Investing is an uncertain business. The outcome is never known but by following a plan and framework laid out in advance, the odds of success can be increased so they fall in your favor. Follow these five keys to success and you will not only do better, you will feel more in control over what is happening in your portfolio.
Key No. 1. Time Horizon
Establishing a new position in a stock involves an honest look at what your time horizon is for the investment. Specifically, how long do you plan to hold the position before it reaches your price target for selling? Investors (not traders) must have time horizons measured in years - and this is one of the first keys to success. I like to use a five-year period and my target is a doubling of the stock price in that time. Of course I may, and often do, hold the position for much longer than the five-year period but my general rule is to give the position five years to get to where my research of the company and the sector it is in tell me the price should be.
Key No. 2. Buy Low in an Underperforming Sector
Buy the best company in a sector that is the most hated in the market. At any given time in the market there is usually at least one sector that is widely hated and no one wants to be near it. A great example of this in the recent past was the housing and home builder sector. Companies in these businesses were crushed in the housing bust and subprime debacle that exploded in 2008. No one was spared. And yet, here we are barely five years later and this sector has soared. Recent examples are: Pulte Homes (PHM) which went below $4 per share but is now trading above $20 per share; and Toll Brothers (TOL) which traded under $14 per share and is now over $35. There are, of course, many other examples as well.
Key No. 3. Buy the Best and Strongest.
Within every sector, even hated ones, there will be companies that are stronger and weaker than their competitors. You must be careful here to select the best and financially strongest company in the sector in case not everyone survives. When things are really bad the weaker companies can get washed out and you want to be in the "best of breed." If a weaker competitor does get washed out, the survivors gain market share and emerge even stronger when the turn finally comes.
Key No. 4. Sector Rotation
When you buy a company in a sector of the market that's out of favor you are likely to be early to any reversal. Some will say your investment is "dead money" during that period. If you are good at market timing (and I'm afraid I don't know anyone who is) you may be smart enough to get in just before sentiment turns. Since I can't do that without blind luck, I make my investment and wait with my time horizon in mind for what always seems to be an inevitable turn and rotation back into what was once so hated no one would go near it. This is where multiple baggers are found.
Key No. 5. Buy a Dividend.
If possible, get a company that pays a dividend. While it's certainly true that a company fallen on hard times and in a damaged sector may have to cut its dividend, that is not always a bad thing. The market often punishes companies cutting their dividend, but often it does not as investors recognize the move as a wise management choice to preserve capital to get through the difficult time. When better times come the dividend is restored or increased. Examples of this are readily seen in the financial sector during the credit crisis that hit the banks in 2008. To survive, Citigroup (C) canceled its dividend and has only recently reinstated a small one. Wells Fargo (WFC) slashed its dividend 85% during the crisis to save cash. Morgan Stanley (MS) and JP Morgan (JPM) cut theirs as well - and each of these moves were widely expected in the market and understood to be prudent.
Even with a dividend cut, you are still getting some return while you wait for the tide to turn. And when it does turn you will get both price appreciation and a rise in the dividend.
Use these keys as a framework for establishing new positions in your portfolio and time will work to your advantage. This is not an approach for a quick buck. It requires patience and a reliance on letting the market and the economic cycle operate over time to do what they have always done - they ebb and flow and certain sectors lead while others languish, until the next rotation.
Disclosure: I am long C.