yields should not be viewed in isolation, but rather should be considered alongside a company’s ability to pay that dividend, consistently, for the long term – in other words, its quality,” he said.
Cunningham says there is another problem with a simple dividend because looking at today’s yields, investors may miss out on a situation where a company has cut its dividends for a short period of time, probably due to a one-time crisis.
“Looking at the share price may be a better approach than paying the company’s dividends over the past decade. The more dividends paid than the current price, the better,” he said.
4. Look for a growing company
Cunningham said growth would be a friend of long-term investors and without it the value of any business and income from it would be reduced by inflation.
“The most important thing is a company’s ability to deliver a growing flow of dividends in the future, since in the end all investments are valued based on cash. But we don’t know the future, so we have to look to the past for guidance,” he said.
Cunningham says a company that has built steady growth in the past is more likely to grow steadily in the future, and using growth over several years as a guide to future growth is not reliable enough.
“Look at the growth rate over a ten-year period. It will pick companies that are growing in the long run. Dividend growth is what we’re really behind, so it’s understandable to look at dividend growth over the last 10 years. Dividends are supported by earnings, and revenue comes from sales. It’s also a good idea to look at annual sales and revenue growth. If all else fails, a high growth rate is good, “he said.
5. Look for high quality companies
Cunningham says the problem with looking back to the past in order to have a clear view of the future is that the past can be confusing.
“Sometimes a company’s 10-year growth will be strong, but it’s all in a year or two. It’s not a reliable, defensive growth. Instead, what we want is consistent, repetitive, high-quality growth,” he says.
He says companies that have been consistently successful in the past are more likely to be consistently successful in the future, which means that past growth rates can be a good guide for a company’s future growth.
“Companies that consistently generate increasing profits and dividends are generally considered to be high quality companies. To measure the quality of a company, look at how many times it has been profitable in the last decade and how many times it has paid dividends; more often the better. Then count the last 10. How many times a year sales, revenue and dividends have increased; again, often better. By focusing on high quality, high yielding companies that can generate consistent market-beat growth, you’ll be better off building an outstanding portfolio, “he says.
6. Look for lower prices than earnings
Cingham says the PE ratio is a key tool investors can use to determine the value of shares.
“Valuations do not go unlimited, and they do not go to zero unless the company is destroyed. Therefore, the long-term PE ratio revolves around a moderate value, usually somewhere in the middle of adolescence, although they can go much higher or lower in the short term (for sharp investors). Creates buy-low and sell-high opportunities), ”he says.
According to Kingham, there is a problem with the standard PE ratio, although earnings from one year to the next can be quite volatile.
So he says a good way is to compare the stock price with the company’s earnings over a few years, instead of looking at a single year in isolation.
7. Avoid additional financial obligations
Cunningham says that no matter how prosperous a business is, if it has too much debt it can be like a time bomb waiting to explode when something goes wrong.
“Debt is one of the major corporate killers. Fortunately, many good companies do not need to use a lot of debt to generate outstanding returns for their shareholders. It is also true that some companies can handle more debt than others. Or stable, low debt. Stable companies like supermarkets or utilities can handle more debt. However, this does not mean that they should manage more, “he said.
Kingham says there are different ways to measure debt to find out if a company has too much.
“You can look at interest payments, see how well the loan interest is covered by the company’s profits. If the interest is more than 10 percent of the profit, it would be a good idea to see if the company needs or can manage. You can also look at the total amount of debt and compare it to the profit. Some investors look at loans for not exceeding 5 times the average profit of the last few years. Says.
While conservative financing focuses on consistently profitable companies, investors can avoid debt problems.
8. Compare stocks with market averages
Cunningham says most investors who choose their own stocks want to lose market share in terms of earnings, growth or both.
To lose market share in the long run, a portfolio must generate more returns from one or more dividend earnings, company growth and valuation changes.
According to Kingham, therefore, it is a good idea to examine potential investments against the market.
“You usually want to see that a company’s high dividend yield, low valuation ratio and higher, long-term growth rate are higher than the market. Yield and low valuation of market equivalent value. To be truly outstanding investment, a stock must be both a cheap and high quality company, “he said.
9. Follow a systematic investment plan
Before investing in a company, Kingham says, investors need to look at their income, dividends, debt levels, as well as learn about a company’s history, what it does to make a profit, and how the company can grow in the future.
To conduct this research successfully, it is important to use a checklist so that no action is missed or forgotten.
“There are many things that can be included in a checklist, but the main areas to cover are the company’s past, its current situation and its future prospects,” he says.
Cunningham lists some questions that investors may want to consider in their next investment analysis:
- Is it the same industry, the same work, for a long time?
- Is the company in the top group in the market?
- Does it have a highly successful and profitable past?
- Has it escaped major crises over the last decade (if so, have they been successfully resolved)?
- Is there an obvious current threat to its economic engine?
- Does it have any sustainable competitive advantage?
- Is there a possibility that its economic engine may become obsolete in the next decade or its industry may be severely disrupted?
10. Continuously improve your portfolio
Kingham says once investors fill a portfolio with twenty to thirty high yield shares from a high quality company they should actively manage their portfolio the way a gardener actively manages a garden.
“When the grass grows too much, it is cut. Similarly, when the share price of a company rises faster than that of the company, it may no longer have a low valuation and high yield. When that happens, it can be profitable to sell.” And reinvest in other companies where the share price is lower, and the dividend yield is higher, “he said.
Kingham says the process of developing a portfolio can be easily achieved by selling the least attractive value investments in one month and adding better investments in the next.
“With 30 holdings, it will replace six of them each year, giving a 20 percent turnover ratio and an average holding period of 5 years. This process of continuous improvement over time can add significantly to returns,” he said.
Therefore, in order to create and maintain a high standard, dividend-paying portfolio investors need to have a plan for each step, starting with finding and analyzing companies, sensitively diversifying their portfolio and which stocks to hold and which to sell. It’s up to you to decide.
(Disclaimer: This article is based on John Kingham’s book “The Defensive Value Investor”.)