Author: Reuben Gregg Brewer | October 11, 2019
Through thick and thin
There's no one "right" way to invest, which is great because there are no two human beings that are exactly alike. When you break it down, investing is a very individual endeavor. If you don't pick an approach that fits your personality you won't stick with it when your way of investing invariably goes out of favor. And rest assured that every investment approach goes out of favor from time to time. If you don't have the fortitude to stick it out through the rough times your results will likely be worse than you would like.
However, if you take the time to know yourself and pick an approach that makes sense to you, there's no reason to doubt that you can achieve great things. Here are 10 strategies that can help you beat the market if you can stick with them through thick and thin.
1. Value investing: Cheap is good
Who doesn't like a good sale? Buying a "widget" you want at half off is way better than paying full fare. Switch the word "widget" with stock and you've suddenly become a value investor. The whole idea of value investing goes back to Benjamin Graham, the man who helped train Warren Buffett. Graham's notion was to find companies that Mr. Market had temporarily mispriced, looking to buy with a margin of safety so that even if you were wrong about the company's prospects you could still make money on the trade.
There are a lot of different ways to measure value, and no one way is perfect. But some key tools you'll want to use are ratios like price to book value, price to sales, price to earnings, and price to cash flow. Basically, the goal is to find stocks that look cheap relative to their own history, peers, and the market. That said, patience is a virtue for value investors. Often it takes time for the market to see the value a company offers. And you need to be careful to keep an eye on a company's future prospects, since a cheap stock that has weak prospects may not be a deal at all.
For investors who like the idea of value investing, but don't want to do all the digging that this approach requires, an exchange traded fund (ETF) like SPDR S&P 500 Value ETF (NYSEMKT: SPYV) might be a good fit. This ETF uses some of the ratios noted above to screen the S&P 500 Index, picking those names that look like they are on sale. With a tiny 0.04% expense ratio and several hundred holdings (selected from some of the largest and most liquid stocks on the market), it's a good alternative for investors not interested in a do-it-yourself portfolio.
2. Growth investing: Always building for the future
Growth investors aren't as interested in what a company's business is worth today, they want to figure out what a company will be worth in the future. Instead of looking at valuation ratios (which are often elevated for these stocks), growth investors will examine things like sales growth, earnings growth, and price to growth ratios, among others. The idea is to find a company where the future growth potential doesn't appear to be fully reflected in the current price -- even if the current price appears elevated.
It takes some fortitude to be a growth investor. For starters, growth stocks are often expensive, valuation wise (a value investor would likely wince at the price). Second, you need to be willing to stick through soft patches while, at the same time, being prepared to sell when a company's growth prospects are fully reflected in its stock price or it has reached its full growth potential and growth is about to slow down. Often, there's nothing backing a company's future but the hope that it will execute on the plan management has laid out. But when a great growth stock is hitting on all cylinders the price gains can be huge. They can also be enough to offset any mistakes you may make along the way. While value investing can be slow and tedious, investing for growth is usually exciting and your portfolio will probably require a lot of attention.
If you like the idea of buying a growing company, but don't think you can handle the constant portfolio monitoring, then look at a pooled investment product like SPDR S&P 500 Growth ETF (NYSEMKT: SPYG). Like its value counterpart, this ETF has low expenses (0.04%) and a diversified portfolio.
3. Income investing: The power of compounding
Focusing on income stocks is another way to grow your nest egg, though it often doesn't get the credit it deserves. However, Hartford Funds recently noted that between 1960 and 2018 an incredible 82% of the total return of the S&P 500 Index can be attributed to dividends and compounding. In other words, dividends are important and reinvesting those disbursements is one of the key underpinnings of long-term growth.
That said, you have to be smart when you start looking for stock with elevated yields. Sometimes a large yield is a warning sign that a dividend cut is imminent. You also don't want to get stuck with a high, but stagnant yield which will get diminished by the ravages of inflation over time. There's a happy medium between yield, financial strength, and growth that represents the sweet spot for income investors.
You'll want to pay attention to balance sheets, payout ratios, the underlying prospects of a business model, and future growth plans. It's a lot to take in, but it sounds worse than it really is. A good place to start is by looking for companies with a long history of dividend increases behind them that also yield more than the S&P 500 Index. This, by the way, is the basic approach taken by iShares Dividend Select ETF (NYSEMKT: DVY) for those that prefer not to do all the work themselves. It has a pretty reasonable expense ratio of 0.39% and a solid 3.4% trailing yield.
4. Dividend growth investing: Buying a growing "paycheck"
Looking for fat yields isn't the only way to invest in dividend stocks. The other notable approach is looking for companies that increase their dividends annually and at a rapid clip. If a company's dividend increases outpace inflation then your buying power grows over time. Often the best options here have relatively low yields. However the dividend growth achieved over time will make up for the low starting point when you compare the current dividend to your purchase price.
As an example, Hormel Foods' (NYSE: HRL) yield has never gotten too far above 2%. But if you bought the stock a decade ago your annual dividend haul was just $0.19 per share. The current run rate is around four times larger, at $0.82 per share annually. You could have bought the stock for less than $10 per share in 2009 -- meaning the yield based on purchase price would be over 8% today! That's the power of a fast growing dividend. The key is to make sure you are picking financially strong companies with good growth prospects, focusing more on the future than the company's current yield.
For investors looking to tap into dividend growth stocks without doing all the stock by stock research it might require, it's worth considering Vanguard Dividend Appreciation ETF (NYSEMKT: VIG). Although the yield is modest at just 1.7%, it focuses on companies with long histories of dividend growth and only charges a tiny 0.06% expense ratio.
5. Blue chips: Sticking with the biggest and best
A close cousin to these dividend approaches is investing in so-called blue chip stocks. These are generally the largest and best-known names on Wall Street. The problem with this style of investing is that most people are aware of how well run these companies are. Which is why it is best to be patient and look to add companies to your portfolio when they are temporarily out of favor for some reason. That's pretty much what has made Warren Buffett famous, noting that he picked up iconic companies like Coca-Cola (NYSE: KO) and American Express (NYSE: AXP) when they weren't exactly hot stocks.
The truth is it can be really hard to buy an out-of-favor blue chip, so this style of investing isn't as easy as it sounds. However, a good place to start is with Dividend Aristocrats, which are companies that have increased their dividends annually for 25 consecutive years. You don't achieve a record like that without being a well-run company. But you also need to pay attention to valuation, so you also need to look at some of the same metrics that a value investor would. In the end, buying blue chips is kind of a mix of dividend and value investing, with a clear focus on large, household names.
If you don't want to do the digging (and waiting) on this one, it's probably best to simply punt. In this case that means buying something like ProShares S&P 500 Dividend Aristocrats ETF (NYSEMKT: NOBL). With this fund you'll get all of the companies in the S&P 500, which tend to be large and successful, that have increased their dividends for 25 years or more. You won't benefit from timing your purchases on individual stocks, but with an expense ratio of 0.35% and a yield of around 2.2%, the ease this ETF offers may be a worthwhile trade off for more passive investors.
6. ESG: Doing the right thing and making money
If those big-picture approaches don't resonate with you, then how about something a little more specific -- like environmental, social, and governance (ESG) investing? Essentially, you'll be looking for companies that are doing good while making money and avoiding so-called "sin stocks" that sell things like tobacco and weapons. Generally speaking this area of investing is gaining in popularity, which should be a net benefit over the long term.
That said, there are a lot of different ways to look at ESG issues. If you focus too much on a single issue (like supporting female employees or hiring ex-military employees) you'll severely limit your investment options (there are ETFs that do each). And that, in turn, could hinder your investment returns. At the very least it's likely to lead to diversification issues. It seems obvious that you wouldn't want to own Altria (NYSE: MO), which makes tobacco products, but what about Alphabet (Nasdaq: GOOG) and Starbucks (Nasdaq: SBUX)? Alphabet had to deal with a staff walkout over its treatment of women in late 2018 and it has been accused of stifling free speech by an employee fired over an email that he probably shouldn't have sent (two sides of the same story, as it were). Starbucks, meanwhile, has gotten in trouble over its diversity and inclusion efforts, specifically as it relates to customers. It gets tricky and the best option is probably to outsource the effort of clearing companies on ESG issues.
In this case, the best way to outsource is to start with a broad based ESG ETF like iShares MSCI KLD 400 Social ETF (NYSEMKT: DSI), one of the larger funds in the category. If you want to pick individual stocks, use the ETF's portfolio as a short list of "ESG approved" names. That said, with a 0.25% expense ratio and a collection of roughly 400 stocks, you might just want to buy this ETF and call it a day. Your portfolio won't be perfectly tailored to your specific ESG goals, but you'll save a lot of time and effort.
7. Technology stocks: The future is still being written
Another specific and yet broad investment theme that you might want to look into is technology. That is a multifaceted word, which could encompass everything from alternative meat products (Beyond Meat (Nasdaq: BYND)) to computer products (Microsoft (Nasdaq: MSFT)) to internet-focused names (Amazon.com (Nasdaq: AMZN) and Alphabet). And that doesn't even do justice to all of the possibilities. What is key, however, is that you will be focusing on names that are pushing the boundaries on what we, as a society, are doing today. It's not too far away from growth investing, only honing in on technology will remove options like Fastenal (Nasdaq: FAST), which is a fast growing company... but selling bolts and other parts isn't moving society forward very much.
When you look at tech stocks, you'll want to differentiate between a good story and a good stock. That can be hard at times. For example, Beyond Meat is a money-losing company that will likely have a hard time competing with larger packaged food companies once they start to compete more aggressively in the meatless space. But then Amazon lost money for years as it spent heavily to gain scale, along the way cementing itself as an online leader in key emerging categories (from shopping to cloud storage). If you go down the technology path, you might consider starting with an ETF as a core holding and then supplementing with individual stocks about which you have strong convictions.
A good ETF option is Technology Select Sector SPDR Fund (NYSEMKT: XLK). The fund owns the technology stocks contained in the S&P 500 Index, which means you'll be focused on some of the largest and best run tech companies in the world. Its expense ratio is a modest 0.13%. What you'll miss out on are small names that have more growth potential, which is why you might also want to look at iShares Expanded Tech Sector ETF (NYSEMKT: IGM), which holds more than four times as many stocks. There's a fair amount of overlap at the top, but it goes well beyond the biggest names in the sector. That said, the 0.46% expense ratio is a lot higher. You can own both, cherry pick names from one or the other, or own one and pick individual names you like from the other. Either way, these ETFs will give you a foundation from which to build.
8. Cannabis: Riding the legalization wave
Calendar year 2019 hasn't been kind to most marijuana-related stocks. That said, the long-term trend toward the legalization of cannabis appears to remain solidly on track. Some industry watchers are suggesting that pot could be a $41 billion industry by 2025, roughly four times larger than it is today. That means there could be a big opportunity here, even if the target figure is overly optimistic. And the recent sell off is probably a good sign, as it suggests investors are becoming more rational about their expectations. It's no longer enough to sell marijuana, you also need to make money.
Unlike the other investment approaches listed so far, marijuana is highly focused and there's no way around that fact. The two broad options (stock picking versus a fund) are the same, but you don't have a massive pond in which to fish. So on the whole, punting is probably the best approach to ensure diversification in this still-young industry. That means an ETF like ETFMG Alternative Harvest ETF (NYSEMKT: MJ), one of the largest players in the space. The 0.75% expense ratio is pretty steep and it only owns 40 stocks, so maybe you'll want to pair your pot bet with an approach that's a little more diversified. That said, if you want to cherry pick stocks, try to err on the side of caution. Adding ".com" to a name in the late 1990s didn't make a company a great tech stock and the same idea holds true here. Meanwhile, expect a side of volatility along with marijuana's potential growth, which the recent weakness in the shares of key growers highlights. This niche sector isn't appropriate for the risk averse.
9. Electric vehicles: More are hitting the road every day
Another theme that's worth watching closely is electrification within the transportation sector. This trend goes well beyond Tesla (Nasdaq: TSLA), which makes headlines and has been an important catalyst for electrification, but is really just one of many names looking to tap into what is expected to be a huge growth opportunity. In fact, electrification is probably one of the biggest things to hit the auto sector since it first burst onto the scene. And it impacts everything from vehicle consumers to vehicle makers and original equipment and aftermarket parts suppliers, such as Eaton Corp (NYSE: ETN), which recently started up an eMobility division.
Basically, if you are looking at the space, make sure to think broadly. Yes, automakers are a key piece of the puzzle, but the trend is so much bigger. Even diesel engine giant Cummins (NYSE: CMI) is getting in on the act. And it's also important to think beyond passenger cars. Trucks of all types are also being electrified, from those that ferry packages around town to the semis that haul freight across long distances. Since the trend is still getting started, though, it might make sense to focus on established companies (like Eaton and Cummins) that are building their electrification bonafides along with the vehicle sector. Tesla is a prime example of the ups and downs to which an industry upstart can expose you. Tesla and other one-trick ponies are generally only appropriate for investors with strong stomachs.
For investors that want a one-stop shop on this theme, it might be worth looking at Global X Autonomous & Electric Vehicles ETF (NYSEMKT: DRIV). Although the name implies two masters, electrification and autonomous vehicles really go hand in hand. The expense ratio is a little steep at 0.68% and the fund is rather small, with just $12 million in assets. However, it is a solid all-in-one option. That said, if you want to pick individual names, starting with the fund's list of more than 70 names may help to broaden your list of potential investment candidates beyond the car makers.
10. Renewable power: Not sexy, but still big business
Another worthwhile thematic investment you might want to look at dovetails nicely with electric cars: Renewable power. In fact, one of the knocks against electric vehicles today is that the power to charge their batteries still comes largely from carbon fuels. But that is going to change over the next couple of decades as renewable power, like solar and wind, continue to gain share within the global electric grid. The shift will be huge, with renewable power's piece of the pie projected to expand from around 25% today to as much as 40% by 2040 by the International Energy Agency.
Like the electrification of the vehicle market, renewable power touches far more than just utilities. It spans from the companies that make solar panels and wind turbines, and the associated parts, all the way to utilities and their customers. And there's a number of great ways to play it, including buying utilities like NextEra (NYSE: NEE) that is using its regulated core operations to build a giant renewable power division. But there are also names like Brookfield Renewable Partners (NYSE: BEP) that is solely focused on renewable power and quickly gaining scale. Key industry suppliers like Vestas Wind Systems should also be looked at. One caution to consider is that small, focused names may not be the best option, since the inevitable setbacks (company wise and industry wise) that this industry will face will be harder to surmount.
Once again, as we close out this list, there's an ETF that you can buy that will give you broad exposure to the renewable power space: iShares Global Clean Energy ETF (NYSEMKT: ICLN). It's actually not the largest fund in the space, with around $350 million in assets, but it has a broader investment approach than many of its peers. The expense ratio is 0.46%, but roughly 60% of the portfolio is invested in foreign companies, so that is probably a reasonable figure.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Reuben Gregg Brewer owns shares of Eaton and Hormel Foods. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Microsoft, Starbucks, and Tesla. The Motley Fool owns shares of Vanguard Dividend Appreciation ETF and has the following options: long January 2021 $85 calls on Microsoft. The Motley Fool recommends Cummins, Fastenal, and NextEra Energy. The Motley Fool has a disclosure policy.