Some companies pay dividends to their shareholders from after-tax earnings. Investors benefit from the regular dividend income and could also benefit from share price appreciation. However, most companies do not pay dividends. Some buy back stock with their surplus cash, while others reinvest in operations or make strategic acquisitions. You could miss potential capital gains if you limit your portfolio to dividend-paying stocks. You can make money by researching and accumulating quality stocks at reasonable prices and holding them over the long term.
Prepare a short list of companies in industries that you understand. For example, if you do not understand technology, avoid the sector because you will not be able to evaluate the industry fundamentals. If you work in the oil and gas sector, prepare a list of companies of different sizes in the energy and mining sectors. You can always invest in professionally managed mutual funds in other sectors if you want a diversified portfolio.Step 2
Research the fundamentals of the companies in your short list. At a minimum, this means reviewing the quarterly financial statements posted on the investor relations sections of corporate websites. If you have the time, listen to the recent quarterly earnings conference calls. Pay particular attention to the question-and-answer session, because that is when analysts often ask probing questions of management. Successful companies manage costs, focus on innovation and generate consistent cash flow.Step 3
Analyze price and volume charts to set entry and exit points for the stocks in your short list. Your reference point could be the industry price-to-earnings ratio, which you can find on financial websites. For example, if the industry PE ratio is 10, you could set your entry and exit points at 5 percent below and 15 percent above this ratio, respectively.Step 4
Sell when there is an adverse long-term change in the business or industry fundamentals. For example, if a technology company fails to keep pace with its competitors in bringing new products to market, it will lose market share and revenues. Do not hold on to its shares hoping for a miracle turnaround, because cutting your losses and reinvesting the cash elsewhere is often the best way to make money.Step 5
Hedge your investments with options. Call and put options give holders the rights to buy and sell the underlying stocks at specified strike prices on or before expiration. You can buy put options if you think there might be a market correction. If you are right, the put options will increase in value and partially offset the stock price decline. If not, you are limiting your risk to the option premium. You could also write call options on a stock if you think its price will stay within a narrow trading range. If you are right, you make money from the premium because the stock price would not rise above the strike price before expiration and the call option would expire worthless. The risk is that the stock price keeps rising, the option holder exercises his right to buy the underlying stock and you would have to sell the shares at below-market prices.
Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.