Foreign Exchange trading, known as Forex, appears to have get-rich-quick appeal, but the reality is that most Forex traders lose money – sometimes a lot of it.
Instead of speculating on currency movements, I’d rather build wealth by investing in shares and share-backed investments. Studies have shown that over the long haul, shares have beaten the returns from all the major classes of assets such as property, commodities and cash savings.
Beware! Some shares are as risky as Forex
However, I reckon it would be folly to bring a get-rich-quick approach to investing in shares because it may lead to taking punts on risky, profitless companies with an enticing story. Such beasts could end up being no better than Forex trading for investors, with a high percentage of losers. For example, those backing Sirius Minerals have endured a rough ride so far.
To me, one of the keys to finding successful investments in the stock market is to focus on the quality of the underlying business, which usually shows up in the trading and financial record. If you can find a company with a multi-year record of rising revenue, earnings and cash flow, you’re off to a good start with your research.
But I’d also look for decent quality indicators such as chunky profit margins and a good return on capital employed. If you can find those, there’s a good chance the business operates in a well-protected and profitable niche of the market.
Don’t rely entirely on the numbers
However, the numbers alone won’t always tell you everything you need to know about a business. It pays to dig into the nature of the firm’s operations to try to get to grips with how the company can maintain its resilient trading position in the market.
Some firms can throw out tasty looking financial numbers that aren’t sustainable. The cyclical firms can be a good example of that phenomenon. Banks, housebuilders, retailers and others can all be trading their socks off one minute and crashing the next, which can lead to a roller coaster ride for investors. Sometimes, such companies can deliver a poor investing outcome even when you hold the shares for a very long time.
Overcoming the quality/valuation problem
But when you’ve pinned down a quality business with sustainable operations, the next challenge is to buy the shares as cheaply as you can, so the focus moves to valuation. And I admit that genuine, high-quality businesses rarely sell at bargain-basement valuations. But if you over-pay for shares, you could end up turning a decent company into a poor investment if the valuation goes on to ‘normalise’.
Well-known US investor Warren Buffett overcame the problem by adjusting his investment strategy. Instead of buying cheap valuations whatever the quality of the enterprise, he moved towards buying the shares of high-quality companies when their valuations were fair. And I think that kind of strategy could help you to invest your way to wealth.
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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.
Motley Fool UK 2020