Investments in the Canadian stock market today should focus on high-quality stocks, bottom-up investing principles and more to profit with the least amount of risk

Stocks that make up the Canadian stock market today don’t go up and down like a bunch of people in an elevator. They are more like commuters in a city. Most go the same way every morning and evening, with the traffic. But lots of others go against the traffic, if only sporadically.

We think that by following our philosophy over long periods and you’ll have an above-average chance to achieve superior investing results.

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Use the bottom-up approach to investing to get the best from the Canadian stock market today

We think that most investors are far better off with “bottom-up investing” as opposed to “top-down investing.” Bottom-up is where you look closely at individual stocks and single out those with a history of sales and earnings, not to mention dividends. Then you buy a diversified, balanced selection of stocks that represent prosperous businesses with a strong hold on their markets.

We advise you to invest this way within the framework of our three-part Successful Investor portfolio strategy.

Over periods of five years and beyond, top investment honours generally go to a member of the bottom-up investing crowd. That’s partly because bottom-uppers tend to make fewer big mistakes. This lets their gains accumulate. This also leads to longer holding periods, which provide greater tax deferrals and lower brokerage costs.

Make fewer trades and invest in high-quality companies to be a Successful Investor in the Canadian stock market today

In the long run, the best way to cut commissions is by sticking to high-quality investments and making fewer transactions. This cuts those commissions, and it improves your tax deferral benefits.

For instance, suppose you buy an investment at $10 and it goes to $20. As long as you hold on, you defer taxes — the entire $20 keeps on producing dividends and capital gains for you. If you sell, you’ll have only $18 or so to reinvest, after capital-gains taxes and commissions. The lost 10% of your capital can take an enormous bite out of the potential returns had you let it compound for a decade or two.

Pick top stocks from the Canadian stock market today with the help of these factors

• We look for political stability. For example, mineral exploration is risky enough without the threat of expropriation or onerous taxes.
• We look for well-financed stocks with no immediate need to sell shares at low prices, since that would dilute the interests of existing investors.
• We like to see a sound balance sheet with reasonable debt.
• We want to see experienced management with proven ability to develop and finance a new business.
• We avoid stocks trading over-the-counter where regulatory reporting and so on is lax.
• We avoid stocks trading at unsustainably high prices due to broker hype or investor mania.
• We compare the market cap of the stock with the estimated value of its reserves, future product sales and so on.

We take a ‘wait and see’ attitude with some stocks on the Canadian stock market today

Even if a stock has what looks like a positive outlook, we may still refrain from recommending it for a number of reasons. Our stock research may lead us to conclude that it presents too much risk of heavy losses if it fails to thrive. Or we may feel that stocks we already recommend offer better alternatives. Or we may simply prefer to hold off on a promising stock because we feel it has limited near-term potential. This can happen because it has been over hyped in the broker/media limelight, for instance.

In many cases, we watch the progress of these stocks we like a little. We may recommend buying them months or even years later, but only after seeing favourable developments and signs of progress.

Use our three-part Successful Investor approach to make money in the Canadian stock market today

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Bonus tip: More on diversifying your portfolio across the sectors

If you diversify your stock holdings following our Successful Investor approach, you improve your chances of making money over long periods, no matter what happens in the market.

For example, manufacturing stocks may suffer if raw-material prices rise, but in that case your Resources stocks will gain. Rising wages can put pressure on manufacturers, but your Consumer stocks should do better as workers spend more.

If borrowers can’t pay back their loans, your Finance stocks will suffer. But high default rates usually lead to lower interest rates, which pushes up the value of your Utilities stocks.

As part of their portfolio diversification strategy, most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

For example, conservative or income-seeking investors may want to emphasize utilities and Canadian banks in their portfolio diversification, because of these stocks’ high and generally secure dividends.

More aggressive investors might want to increase their portfolio weightings in Resources or Manufacturing stocks.

However, note that if you have Resource holdings, you should spread them out among oil and gas, metals and other Resources stocks for diversification and exposure to a number of areas.

What worries you the most about the Canadian stock market today?

Which Canadian investments do you feel have the most potential for growth in the coming years?