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The Most Powerful Market-Timing Technique

If I am not mistaken, the fairy lights are starting to appear along Orchard Road.

That can mean only one thing – it’s beginning to look a lot like Christmas.

But for stock-market investors it can mean something completely different. It is that time of the year stock are supposed to rise.

According to stock –market experts, it’s time for the Santa Rally.

Useless coin-toss

Regular readers will know that I treat market-timing strategies, such as the “Santa Rally” advice, with the contempt that it deserves.

It is about as accurate as a coin-toss, which is really not how we should be approaching something as serious as investing for the long term.

Stock pickers should buy shares when they think that they are cheap, regardless of what stock-market pundits say.

For instance, investors, who are investing through an index tracker, should be putting money into the stock market all the time.

It is nonsense

Market timing is nonsense. It doesn’t work.

But there is one timing strategy that is worth paying attention to. It is buying dividend stocks all the time, especially those that have the ability to increase their payouts.

If we consider the 30 companies that make up the Straits Times Index, we find that in almost every instance, the total return over the long term is higher than the growth in the share price.

That is not a coincidence.

Study after study has shown that the bulk of the returns from investing in shares have been thanks to dividends, especially when the payout is growing.

Rising payout

That stands to reason. If a company is able to lift its payout consistently, then the share price is likely to rise too, as investors buy into the rising dividend.

So a good strategy for investors is to look for companies that have the ability to lift their payouts consistently. These companies tend to have certain attributes.

They include a good return on equity, which means that they are generating a decent level of profit from the money that investors have put into the business.

They should have low levels of debt because every dollar that is used to service a loan is a dollar that can’t be paid out as a dividend.

But that is not quite enough, if you want to achieve really exceptional returns.

To capitalise on the growing payouts, any dividends that we receive should be ploughed back into the company immediately.

“Free” money

If a company is able to raise its dividends, then it stands to reason that you want to own as many of its shares as possible. Buying more shares using those dividends will let you to achieve that by effectively using “free” money.

But even if a company doesn’t or can’t raise its dividends, it still makes sense to reinvest the dividends. The more shares you own mean more dividends the next time payday comes around.

Some companies actively encourage investors to buy more shares by offering to issue dividends as stock rather than cash. These dividend reinvestment plans make good sense because you don’t pay commission on the additional purchases.

Timely investment

There is something else to consider. Dividends are paid periodically. Some companies pay them annually. Some pay them every six months, while some pay them every quarter.

By opting to reinvest the dividends immediately, we get more units when the share price is low. But, of course, we get fewer shares when the price is high.

However, by automatically reinvesting the shares, we are less likely to talk ourselves out of buying shares just because markets are down. Similarly, we are less likely to balk because we think that prices are high.

Instead, we simply add units to an investment that is likely to grow over time.

It is called compounding, which is probably one of the most powerful market-timing techniques we can have in our armoury.

What’s more, it is a market-timing strategy that works.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.