You’ve finally saved some cash and you’re ready to invest.
GICs are currently unimpressive, savings accounts are nothing to write home about, bonds are not very attractive. So, what’s left?
Stocks, or more appropriately “Equities”, are securities that trade on a stock exchange and represent ownership in a company. So, for example, if you were to buy 100 shares of, say, Tesla, you would
actually be a co-owner of the company. Stocks generate returns for you in two ways.
First, they may pay dividends. For example, as of today, Enbridge Inc. (ENB.TO), which trades on the Toronto Stock Exchange, is paying a dividend of roughly 6.77% per year. This means that if you were to invest $10,000 in Enbridge now, and the company maintained its current dividend indefinitely, you could expect to earn $677 per year.
Second, stocks can also increase in value. For example, if you were to have invested $10,000 exactly 1 year ago today into the S&P/TSX Composite index (^GSPTSE), a pool of stocks that trade on the Toronto Stock Exchange, you would have about $12,590 today, NOT including any dividends.
When you compare that to the average 5-year GIC rates of the big banks (they’re floating somewhere around the 1.2-1.5% mark), then it’s pretty cut and dry right? Put all your money into stocks!
Whoa, not so fast there. If only it were that easy. Stocks don’t always go up; they often go down in value. Companies cut dividends, technologies become obsolete, and some companies turn out to be a farce (remember Enron?)
One (of the many) key indicator you should be looking at when deciding whether or not to invest in stocks is the P/E or Price to Earnings ratio. The price-earnings ratio, also known as P/E ratio is the ratio of a company stock price to the company's earnings per share. The ratio can be used for valuing companies and to find out whether they are overvalued or undervalued.
For example, if share ABC is trading at $100 per share, and in the most recent 12 months has reported earnings of $10 per share, then the P/E ratio is 100/10 = 10.
So, what does that tell us, well, on its own, nothing. However, when you compare that to the stock’s historical P/E ratio, the company’s ratio in comparison to its competitors and the market in general, along with other factors such as the strength of the company’s position in the market, the longevity and quality of its board of directors and senior management, then it helps round out a profile for the company as a buy or sell target.
But what about stocks in general? Take a look at this graph:
This is the historical P/E ratio of the S&P 500. The S&P 500 is a stock market index that tracks 500 large companies listed on various US stock exchanges and is often used as a barometer of stock prices around the world.
Some key facts to help put this chart into context:
So, basic math here, the historical P/E trend since the 1800’s has been 15.94 as measured by the Mean (aka. Simple average). What’s the current P/E ratio as of today (July 29, 2021)? 34.55.
It doesn’t take a genius to understand that stocks may be over-priced in comparison to their historical trend. But it also doesn’t take a genius to understand that we’ve gone higher, waaaayyyyyyy higher than 34.55 in the past.
So, what does that mean for someone who’s got a bunch of cash sitting idle right now? Well, that depends.
If you’re ready to invest for the long-run, say 10+ years, then you may be ok to simply invest in stocks right now.
If you’re only looking at investing over the short-term, then stocks might not be the smartest move at the moment.
If you would be devastated by a temporary loss in the value of your investments, even if you are invested over the long run, then dumping a ton of cash into stocks right now may not be so great for your mental health.
However, at some point, you’ll probably need to pull the trigger and invest. Sitting in cash, while “safe”, will likely deplete the purchasing power of your wealth over time.
If massive drops in the value of your investments strikes fear in your heart, then maybe you’d want to consider dollar-cost-averaging into the market over the course of several months or years (I’ll write an article on that in the future).
Bottom line, it’s a strange time for stocks, but there are techniques to get into the market in a safer way.
Talk to your advisor, do your homework, don’t sit on the sidelines.
Fabio Campanella CPA, CA, CFP, CIM has been providing clients with integrated tax, estate, and investment advice since 2002. He is an IIROC licensed investment advisor with Queensbury Securities Inc. and a tax specialist with Campanella McDonald LLP. You can reach him directly with investment inquiries at firstname.lastname@example.org and you can access his personal website here: CLICK HERE.