The case for investing in stocks

SSL in the Money

Deborah Vieira

Wednesday, February 01, 2012

WE all have financial goals in life; whether it is to pay for our children's education, to be able to retire at a reasonable age, or simply to be able to buy the things we desire. Unfortunately, spending less than we earn is typically not enough for us to meet our objectives. We have to do more; we have to invest our savings and put our money to work.

Stocks are but one of many possible ways to invest your hard-earned money as you seek to achieve your financial objectives. Why choose stocks instead of other options, such as bonds or real estate? While stocks carry more risk than a certificate of deposit or Government treasury, they are one of the best ways to put your money to work and are vital to achieving portfolio growth. Over the long term, empirical evidence has shown that stocks tend to outperform other types of investments.

What is a stock? Perhaps the most common misperception among new investors is that stocks are simply pieces of paper that are traded. However, this is not the case. When you buy a stock in a company, you become part-owner of that business. This gives you a vote at annual shareholders' meetings and a right to a share of future profits. To put this into perspective, if you were to buy one million shares of AMG Packaging & Paper Company Limited, you would own approximately one per cent of the company. Indeed you become a part-owner when you buy stocks, no matter how small your stake may be, so ensure that you purchase a company with sound fundamentals.

The average investor buys shares with the hope that price will appreciate, so that they can be sold at a profit. In general, greater demand will drive a stock's price and this in turn is driven by the prospect of the company's sales and profits going up. If you bought one of SSL's stock picks such as National Commercial Bank of Jamaica Limited a year ago and sold it on January 30, 2012, you would have achieved a capital gain of approximately 32 per cent , in addition to dividends, greatly exceeding the Treasury-Bill rate, which is just above six per cent before tax.

In addition to the potential for capital gains, stocks may provide investors with current income. A dividend is a periodic payout of profit to shareholders, often quarterly or annually. This income opportunity is an added incentive to invest in a stock for the long term and provides a buffer if price declines. Notably, in Jamaica there is no tax on capital gains or dividends.

Dividends can be thought of as "cash rewards" offered by the company. The company's board of directors chooses when to declare a dividend and the payout ratio (the amount of dividends relative to the company's earnings). Most older and mature companies pay a regular dividend, whereas most newer and smaller ones do not as they tend to reinvest profits to enable long-term growth. At the same time, while some stocks may have a high yield, one would certainly want to ensure that the dividend payout is sustainable. So choose a company with an established track record of earnings and potential for future growth.

A few examples of good dividend yielding stocks are Scotia Group Jamaica Limited, which yielded 6.33 per cent (based on trailing twelve-month dividend as at January 30, 2012); NCB, which yielded 5.71 per cent, and Carreras Group Limited, 9.35 per cent.

A look at the annual rate of return on stock investments during a brief period of a few years, when conditions are tough, may show limitations for returns on stock investing. However, historically, stock markets have produced one of the top annualised rates of return for any investment. Long-term investors who can cope with the ups and downs of the stock market tend to see a nice return on their investments.

It is easy to diversify your equity portfolio. For example, technology companies, like cell phone providers, likely won't move in synch with energy companies, heavy industrial manufacturers or consumer cyclical products like automobile manufacturers because each sector responds differently to movements in the overall economy. So say you place yourself in five different sectors, you are spreading your risk. The size of the companies you invest in may also provide you a way to diversify your risk. Small companies, for example, tend to rise early in economic recoveries and fall quickly during downturns, while the largest companies tend to rise more slowly during recoveries, but maintain their strength longer through economic drawbacks.

Unlike real estate, which is an illiquid investment, that is, not easily converted to cash. Investing in the stock market allows you to sell your holdings easily through your stock broker at a minimal cost. Due to the existence of a stock exchange, such as the Jamaica Stock Exchange, which brings together both buyers and sellers, you are able to decide at what price to sell your stock. However, it is important to note that not all stocks are liquid, as this depends on the amount of shares that are in the hands of the general public.

It's easy to invest in something that you can relate to given the vast amount of companies and industries from which to choose. From banks to bakeries, buy what you believe in. Forget the common misconception that you have to start with a huge amount to benefit from the stock market. This is by no means so. Start small and gradually build a portfolio of stocks from fundamentally sound companies with room for growth.

Deborah Vieira is a Wealth Advisor at Stocks & Securities Ltd. You may contact her at dvieira@sslinvest.com

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The case for investing in stocks