In a way, companies are like people. There is a stage in their life when they are growing quickly. They start out very fragile, where one wrong move could send them into bankruptcy. If conditions are right and they make the right moves, they will start growing and expanding into other markets. Companies at this stage require a lot of resources to develop new products, market to new consumers, and build plants, equipment, and offices.
Investors in these types of companies should likewise be young and growing in their careers. Returns from these growth companies will be spotty. Some years they may very well double in price. Other years, however, they may decline in price or simply go nowhere. They are very unlikely to be paying a dividend – they need all the cash they can get to fund operations and meet payroll. They can also go out of business if conditions turn against them. These stocks are not meant to be the sole source of income for an individual. COmpanies such as these may take years to grow and reach the point where they are stable and strong.
Other companies are much older. They have established a large and broad market. They are generating plenty of cash from operations to fund research and further expansion. They can also send some cash to shareholders in the form of dividends or stock buybacks. (Although I’ve never really seen stock buybacks do much for the share price – just closing the loop on all of the options these companies tend to be giving to executives).
If conditions in the economy turn bad they have plenty of cash with which to weather the storm. They can cut divisions and sell off equipment to save or raise cash. They often come out of economic downturns stronger than before because they discontinue poorly performing stores, restaurants, or divisions and many of their competitors go out of business, so they emerge leaner in a more friendly environment. They often encourage regulation because they can afford to pay the high costs of compliance while the costs and mountains of paperwork keep start-ups out.
These types of companies are suited for older investors who can’t wait for several years for a company to grow. They tend to pay high dividends, providing the investor with a steady source of income even if the share price is not increasing. The growth prospects for these companies is limited, however, since they have already grown into most markets. They do have international operations often, however, so they are somewhat insulated from an economic downturn in one country.
Most investors should own portions of both of these types of companies. The younger investors, however, should have far more growth than income stocks. Vice versa for the older investor.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.