Do you invest based on hot tips? I did, and it cost me with Monterey Gourmet Foods (Nasdaq: PSTA ) in December 2002.
"It's a good stock, bound to go back up." That was the "warm" tip I followed. I sold three months later for a 25% loss. I'm just lucky that I hadn't bought it in the summer of 2002, near the peak of its "hot" status. It's down 60% since then.
The stock market seems to thrive on "hot tips." Earlier this year, you might have heard on financial-news shows that precious metals were "hot." Every day, it seemed, gold reached new highs. Maybe you bought some. Then the market tanked. Earlier this month, the price was more than 20% off from its high in May.
Buying on hot tips can be a costly mistake, but that doesn't mean investing isn't the best way to make money.
Survey says ...
Despite my previous example, I'll still tell you that investing is the ideal way to build wealth -- as long as you know what to buy. Jeremy Siegel proved it in his recent book, and he also revealed the best stocks to own.
In The Future for Investors, Siegel writes:
The dominance of stocks over other assets is overwhelming. Swings in investor sentiment, as well as political and economic crises, can throw stocks off their long-term path, but the fundamental forces generating economic growth have always enabled equities to regain their footing. Despite our history of depressions, wars, financial panics, and most recently the terrorist attacks and scandals that we faced in 2001 and 2002, the resiliency of stock returns is indisputable.
Avoid the hot stuff
Even though stocks are "where it's at" to build wealth, chasing the hot idea is not. I learned that lesson with Intel; maybe you learned that lesson with gold. Bill Miller of Legg Mason advises that the time to invest in hot ideas is before they heat up.
Today people want commodities, emerging market, non-U.S. assets, and small- and mid-cap stocks. Those were all cheap five years ago and had you bought them then you would be sitting on enormous gains. But five or six years ago, everyone wanted tech and Internet and telecom stocks. ... The time to buy them was in 1994 or 1995, when they were cheap. But in 1994 or 1995, people wanted banks and small and mid caps, which should have been bought in 1990, and well, you get the picture.
Be the tortoise
If you miss the trends and avoid the rockets, that's OK. Then the secret to success is investing in stocks that are long-term winners. Remember Aesop's fable about the tortoise and the hare? Slow and steady wins the race.
So, are you ready to know the right stocks? Invest in dividend-paying stalwarts such as Bristol-Myers Squibb (NYSE: BMY ) , Heinz (NYSE: HNZ ) , and Hershey (NYSE: HSY ) , which do the same steady thing, day after day, year after year. That leads to wealth. Consider: $1,000 invested in Hershey 20 years ago would be worth some $15,000 today. That's an average return of nearly 15% per year on price appreciation alone. Had you reinvested the company's dividends, your results would have been even better.
And avoid "hot" companies when they're the hottest -- like Qwest Communications (NYSE: Q ) in the late 1990s. By the time we regular investors hear about them, the growth is mostly over, and the stock is likely overvalued. And if we invest too late, we're left holding the bag.
Qwest has fallen more than 85% from its highs. If you'd bought $1,000 worth at its peak in early 2000, you would have about $138 now.
The Foolish bottom line
Stable, reasonably valued companies such as Hershey -- which do what they do well day in and day out, reward shareholders with dividends, and can cope with economic slowdowns -- can serve as the foundation of a market-beating portfolio. In Motley Fool Income Investor, Mathew Emmert is picking companies that are a lot more like Heinz or Hershey than Qwest. In fact, he recommended Heinz to his subscribers.
While not "hot," Heinz should be cooking along for many years, giving investors a market-beating return through a combination of capital gains and dividends. And if the current market environment keeps up and we don't see capital gains for a while, you still have the dividends to take to the bank. Give the strategy a try. In fact, if you start today with a 30-day free trial, you'll get to see Mathew's two latest dividend picks, as well as all his other recommendations. Click here to learn more.
This article was originally published on July 20, 2006. It has been updated.