Many investors swear that it’s impossible to beat the stock market, but is that actually true? While it’s okay to be skeptical about outsmarting a market that baffles even the savviest fund managers, I’m here with a contradicting finding. Beating the stock market is very much possible, and if you want to see your stock market returns outpacing popular market benchmarks then pick up a strategy that guides you on what stocks to buy and how to time the market for maximum returns.
Now, even though there’s no fail-safe way of doing it, there are proven investment tactics that have recorded an impressive track record of success and there are the top 3 I think you should know!
Method #1: Investing In Cyclical Investments
The first strategy you can use to outsmart the stock market is to bet the ranch on cyclical investments. For beginners, cyclical investments, are those whose growth rates witness see-sawing changes depending on how the economy is performing. These types of stocks heavily depend on the fluctuations of the economy. When the economy is on an upward trend, these stocks will perform stunningly. Conversely, when the economy is undergoing a downturn, these stocks will also take a dip, hence exposing investors to stinging losses. Companies whose stocks are labeled as cyclical are those that suffer the beatings of an underperforming economy. These companies primarily sell goods and services that buyers can easily scratch off their shopping lists during tough times. Think restaurants, airlines, automobiles, hotel services, and luxury designer clothes. No, doubt, these are things you and I can correctly do without.
On the other hand, non-cyclical stocks, those whose growth rates remain relatively stable, economic performance notwithstanding. These companies are so immune to economic changes that they’re bound to siphon profits even in a tumultuous economic climate. Typically, companies that fit this category sell necessities such as food, real estate, and essential household utilities like soap, toothpaste, and electric power. Usually, you wouldn’t find someone postponing a bath for months until the economy picks up, right?
However, while the defense of non-cyclical stocks is undeniable, there are exceptions. Occasionally, an economic slow-down may find non-cyclical stocks on the wrong foot and equally deal them a blow. But even if it happens, the aftermath will be significantly less impactful than you would see with cyclical stocks.
So you’re probably wondering how timing cyclical and non-cyclical investments will help you outpace the market, right? It’s simple, really. When the economy is slowly getting back to its feet following a crippling recession, cyclical stocks will rise with it. This is the ideal time to find financial footing in industries that fall in the cyclical sector a hundred percent.
The strongest indicator of a recovering economy tends to be decreasing oil prices, so when you watch the news and catch wind of that, don’t hesitate to invest in the most significant cyclical stocks at that moment.
In contrast, if the economy is at its peak and economic forecasts insinuate hard times ahead, it’s best to sell your cyclical stocks and purchase alternative non-cyclical investment vehicles. This is because usually, the stock market moves in anticipation of an economic cycle. And if the stock market foresees looming danger, a.k.a recession, it instinctively chooses to underprice non-defensive (cyclical) stocks. Get the gist?
In summary, this investment strategy is based on the idea of buying cyclical stocks at the onset of an economic expansion and selling them just before an economic recession. While at it, don’t forget that bigger companies in the cyclical range carry a smaller risk than the smaller companies.
Now, like any other strategy, timing cyclical stocks isn’t fool-proof. While it features shining, expert-backed moves that enable investors to tap into generous gains, the drawbacks aren’t easy to ignore either. Here’s a closer look at the pros and cons of this investment strategy.
Pros · It’s an excellent opportunity to attract returns that beat the market’s average. · Selling cyclical stocks and purchasing the non-cyclical alternatives provides a cushion to fall back on during economic slumps; and · This buy-and-sell strategy is relatively easier to predict since it’s hinged on economic cycles.
Cons · Timing the market is a losing battle. Any expert investor will affirm that timing the stock market remains to be a mystery; also · Understanding economic analysis may require a strong background in finance, economics, or any related field. Actually, even seasoned economists grit their teeth sometimes and are often left clueless about where the market is headed, so your chances of sub-consciously holding cyclical stocks even when the economy recedes aren’t so dim.
Method #2: Investing In Dual Edge Stocks
The second strategy that will help you beat the market is investing in dual edge stocks. I’m pretty sure you’ve come across growth stocks and dividend stocks, and more often than not, these two have been sold to you as stack-rivals in the stock market. It’s either you have one or the other. While that’s the narrative peddled by most market analysts, it doesn’t hold water all the time. As it turns out, purchasing a combination of growth stocks and dividend stocks is a smart tactic to dislodge the market from its position of power.
But before I dig deeper, what do I mean by growth stocks and dividend stocks? In a nutshell, growth stocks refer to publicly traded shares belonging to companies with high growth potentials. This high growth potential stems from the fact that these companies usually don’t redistribute profits to investors in dividends, but rather, they plow back their earnings for upscaling. As a result, their shares can potentially draw radically high returns over a small time-window, and more so, when the economy is expanding. Tesla is a classic example of a growth company that doesn’t pay dividends.
Conversely, dividend-yielding stocks are those shares that embrace a slow-but-steady investing approach. Companies that payout regular dividends to investors are owned by companies, reducing the amount of money in their balance sheets. Consequently, these companies grow at a significantly slower pace because they have limited funds for expansion. However, buying these companies’ stocks can be advantageous if you’re in a stage of life that calls for additional passive income. For example, if you’re nearing retirement, dividend stocks will come through in supplementing your income sources. However, in as much as dividend-yielding stocks are a lofty source of passive income, they’re limited in terms of capital appreciation. The small dividends will only build up your hunger for something bigger, only to hit retirement and realize that there wasn’t a feast to look forward to. See, with growth stocks, you’re more likely to see increases in the value of your initial investment as the company scales upwards and at high speed. This isn’t the case with dividend stocks.
Clearly, both growth and dividend stocks have their sheen, so which route should you take? Well, this will shock you, but the thing is, you don’t have to pick aside. There are stocks that payout handsome dividend payouts while at the same time offering colossal capital appreciation. These stocks combine both growth and dividend stocks’ properties, making them a critical asset for outperforming the market.
Of course, you’re probably wondering how you can identify such a brilliant mix of high growth-high dividend stocks. While I’ll admit that double-edge stocks are invisible to the untrained eye, all it takes is some extra skill and precision to get there.
The first step is to pick a stock that beats the halfway mark. By this, I’m implying that you should start by assessing stocks that generate high growth, preferably 25% annual growth or more. Next, look into their annual rate of returns and consider those with a yearly rate of return of 15% or more. Once you have a list, start dissecting those companies in this list that pay dividends. To be honest, you won’t find many of them that meet this criterion but keep searching until you find a few with a dividend yield of 3% or more. If you’re having trouble filtering through stocks that meet your investment standards, consider employing stock screeners.
I bet at this point, the idea of killing two birds with one stone sounds exciting, doesn’t it? Who wouldn’t be excited at the opportunity of reaping financial rewards from high growth stocks that simultaneously pay dividends? Absolutely no one. However, while double-edge stocks are safer and offer an admired level of stability and income generation, diversification can prove to be a major bummer. The thing is, dual-edge stocks are so few and far between that finding enough of them to diversify your portfolio is almost impossible so set your expectations accordingly.
Method #3: Investing In Value Stocks
The final strategy that will help you beat the market is investing in value stocks. These are mature and relatively steady companies trading way below their true worth and long-term growth potential. Actually, value investing is the springboard that set Buffett on the path to financial success. But what is it exactly and how can you leverage this method to beat the market like Buffett did?
It’s pretty simple. This approach is also known as the Intelligent Investor Approach and is based on buying stocks selling at a price below their Net Current Assets Value (NCAV). The NCAV refers to a company’s current and long-term assets minus all its debts and liabilities. This is what determines a company’s profitability and growth potential.
By shopping for underrated stocks in this way, you’ll end up purchasing stocks at huge discounts. Consequently, this raises your stakes of shelling profits when the market finally starts acknowledging the true value of the stock.
So, how can you identify a value stock? A company’s shares can be underrated because of information gaps and market inefficiencies that cause a mismatch between its performance and market value. Primarily, ratios are used to identify value stocks. A standard ratio that’s used is the Price-to-Book Value Ratio. This ratio compares the market value of a stock to the value reflected by its balance sheet.
The second ratio that you can use to identify a value stock is the Price-to-sales ratio. This one compares a company’s market value to the number of sales generated over the previous year.
An example of a value stock worth looking into is the Lincoln National Corp, a life insurance company. In 2020, the stock dipped by roughly 14%, even though its revenue and net income sprang upwards by 15.6% and 347.2%, respectively.
Of course, no investment strategy is perfect so I’m going to weigh in on the advantages and disadvantages of buying value stocks.
The first pro is that theoretically, when you buy this stock, you’re already slated to be in a profitable position. Let me explain this concept with an example. Think about landing a lucrative coupon while shopping at a retail store. Since you’ll be buying a product for less than its original price, you’re already capitalizing on a deal and with value stocks you stand a better chance of seeing that profit come to fruition. Another benefit of value stocks is that they typically carry less risk. Presumptuously, value stocks are so under-valued that they can’t go any lower. Even if they do fall, they’ll do so by a minimal margin. These stocks have more-than-enough room for attracting gains and very slim chances of depreciating farther.
On the flipside, identifying under-valued stock is a skill that only a few investors possess. Not only are they rare, but you’ll need to watch the news, understand some basic accounting concepts, and research like your life depends on it. And as if finding these stocks isn’t tricky enough, diversification is double the trouble. With value-investing, you’re clueless on when the day of the feast will come. You literally just buy your stock and hang onto it, hoping that the market comes to its senses sooner. But what if this never happens? That’s a thought worth entertaining.
And those are the 3 proven ways to beat the stock market!