Could I build my wealth by buying gold and hoping its price rises? Perhaps. But I am not doing that. Gold is not a productive asset. Instead, if I wanted to build my wealth from scratch right now, I would start investing in quality companies selling at cheap prices. Let me explain the elements of that approach in turn.
Building wealth from scratch
To increase financial resources from a standing start by buying shares, several things need to happen.
First, I need to put money into buying those shares. That could be a lump sum upfront, or I might drip-feed money in on a regular basis. But one way or another, I will need to have some funds to invest.
Secondly, I need to buy shares that grow in value, pay me dividends, or both. Over time, that is what could hopefully help me grow wealth from the money I invest.
Investing in high-quality companies
So should I buy a share just because I think its price will keep rising or the dividend yield is high?
I would not do that. A share is a small piece of a business. I prefer to buy or sell based on what I expect the long-term performance of that business to be, not merely the momentum I see in share price movements.
As for dividend yield, if a business becomes less successful it may no longer be able to afford to pay that dividend. So, again, my focus is on the quality of the business and how I expect it to do in coming years and decades.
Buying cheap shares
But like a quality car or dream holiday, paying too much even for something attractive can mean it is no bargain. If I overpay for a share, it may turn out to be a poor investment, even though the company has strong prospects.
That is why I focus on valuation when buying a share. Take FTSE 100 engineer Spirax-Sarco as an example. I think it has an excellent business with strong prospects. But I would not buy shares in the firm for my portfolio at their current price.
With a price-to-earnings (P/E) ratio of 37, the shares look expensive to me. They have fallen 23% in the past year, even though the firm’s most recent annual results recorded basic earnings per share soaring 35% and the dividend increasing for the 54th year in a row, this time by 15%.
Instead, I would rather buy shares in great companies that trade at what I think are compelling prices. That strikes me as one way I can seek to build my wealth.
For example, retailer B&M has a P/E ratio of 11, making it much more competitively valued on that metric than Spirax-Sarco. Admittedly, its recent business performance has been less impressive than the engineer. But I see B&M’s strong brand, large customer base and retail experience as key growth drivers. Revenues in the most recent quarter grew 12.3% compared to the same period last year.
If I had spare cash and had never bought shares before, I would start investing in firms like B&M that I felt combined excellent business prospects with an attractive valuation.
