CashNews.co
A lot of people like the idea of becoming a millionaire – and the stock market is a common place to try and make the dream come true. It may seem that the way to aim for a million is to invest in dozens of little-known companies and hope that one of them hits it big.
For example, Nvidia has soared 2,635% over the past five years.
Five years ago, I was already aware of the chipmaker’s growth story. If I had invested under £40,000 in its shares then, I would now be a millionaire thanks to my Nvidia holding alone.
There are several problems with such an approach however (and not just that it relies on the benefit of hindsight).
Putting all of my money into one share, no matter how attractive it seems, goes against the basic risk management principle of diversification. Secondly, loads of small companies end up going nowhere from an investment perspective – even if they have the makings of a brilliant business.
That does not mean I can not still aim for a million. Far from it. But I would not try to do so by taking a scattergun approach to exciting small businesses. Instead, I would focus on proven, sizeable businesses. That does not necesarily limit me to the FTSE 100but I would be happy to adopt a strategy that focused on FTSE 100 shares.
I would also do less not more. Rather than buying dozens of FTSE 100 shares, I would stick to a dozen – or even less.
Why? Think of it like this. Investing in the top 10% or so of FTSE 100 shares would mean my overall performance was far better than if I bought a wider selection.
Say I invested £800 a month in shares that had an average compound annual growth rate (CAGR) of 5%. I would be a millionaire in 38 years. If I took the same strategy and achieved an average CAGR of 10%, I could aim for a million in 26 years. At 15%, just two decades would be enough.
But how could I find such shares? As an example, consider FTSE 100 rental specialist Ashtead (LSE: AHT). Its share price is up 158% over the past five years and the total return has also been boosted by dividends on top of that (albeit the current yield is only 1.4%).
Five years ago, it was already obvious that Ashtead was a fine business. It had identified a profitable niche with long-term demand from customers that often had deep pockets and limited choices of supplier. It offered multiple competitive advantages, from scale of network to multinational reach enabling it to service one client in multiple markets.
Those strengths remain true today, in my opinion. But with a price-to-earnings ratio of 21, the valuation is a little too rich for my tastes. After all, returns are based not only on how good (or bad) a business is, but the price at which it is bought. Ashtead could run into heavier weather, for example, if US construction activity slows and equipment rental demand drops.