|
Value Investing
| Value Investing focuses on the fundamental analysis
and investigation of the company. |
Value Investing relates to the selection of securities
to be bought or sold on the basis of the company's assets.
The key to Value Investing is being able to determine when
a stock's current price does not reflect the value of its
assets. For example, an investor might look for a stock in
which current assets exceed liabilities on a per share basis
by more than the market price of the stock. More attention
is paid to the financial statement, the brand names, patented
technology, and the strength of the management team of the
company than earning projections per se. The Price to Earnings
(P-E) ratio of the stock is often a key yardstick in deciding
whether a stock is undervalued, fairly valued or over-valued.
In a nutshell, Value Investors place moreemphasis on the "Fundamentals"
of the company than on the stock itself. Their slogan is "buy
low and sell high".
Basic value analysis:
|
1. Many factors require analysis. Earnings per share,
sales, asset values, profit margins, return on equity,
return on sales and return on assets, debt, management
changes, patents, competition, are just some examples
of the myriad of items to be evaluated.
2. Security analysis based on fundamentals requires
a well-organized approach with a myriad of data. In
this day and age, the individual investor has a level
playing field in availability of the same data as the
professional analyst, but the culling of it to derive
meaningful information takes much skill, and more importantly,
time.
3. Value investors look for stocks priced below some
yardstick of their true worth, and are essentially bargain
hunters. They look for out-of-favor companies with depressed
stock prices in relation to cash flow, low price-to-book
value and price-to-earnings ratios.
4. Value investors tend to hold stocks for long periods.
The longer the time horizon, the more important is the
fundamental analysis. Technical analysis of a stock's
price and volume chart pattern is far less important
to a buy-and-hold strategy of several months and more
reasonably, several years. Except to take a position
at a relatively favorable entry point for the long haul,
the precise purchase price based on the technicals of
the stock is not that vital to value investors. In addition,
value stocks by definition have low valuations in terms
of price-to-earnings or price-to-cash flow ratios; they
offer less volatility and risk in the short term than
growth stocks.
|
Value Investors have tremendous patience in waiting until
the market ultimately recognizes the value in the stock that
they originally saw and bought. They tend to be more cautious
as well as loyal in contrast to the seeming fickleness of
momentum investors who drop stocks when they are no longer
popular.
Momentum Investing
| A long wait for a stock to pay off has little appeal
to the high risk-taking, knock 'em, sock 'em, Momentum
Investor |
In the eyes of the Momentum Investor, the stodgy evaluation
required to hunt for value in beaten down stocks is too staid
for their temperament. Buying low to go high implies that
the stock was previously at a higher price than it is now
and therefore there are disgruntled investors who purchased
the stock at a higher price, who are just itching to get rid
of it close to their purchase price. This is called Overhead
Supply and often takes years to overcome thereby stunting
the stock's price growth. The long wait has little appeal
to the high risk-taking, high reward-seeking, knock 'em, sock
'em, Momentum Investor. Likewise, waiting patiently for several
months to years before they find out whether they have been
successful or made a mistake goes against the grain of Momentum
Investors. Their temperament calls for quick action.
Momentum Investing focuses its attention on the tendency
of a stock's price to continue movement in a single direction,
where the momentum may be upwards, downwards or sideways.
Hence, direction, and more importantly the timing of the purchase
or sale of the stock, is the essence of Momentum Investing.
Substantial attention is paid to the price and volume relationships
of the stock, and their momentum is the underlying factor
behind trend analysis of stock prices. Modern day software
analysis programs place tremendous importance on the "Technical"
analysis of the stock's price and volume trend, and therefore
its aspirants are known as "trend followers". Momentum
Investing is the opposite of Value Investing, concentrating
on the relative strength of the stock price and volume, while
paying little attention to the company's fundamentals. Slogans
such as "the trend is your friend" and "buying
high to go higher" are characteristic of this style of
investing.
Most people who play "Momentum" only are essentially
very short term oriented - of the order of a day to a week
or so at most, and so they have little concern for Earnings
or whether the company produces hula hoops, semiconductors,
or steel pipes and tubes. These investors have little appreciation
for the need to understand the fundamentals of the stock,
since the short time factor of their ownership of the stock
makes this of little importance in the decision making process.
Therefore, being consumed with Technical Indicators relating
to price and volume only prevents the full appreciation of
"high octane", consistent earnings being the fuel
for achieving high rewards and reducing risk. As long as the
stock "pops" they take the ride and are gone. Some
are very good at it, and make a good living doing that. However,
they seldom ride a stock for long gains of 100%, 200%, and
400%. Rather they hop on and off the same stock several times
to make smaller gains in that stock over shorter bursts of
time. They are USUALLY content if they collect 25 to 30% in
a very short period of time and move on to the next stock.
The shortness of their engagement with a stock in effect eliminates
the need for them to do any fundamental analysis of the company
itself. To be highly successful, they have to be glued to
their screens, and work with Real Time computer tools. They
seldom do well unless they have the best of online data on
a tick-by-tick basis, with good visibility of bid and asked
spreads and volumes.Above all they need strong stomachs, especially
in dealing with program trading in highly volatile markets
that has become an accepted part of their investment life.
Discounted news, which has already had its impact on the
stock's price, is difficult to assess in Fundamental terms,
but there are several mechanisms for assessing the technical
aspects of an overbought or oversold stock, relating to price
and volume indicators.
All of this is the antithesis of Value Investing and has
no place in the Value Investor's vocabulary. Like oil and
water, these two types of investing are poles apart. But so
what, I ask?! Each has its place and investors will gravitate
to one or the other depending on their personal traits and
on their risk & reward preferences. To denigrate one or
the other is to be childish.
Growth Investing - HGS
High Growth Stock (HGS) Investors pluck the best of both
worlds. Rather than "buy low to go high" or "buy
high to go higher", they strive to "buy right".
They place importance on four underlying principles, one Fundamental,
the second Technical, the third is understanding Market direction
and the fourth is their approach to Money Management:
It is important to realize that HGS investing utilizes a
balanced approach from both disciplines, fundamental and technical,
in determining the "what", the "why",
the "when", the "how" and the "so
what" of a stock's buy, hold and sell strategies, described
in this book.
| Fundamental Analysis
focuses primarily on all aspects of the earnings
of the company, past, present and future,
and helps in determining "what"
stocks are good HGS candidates. |
|
| Technical Analysis
concentrates entirely on the stock's price
and volume behavior to determine "when"
to purchase it. So the technicals are essential
in "reading the tea leaves" for
timing the buy and sell points. |
|
| HGS
Investing is the blend of the two analysis
styles and establishes the best candidates for purchase
and for sale. |
|
| Wall Street rewards high EPS stocks |
1) The underlying Fundamental Analysis of the
Growth Investing process is that Wall Street strongly
rewards high earnings per share (EPS) growth and punishes
poor earnings performance. Earnings greater than 100%
per quarter invariably attracts attention. This results
in large price gains of 100 to 400% in a matter of months
and not years. In addition, earningsoptics which focuses
on the earnings momentum growth (velocity and acceleration)
are key to finding strong leaders, which deliver unusually
high, rewards quickly. The HGS Investor focuses on this
aspect of Value Investing to find companies with strong
earnings growth.
It is the earnings per share (EPS) growth rate that
is the Key Driver in determining the stock's price.
Factors surrounding earnings growth rates, both annual
and quarterly, earnings momentum which is the change
in earnings from qtr to qtr, and the earnings acceleration
of that growth all combine to be the key items of focus.
Likewise, relevant news regarding earnings reports,
such as report dates, earnings surprises, analysts'
revisions in estimates, and stock splits all play a
vital part in the Fundamental Analysis.
The Fundamental Analysis will not establish when it
is a good time to buy a stock or when the price movement
is most likely to occur, or where to place stop-loss
orders to avoid catastrophic price drops. Price movements
can occur due to program trading, psychological changes
in mood in the marketplace, and unreasonable fears and
panics due to political, monetary and industrial changes
in the country, or for that matter, in the world. The
intermediate term investor, and more importantly the
short-term trader, needs more help than fundamental
analysis alone. That help comes from the Technical Analysis
of the stock.
2) The underlying Technical Analysis is the
realization that to gain major rewards, one must buy
stocks with strong price momentum and little to no overhead
supply. This often means buying stocks at or near new
highs and has led to the term of "buying high to
go higher", which brings both risk and reward.
The risk is minimized by timing the purchase to the
start of a new upward trend after the stock has based
(moved sideways), coupled with bullish support through
high volume at the breakout to a new high.
| Market Direction... keeping the wind at your
back! |
3) The Market Direction: HGS investors know
when to modulate their approach dependent on whether
the market is very strong or very weak. Therefore, they
must acquire many of the skills that a "Short Term
Technician Trader" has already become unconsciously
competent at, similar to the steps taken in learning
to drive a car. One moves from being consciously incompetent,
to consciously competent to unconsciously competent
with experience over time. In other words, the HGS Investor's
superior performance will only come from being excellent
at "Reading the Tea Leaves" i.e. analyzing
some of the many technical indicators. There is no shirking
that necessity, since the intent is to ride qualified
"hot stocks", but to do so with a very healthy
respect for the associated risk. If one cannot admit
a mistake and quickly take action this type of investing
is probably not for you, and it is best to learn another
discipline. Ideally, one rides a stock for several weeks
to months depending on the strength of the market.
| When a mistake is made, they take fast corrective
action! |
4) Money Management: HGS investors are aggressive
in decision-making and taking action. They pounce in
Bull Markets and Intermediate Bull Runs, and step aside
in Bear Markets and Major Corrections. They recognize
that dawdling is fatal. When the market is weak, they
are quick to take profits off the table and ask questions
later. On the other hand, they have no fear in re-entering
the very stock they just left if they believe they made
a mistake and can take advantage of another "pop"
or "bounce" play. Above all, when a mistake
is made, they take fast corrective action to preserve
capital. Their loyalty is to capital preservation rather
than a company or its stock. These traits are similar
to those of the Momentum Investor.
|
|
strong fundamentals and earnings, as
well as price momentum
|
The key distinction however from Momentum Investing is that
HGS investors believe in a balanced stock, one that has strong
fundamental and earnings credentials as well as price momentum.
In addition, it requires persistence of money flow into the
stock as measured by technical indicators being bullish through
increasing price and surging volume. Timing of the purchase
of the stock is vital so one must choose a candidate that
is properly based and "ripe to pop". We avoid being
unruly dogs chasing fast cars (buying a stock that has climbed
too far, too fast), which meet with the usual expected unfortunate
result. These factors blunt the risk and enhance the reward
by "Buying Right" rather than "Buying High
to go Higher" with momentum alone.
Many individual investors have difficulty in timing the market,
but one does not have to be a soothsayer to be successful.
Rather, one can make judgments as to when to buy or sell a
stock by carefully measuring the extent to which it is extended
from its base support. Similarly, by applying the concept
of Group Strength and Group Speed (momentum), one can establish
when the market is rotating into or out of a group, which
is a sure sign that the stocks in the group are coming into
favor or are about to be trashed.
HGS Investors select the cream of the crop by applying the
80:20 rule to finding the best stocks - those with Earnings
Growth, Relative Strength and Group Strength each ranked at
80 or greater. This is the basic thrust of the ERG factor
concept described in the next chapter. In addition they have
learned to never fall in love with one scenario for the direction
of the Market or their stocks. As such they develop the High,
Middle and Low Road Scenarios and let the Market and their
stocks tell them which direction they are on. They work in
"three's" and use the stoplight technique of red,
yellow and green to establish the odds of reward and risk.
They try to keep the process simple, by focusing on tops-down
approaches rather than grimbling data from the bottom-up.
Like all approaches to investing, it is imperative to have
a process with which one is comfortable. One of the biggest
failings of aspiring investors is that they are continually
chopping and changing their approach, because "the system"
is not working. That is a fatal mistake, especially if the
current market conditions are not conducive to HGS investing.
I balance my investment interests in two types of portfolios
- one for small cap high growth stocks which aims for high
profits and tempers risk with quick action (I refer to these
as Cha-cha-cha); and the other for large cap, blue chip growth
stocks, which are held for intermediate to long-term gains
(I call these Mattress Stuffers). That way, I can participate
in the Market most of the time.
Two Types of Portfolios
Cha-cha-cha Stocks
These are the prototypical High Growth Stock candidates.
These stocks have strong fundamental and technical credentials
and usually small to mid-range capitalization from $50 Million
to $1 Billion. In 1998, stocks like Complete Business Solutions
(CBSL), Information Management Resources (IMRS), Safeskin
Corp (SFSK), and Theragenics Corp (THRX) were a few examples
of the type of stocks in this category. They often make large
moves up very quickly and can make just as dramatic reversals
- hence the slogan "Buy Rockets, Sell Rocks". Due
to this, they are poor long-term hold candidates.
An average return on a HGS during good market conditions
can be 25% in 8 weeks if one buys and sells at the correct
times. Also, they can deliver >100% within a year, provided
the stock is a leader in its Industry Group. However, there
are also several large cap stocks that fit this category due
to their unusually better than 25% growth rate despite their
large size. Typical stocks in this category are Dell Computer
(DELL), Intel Corp (INTC), Microsoft Corp (MSFT), and Cisco
Systems (CSCO).
Mattress Stuffers
These are large cap stocks with solid earnings credentials.
At this stage of growth, established companies no longer have
100% and 200% increases in earnings, but what they do have
is earnings stability - dependable earnings growth of 15%
to 25%, year after year after year. The stock's chart pattern
rises steadily, but not as fast as Cha-cha-cha Stocks. These
slower growth stocks can be held much longer thus earning
the name Mattress Stuffers. Stocks like Gillette (G), Coca
Cola (KO), Nike (NKE), Merck (MRK) Pfizer (PFE), Schering
Plough (SGP), Kellogg (K), Procter and Gamble (PG), Clorox
(CLX), Johnson & Johnson (JNJ) are typical Mattress Stuffers.
Invariably, when one portfolio is not working there is opportunity
in the other and so one can keep engaged in the market for
far longer periods by being aware of such shifts in Market
and Group rotation. Don't fall into the trap of forcing engagement
in small cap breakouts or giving up tried and proven principles
to just have a flutter out of shear boredom of sitting on
the sidelines when the market is weak. Even worse is to flitter
from one approach to another like a butterfly by mixing HGS
investing techniques with value investing, or bottom fishing,
or whatever. So stay focused and be patient. In the final
analysis, it's your temperament that matters most, and one's
investing style should depend on one's own make-up. Even within
High Growth Stock investing, one person's temperament may
lead them to concentrate more on the riskier but higher reward,
Cha-cha-cha stocks, and another may focus on the slower growth,
more stable Mattress Stuffers.
Written by Ian Woodward
|
