Note to readers: I originally wrote this article for The Div-Net, and published it on February 2, 2012. But I never re-published it here and after going through some drafts I thought I would publish it here as I think the ideas are timeless.
There are many ways to make money in the stock market. There are a lot of pundits and followers of different strategies that would have you believe that they have a magic way to exploit the market for extraordinary profits with minimal work and time. Every time I read claims like that, I ask myself: "If it was so easy, and it makes you rich so fast, why are you busy writing articles instead of making millions of dollars?". Believe me, if someone has a "secret" that makes tons of money in a short period of time they're not going to share it with the world.
This leads me to the concept of stock trading. To me, stock trading is basically buying an equity with a short-term time horizon with the plan of selling it at a higher price in the near future. You are essentially trying to buy an asset with the hopes that you can quickly turn it and sell at a higher price to a sucker down the line. This is akin to gambling, in my view. There are day traders, who try to close buy-and-sell transactions in the same trading day. There are swing traders who try the "buy Y at $X and sell at $X+" game, and try and sell Y within days, weeks or even a month or two. Make no mistake, however, these are not investors. These are traders. They are trying to exploit an inefficient market by buying an equity at a distressed price and quickly make money on that equity. They try to repeat these transactions over and over again until they make significant profits. Traders are speculators, not investors.
There are a number of reasons that I don't actively trade. First, I can't predict the future. If I buy stock Y at $50, I have no idea if it will be worth $51 tomorrow or $48 tomorrow. Because of my inability to predict the future, I don't buy assets with the plan to quickly sell for a profit. There are analysts and money managers that try to follow trends and predict the way the stock market is going to react to certain news. Some of these money managers are paid millions of dollars to do this. Yet, I read countless articles about money managers that under-perform the general market. When you are actively trading in and out of positions you must remember that you are incurring taxes on capital gains and you are also incurring trading fees on transactions. I can see how taxes and fees could quickly erode any profits one would make with day trading or swing trading. In addition, you have to keep in mind that you are going to incur losses unless you're Nostradamus.
The main reason I don't trade, however, is that I'm an investor first and foremost. I believe the stock market is a wonderfully efficient platform for an average Joe like me to take my middle class income and invest with some of the biggest and best companies in the world. I like to invest with quality companies that have a history of rising earnings, revenues and dividends. I invest with companies that have an economic moat, economies of scale, large distribution networks, brand name products that people want and/or need. I invest with companies that can raise prices on their products at a percentage that exceeds inflation. I invest with companies like Johnson & Johnson (JNJ), Philip Morris International (PM) and Coca-Cola (KO) because I believe that they do an excellent job of making money and I believe that over the course of many, many years they will grow my investments many times over.
Stock trading is relying on your ability to forecast the future, stock trends, market efficiencies and your chances at selling your asset for a higher price in a short period of time. Many people have thought this was the true path to riches, and many people have failed. I'm not saying that day trading or swing trading can't make you money, but I don't believe it's the most efficient or reliable way of doing so. It's speculating. You could go to Las Vegas and double your money tomorrow. But how repeatable is that?
I like investing. I like putting my chips on major, multinational companies and letting them churn out profits over decades. They pay me dividends to invest with them, which I use to reinvest into my portfolio. Those reinvested dividends then accumulate additional shares, which then pay out larger dividends and this repeats itself over and over again. This is a reliable, repeatable and true way to build wealth over time. It's not speculating, it's not trading, it's not gambling and it won't make you rich over night. But, I believe for an investor who can spot value, is willing to be patient and who knows quality when they see it one can slowly build their wealth over time.
Keep in mind, however, that there is a difference between buy-and-hold and buy-and-monitor. I'm an investor of the latter type. I'm not saying that a long-term value-oriented dividend growth investor should never sell shares of a company. It's important to always monitor your investments and keep an eye out for any changes in a company's fundamentals. For instance, I spotted some changing fundamentals in one of my investments, Telefonica S.A. (TEF) (ADR) recently and I sold my shares because I believed the dividend was not sustainable. The dividend was cut a week later. It's important to keep a checklist of when to sell a dividend growth stock.
All in all, a speculator could make money trading in and out of the stock market. Trying to buy stocks at one price, just to sell in quick order at a higher price is simply not a game I'm willing to play. I have a full-time job and I have other things to attend to, and things I'd rather do than fret around my computer waiting for the right price to come. I'd rather invest my money for the long-term with excellent companies that are wonderfully proficient at making money and paying me dividends. The share prices of these companies naturally rise over time because these companies are efficient at increasing earnings and revenues, so their market cap naturally follows as more investors pile money into these companies' shares. I like investing in appreciating assets that rise in value over time, that also provide cash flow until the time comes to sell those assets, if ever.
What about you? Do you execute a trading strategy at all?
Full Disclosure: I'm long JNJ, PM, KO.
Thanks for reading.