The ASX share market has produced decent returns and enabled good compounding of wealth. There are a few different ways I like to invest to try to beat the market.
No investment style is guaranteed to beat the market every single year, but it can deliver better returns over the long term.
But, the ASX hasn't been a strong performer in recent times. As we can see with the Vanguard Australian Shares Index ETF (ASX: VAS) – which tracks 300 of the biggest businesses on the ASX – the 10-year return to October 2023 was only an average of 6.5% per annum. Plenty of individual ASX shares, and the global share market, have done better than that.
I think Aussies can do better than the stock market, and these are the areas I'd look for.
High-quality ASX shares
Businesses that are high-quality can deliver better returns than the market over the long term, though it's not certain to happen.
What's a high-quality business? This can be measured in different ways, but there are a few things I'd point to. A strong brand, patent, management team or network effects can provide advantages. Having a high (and stable/growing) return on equity (ROE) is also a good measure of high quality.
The sorts of names I think can fit into this category on the ASX include Wesfarmers Ltd (ASX: WES), Xero Limited (ASX: XRO), Premier Investments Limited (ASX: PMV) and Reece Ltd (ASX: REH).
I'd still only want to invest in these names when they're at a good price – no business is worth an infinite price.
ASX small-cap shares
ASX small-cap shares are capable of producing very good returns because they're earlier on in their growth.
It's much easier for a business to grow revenue from $10 million to $20 million than it is to go from $1 billion to $2 billion.
All of the large businesses today were small at one point. If we can identify those smaller stocks before they become profit juggernauts, then we could experience lots of capital growth. But, a small business isn't guaranteed to do well just because it's small.
I think the market is being pessimistic on ASX small-cap shares, so this period could be a good time to invest.
I've written a few articles about small businesses that I think look(ed) cheap.
Cyclical stocks
There are some industries that go through cycles – there isn't consistent demand throughout the economic cycle.
It's very difficult to predict when a commodity is going to see a price change from strength to weakness. But, when a commodity does go through a major fall, there could be an opportunity to invest in the relevant businesses and own them for the next (say) two to four years until better conditions return.
ASX mining shares and ASX discretionary retail shares are two areas in which I think I can benefit from cyclical opportunities. I also recently invested in a beaten-up agricultural business.
ASX dividend shares
Businesses that pay good dividends and grow can deliver good returns.
For example, imagine there's a company that pays a 5% dividend yield each year – that's a 5% return. Now let's say this business grows its earnings per share (EPS) by an average of 6% per year and maintains the same price/earnings (P/E) ratio – that'd mean the share price grows by 6% per year.
Combined, the total return would be an average of 11% per year, which would outperform the ASX share market.
I'd include Wesfarmers as this kind of business, but others that are growing their earnings and paying sizeable dividends include GQG Partners Inc (ASX: GQG), Sonic Healthcare Ltd (ASX: SHL), Propel Funeral Partners Ltd (ASX: PFP) and Brickworks Limited (ASX: BKW).
