Good value investors do not panic when stock indexes crash. They embrace these situations and benefit from them. Clearly, you can hardly make a fortune overnight. But then, you normally have to be patient to make a million. In my view, cheap dividend shares are a safe and reliable way to retire early.
FTSE 100 crash
The Covid-19 crisis may continue for some time. There is also a high risk of a ‘second wave’. We’ve all heard that a vaccine will not likely be ready until the end of 2021. Meanwhile, the economic recession in the UK is the sharpest one on record. It all looks quite grim. Nevertheless, the current downturn could be an excellent opportunity to start investing.
It seems to me that the FTSE 100 is undervalued despite having rebounded slightly from the lows reached in March. As my colleague Peter Stephens pointed out, investing £500 each month could leave you with £1m after 35 years. This is because the average return of the FTSE 100 is about 8% per year. I agree that it is a sound way of investing.
However, I would recommend investing larger sums of money during downturns, if you can. Recessions are cyclical in nature. Likewise, a stock market crash cannot last forever. The FTSE 100 has a very good recovery history. I’d personally invest more during downturns and less during stock market booms. This would allow you to achieve even better results.
Cheap dividend shares
The easiest way to invest in the FTSE 100 is buy an index that tracks its performance. Many of them pay dividends. The FTSE 100 average dividend yield is about 4%. This sounds attractive.
But there is another way to invest that could help you outperform the Footsie. It simply involves excluding the ‘worst’ companies from the benchmark and distributing your money among the ‘best’ companies.
What do I mean by this? Well, loss-making companies can be excluded straight away. Indeed, if things get better and these companies become profitable again, investors can make a substantial profit too. However, they tend to go bankrupt much more often than profitable companies do. So, they normally drag the stock index down. Such companies also have a highly uncertain outlook. Carnival Corporation seems to be an example of such a company.
It’s also a good idea to avoid highly overvalued companies. It is easy to spot them by their high price-to-earnings (P/E) ratios. Sometimes, you don’t even have to calculate a firm’s P/E ratio. It is often enough to look at the share price graph. If a company’s stock has appreciated dramatically, it is most probably not a bargain anymore. Ocado is a fantastic example of this. It doesn’t have a good earnings history, but the stock has surged because of the hype surrounding delivery services.
Obviously, buying cheap dividend shares also suggests investing in companies that have a good dividend record. It means that a company must have a long history of paying dividends. Moreover, the company has to raise dividends every year.
Finally, I’d suggest investing in larger companies. The size of an enterprise can be judged according to its sales revenue and market capitalisation. Larger companies usually offer more stability than smaller companies do.
I think many companies in the FTSE 100 fit such criteria and will allow you to make a million much earlier than an index fund.
Anna Sokolidou does not have any position in any of the companies mentioned in this article. The Motley Fool UK has recommended Carnival. 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.