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A winning strategy for investing in stocks

A jockey with his hand over his eyes stands in the stirrups of his horse after winning a race.
Hoping a longshot will bring home the bacon is punting, not investing. (Source: Getty) (WILLIAM WEST via Getty Images)

The attitude of newcomers to investing in stocks is a bit like someone who goes to the races for a fun day and is looking for a longshot tip that will mean they go home with a wad of cash.

That’s punting, not investing.

Also by Peter Switzer:

In the world of stocks, a cheap, penny-dreadful mining stock that ends up being a Fortescue or Lynas isn’t easy to find and invest in. It’s a bit like finding the longshot on Melbourne Cup day.

Fortescue Metals Group (FMG)

A graph showing FMG's rise in value since 1999.
(Source: supplied)

The chart above shows the kind of share price spike we hope all our stocks end up being like, but this chart actually shows you what might be a better way of investing.

If you want to get lucky at the races with a longshot, you have more chance betting on a quality horse that might be a long price because it’s:

1. In its first race after a spell

2. Carrying a lot of weight

3. Just been out of form recently

But if it’s won lots of races in the past, it’s a better chance to win at long odds than a horse that nearly always loses.

Quality counts

The same goes for the method of investing I think has lots of legs. If you buy a quality company when the market thinks it’s out of form, you might find that it’s only a short-term thing.

As an example, take CBA in recent times.

After the banking royal commission, the bank’s share price fell. This was a great time to buy this stock.

Similarly, after the Morrison Government asked the banks to put aside profit goals when the coronavirus closed down the economy, CBA’s share price fell again.

This was also a great time to buy shares in our biggest bank.

When Malcolm Turnbull announced the royal commission, CBA’s share price was $80 but it fell to $65 over the time banks were accused of behaving badly.

Its share price then rose to $88 before the COVID crash took the price down to $58.

It has since rebounded to $105.

If you’d bought a CBA share at $65, you would’ve made 61 per cent on your investment over three and a half years (or 17.4 per cent a year).

And if you bought CBA when it was $58, in April 2020, you would’ve made 81 per cent over two years (or 40.5 per cent a year), on one of the best thoroughbred banks in the world.

By the way, the bank pays about 5 per cent a year in dividends as well, so this takes your annual return to 23 per cent, if you bought in 2018, and 46 per cent a year if you bought in 2020.

And then there are franking credits as well.

More examples

Right now, quality companies such as CSL, Xero, REA, Seek and Resmed are out of favour with the market, because health and tech stocks have lost support in recent times.

However, if history is our guide, these companies will be ‘re-loved’ by the market sooner or later. And they could now be in the buy zone for the patient, long-term investor, who knows these quality companies will eventually salute the judge.

This chart of CSL makes the point clearly that, after falls, we should expect a decent bounce-back.


A graph showing CSL's rise in value since 1999.
(Source: supplied)

Last word

Of course just like a horse, the odd quality business can lose its winning ways.

That’s why wise investors eventually hold 10-20 quality companies, so the odd winner-turned-perennial-loser can be diluted by the stable of consistent comeback merchants, which return to form after a run of outs.

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