If you get it right, trading can be a great way to make an income. Or maybe your goal is to earn just enough so you can pursue other interests. That’s certainly possible…if you get it right. But if you get it wrong trading can lead to disappointment, or worse, a disaster.
The pressure of trying to make money every day, every week, can be immense. Traders often become obsessed with the news cycle, price charts, the constant flow of data, and to anything else that might give them an edge.
It’s also very hard to make money consistently. Different markets suit different types of traders. So what works in a directional market, quite often doesn’t work in a flat or ‘range-bound’ market.
On top of this are transaction costs, which can add up quickly. And if you trade full time, there is also the need to constantly pull money out of your account so that you can pay yourself a salary.
So rather than trading for profits, a better and certainly less stressful way to earn an income from shares is to invest in companies that pay dividends. With the launch of our new income advisory, Total Income, I thought it would be a good time to run through what I look for in an income paying stock.
But first, let me tell you one thing you won’t get in this new advisory. You won’t get stale running commentary about the big four banks and Telstra.
Sure, I’ll look at these if I think there’s a good opportunity to add some to an existing holding. However, I see the best value of this service as covering high yielding shares that the market has largely overlooked.
What we don’t want to do!
While it’s always nice to make a capital gain on a stock, the primary goal of Total Income is about earning income. As such, we’re not on the lookout for quick gains. We want to buy into businesses that can pay consistent and growing dividends over the long term.
Sometimes when you’re trading, you might chase after a quickly moving stock because you think that it will still move enough for you to make a profit. But we want to avoid paying any old price for a stock. A stock can quickly form a bubble, only to drop back just as quickly once all the short term traders are out.
So, we won’t chase stocks. If one gets away from us, we’ll put it on a watch list and see if a better opportunity presents itself down the track. Remember, there are over 2,000 companies listed on the ASX — if we miss one then we need to focus on the next opportunity. Creating a successful income earning portfolio takes patience.
What we do want to do!
We want to buy shares in companies that have a history of producing reliable income streams and that are growing consistently. How are we going to go about it?
One of the first things I do is look at a company’s fundamentals. This includes financial data, focussing on debt levels, revenue and earnings growth. You want to see dividends growing in line with underlying earnings growth. Not just increasing as a result of higher payout ratios.
Secondly, I want to see how the business compares with its peers in the sector it operates in. For example, does it have a clear advantage over its rivals? Maybe its management is better, or they have a structural advantage such as a lower cost base, or a dominant distribution network.
Just as important are the fundamentals of the sector itself. A good company in a contracting industry will struggle to keep making profits and increasing dividends. I’ll look for emerging companies in growing industries — companies that have the best opportunity of growing their dividends over time.
But it’s also important to view any recommendation against the backdrop of the global markets and economy. At all times I’ll focus on the need for diversification, and well balanced asset allocation. One thing that concerns me is the potential for inflation, where central banks may have to raise cash rates. Such a move could affect the flow of funds into different asset classes.
Coming soon: Total Income
In short, Total Income will focus on the issue that is affecting so many people. And that’s the need for income.
Through no fault of their own, savers are being penalised in this low interest rate environment. That’s where I can help.
Keep an eye on your inbox tomorrow…
Income Specialist, Daily Reckoning Australia