Buying tickets for the National Lottery doesn’t really count as acting to build a fortune to help you retire early. There’s a vanishingly small chance that you could win the jackpot and a very high chance that you’ll lose everything you ‘invest’ in the Lottery.
Instead, I’d take regular action to build a retirement fortune by investing in the stock market with this simple-but-effective plan.
Firstly, I’d aim to buy the shares of companies and stick with them for the long haul. If I’ve chosen carefully, I’m likely to prosper through my shareholdings as the underlying businesses grow.
So, for me, it makes sense to scour the market for good-quality smaller firms rather than those big beasts in the FTSE 100. Indeed, as a general rule, I find smaller market capitalisations to be more attractive. That’s because a business needs room to grow if it’s to produce large, multi-bagging returns over the years to come.
But it’s no good paying too much for a fast-growing smaller business because potential over-valuation can hurt your returns in the future if that valuation falls back. And one way of avoiding pricey stocks is to focus first on the dividend. If it’s at a reasonable level and forecast to grow, there’s a good chance we’re getting good value with our shares.
And if we stick with firms, they often develop their operations over time, which can lead to a rising share price and growing dividends.
Quality with potential
But a lower valuation on its own isn’t enough. Famous and successful investor Warren Buffett stopped buying purely cheap shares decades ago, for example. I reckon we need to try to ensure each company we pick has a quality business with the potential to thrive over the decades ahead.
One way of pinning down decent quality is to focus on the cash performance of an enterprise. So, I’d go for those that are cash-rich with low levels of borrowings as a starter. But just crunching the financial numbers alone isn’t enough either. On top of that, it’s worth digging into the quality of the management team as represented by the firm’s directors.
I look for ‘clean’ reputations and a stable board that isn’t always changing. I also want those directors to have their own ‘skin’ in the game with chunky shareholdings of their own in the firm.
Letting them run
For me, it’s important a company already has a record of stable earnings and dividend payments before I buy its shares. It’s unlikely an enduring investment will arise from a situation where the firm has yet to earn any meaningful profits. So much can go wrong in the meantime leading to poor returns for shareholders.
But when you do find a decent company and buy its shares at a reasonable price, I reckon the key to gaining life-changing investment returns is to let the investment run. Sometimes, it even pays to buy more shares in the company along the way.
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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.