Choosing Stocks To Trade

When thinking about which stocks to trade the investor has to answer an important question - is she after income or capital growth?

Investing for Income

Some shares are classified as income stocks. There are several reasons for this.

Firstly, they provide a steady, predictable dividend rate and have done over many years. They are usually old, solid, conservative companies where their turnover and profitability does not vary much from year to year. It should keep up with inflation at the least or even better, provide some more.

Usually these companies have little opportunity for great capital growth but do provide a reliable income stream for investors seeking income. Sometimes these companies are companies that provide family staples so that their businesses remain fairly consistent regardless of the economic trend. Sometimes these companies may be utility companies, such as energy providers like electricity gas or water. These companies usually show constant but small growth over the years and their dividend streams are reliable and solid.

Growth Companies

These companies show great capital growth but may have small earnings. Growth companies have exceptional potential which is recognized by the market, hence their price far exceeds the value of the share. In this case, investors are happy to pay a premium on the share price solely on the basis of projected future earnings.

These companies often fall into the speculative category as a gold mining company may see its shares skyrocket when the price of gold rises significantly. The company may have located gold on their prospect but it may take several years and a huge investment before the mine becomes a working reality.

Having the Best of Both Worlds

In this category of stock, there is both future prospect and immediate earnings. These are the best shares, in my opinion, to hold.

The reasons are simple. Firstly, the company pays a reasonable dividend because the business model is successful and costs are being contained. Because there are opportunities for the company to expand, there is also capital growth.

If a careful selection is made, some companies show good dividend growth with consistent capital growth. The total returns from these companies can be most impressive. It is not uncommon for these companies to show an annual rate of return in excess of 15%, comprising income from dividend and capital growth. This measure is called 'total shareholder return'.

When there is a good contribution from the dividends as well as capital growth, then it is not unreasonable to expect this rate of return, year in, year out, over a long period of time. This provides a very satisfactory rate of return for the stock investor without relying on a speculative component in the share price.