Written by Kay Ng at The Motley Fool Canada
At a high level, there are two ways to make money when investing in stocks. First, you can get a price appreciation – buy a stock and then sell it at a higher price in the future. Capital gains are taxed at 50% of your marginal tax rate when realized in your unregistered account. This is a cheap income compared to a normal income. Second, you can earn dividend income from stocks that pay dividends. Eligible Canadian dividends are also taxed at a lower rate than ordinary income.
Earn dividend income as the basis of your returns
Dividend stocks allow you to earn a return on corporate earnings regardless of the stock price. Dividend income can improve your total return and yield stability. When a company consistently pays dividends, management has less capital available and should therefore be more careful with the use of the available capital.
In particular, only declared dividends need to be paid. In other words, companies have the right to cut future dividends that aren’t declared, and in the worst case, eliminate the dividend altogether. For this reason, investors should pay attention to company quality when investing in stocks.
Focus on business quality
Warren Buffett’s number one rule for stock investing is “never lose money.” After all, our capital is limited. How do you protect your money? One way is to make sure you buy wonderful companies that drive long-term stock price performance.
By focusing on company quality, you probably aren’t striving for the highest returns. However, you should improve your long-term yield stability. That means these companies should have more predictable earnings and a stock price with less volatility.
They want companies that don’t have over-indebted balance sheets. A quick check is to compare a stock’s credit rating to that of its peers. For example, Royal Bank of Canada (TSX:RY) S&P’s credit rating is AA-, which is the highest among major Canadian bank stocks. RBC offers a “low” yield of 4.1% compared to its peers, which yield up to 6.3%. The “low” dividend yield is an indication of their quality.
Try to buy stocks in the sell-off
You shouldn’t overpay for stocks because it could take years for their earnings to catch up, meaning the stock price could trade sideways for some time at best. Unfortunately, quality companies that pay dividends tend to have stocks that trade at a premium valuation.
For example, RBC stock is trading at $128.55 per share at the time of writing at about 11.3 times earnings. This is a premium rating compared to the rest of Canada’s big six bank stocks, which trade at price-to-earnings ratios of between eight and 9.7.
Royal Bank is trading at a discount of about 10% according to analysts’ 12-month price target.
investor take-away
In summary, if you’re looking to improve the quality of your returns — that is, improve the stability of your returns and likely long-term total returns — you can fill your diversified portfolio with quality companies that pay consistent dividends. And try to buy the shares at every discount you can find.
For reference, 10-year returns on RBC stock are about 12.9% annually, which essentially turned a $10,000 investment into about $34,212 over the decade. This is a very solid return for a quality company.
The post “3 Tips to Make More Money” first appeared on The Motley Fool Germany.
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Stupid contributor Kay Ng has no positions in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
2023
