Individuals can grow wealth over time and supplement their salaries by investing in equities. If you do not have the time or inclination to research individual companies in which to invest, then broad-based index or exchange-traded funds (ETFs) are a decent option. The younger you are when you start investing, i.e. the longer time horizon you have to invest, the more risk you can and should include in your portfolio. Typically this implies investing in small-cap or mid-cap growth funds, those investing in companies with a market cap of $10 billion or less. The goal here is to purchase diversification with low management fees. If this is what suits you then feel free to stop reading now - just please do not park your excess cash in a checking account. Over time this practice will reduce instead of grow your wealth. Notice I said excess cash. Investing is inherently risky. Pay off any credit card debt and other high interest bearing debt before investing in the market.
I choose to invest a portion of my savings in individual equities rather than funds. I do have the time and inclination to follow the market regularly and research companies often. Investing in individual companies is inherently more risky than investing in funds, but with greater risk comes larger reward.
If you decide to follow this approach, do not over think it. As famed author and investor Peter Lynch put it, "everyone has the brainpower to follow the stock market. If you made it through 5th grade math, you can do it." So this begs the question, what companies should you invest in? I am an advocate of Lynch's approach to investing in companies in which you are familiar, and that sell products or services that are easy for you to understand. Invest in companies you know and love.
These are five great examples of companies I hold in my personal portfolio that sell products or services I use regularly, and apply business models that are easy to understand: Whole Foods Market (NASDAQ:WFM), lululemon athletica (NASDAQ:LULU), eBay (NASDAQ:EBAY), Nordstrom (NYSE:JWN), and Apple (NASDAQ:AAPL).
These are high-growth companies and a portfolio including just these stocks would be prone to some serious short-term dips; when considering how much of your portfolio you should invest in high-growth individual equities, you must consider your time horizon and risk aversion. Of these five companies, Apple is certainly in a league of its own, as it is the largest company on the planet by market cap. I believe it should be owned by anyone who regularly uses and loves Apple's products. In the long run, I am confident that a portfolio including these five stocks alone will make you money. They all capitalize on long-term trends that I do not see going away any time soon. However, you would have to have a strong stomach as they all rely heavily on disposable consumer income.
I am not telling you to invest in these companies in particular. Do your own research. Think about services and products you use and understand. Other companies that come to mind immediately that I do not own, but that I believe are excellent investments in this context are Costco (NASDAQ:COST), Under Armour (NYSE:UA), ULTA Cosmetics (NASDAQ:ULTA), and Priceline.com (NASDAQ:PCLN).
You do not need to be an equities analyst to perform due diligence on a prospective investment. Here are easy steps you can take to research the companies you love and identify great investments:
1) Set Google Alerts that will send you articles from major publications, as well as blogs, about a particular company. This is a great tool for gathering information because it will include major headlines as well as analyst research highlights, upgrades and downgrades. It will also include articles from industry publications, which I personally believe are the best way to identify best in breed companies in a particular industry. Click here to set Google alerts.
2) Go to the Investor Relations page on the company's website and see what management is saying about future prospects and consumer trends. You will always be able to find earnings transcripts, and I would suggest you listen to earnings calls. You can also find downloadable investor presentations that truly represent a company's best efforts at putting its best foot forward for investors. It is a sales pitch so take it with a grain of salt; however, if you go through a presentation and you are unimpressed, then move on and find a company that you truly believe in.
3) Search Youtube. What? Yes, many companies these days advertise on Youtube. Some do even more, posting videos of management talking to consumers about the company, conversations with real customers, employees, etc. Take a look at this YouTube Channel for lululemon. Videos posted here can give you a great sense of a company's culture, how it is viewed by customers, and how management wants the company to be perceived by the public.
4) Determine whether the company is positioned to benefit from a long-term consumer trend that you believe will remain intact for years to come. Examples:
- Whole Foods Market - Local, organic, healthier food
- lululemon athletica - Healthy living, lifestyle brands
- eBay - Online retail, Convenience - Mobile retail/bill pay
- Nordstrom - Enjoyable, personalized retail experience
- Apple - Democratization of hi tech, mobility, and general awesomeness
5) Take a look at the numbers. Again, do not over think it. Use websites like Yahoo Finance for trustworthy summaries of critical company information. When exploring growth companies like those mentioned above, look at the 5 yr. expected PEG ratio. The PEG ratio is calculated by dividing a company's Price to Earnings ratio by its growth rate. A PEG ratio of 1 is generally considered fairly valued, 2 is too expensive. The P/E alone can look astronomical on some high-growth companies, implying the stock is very expensive. The key is the future growth rate. When building valuation models, analysts assume a terminal growth rate by which they expect cash flow to increase year over year beyond a certain number of years in the future, typically 3, 5, 7 or 10 years. Nobody knows exactly what this rate should be, regardless of what you are told, and it weighs heavily on the present valuation and estimated stock price. Use the PEG ratio and if you are so inclined, handicap the growth rate based on your personal future growth assumptions and growth estimates cited in analyst reports that make sense to you. You can use historical data on Yahoo Finance as a sanity check on your assumptions, but stock prices are determined by the future and not the past, so do not put too much weight on historical trends and a trailing P/E ratio.
Due to the recent run in the market, the current 5 yr. PEG ratios cited on Yahoo Finance for the companies mentioned above are: WFM - 2.21; LULU - 1.52; EBAY - 1.58; JWN - 1.29; AAPL - 0.62; Based on PEG ratio alone, these figures imply that Whole Foods in particular, is getting very expensive. It is. As a result, I recently took some profit off the table - though I still love this company. I would suggest waiting for a pullback to start building your position.
Disclosure: I am long WFM, AAPL, JWN, LULU, EBAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.