The Four Investment Approaches
What are the four Investment Approaches?
Investing anywhere in the marketplace these days is a difficult challenge. People invest in mutual funds, equities, bonds, options or property. This article focuses exclusively on equity investing strategies. Equities impact an investors ability to profitably invest in other investment areas. For that reason, consider these four fundamental approaches.
The Four Strategies
The four personal approaches that lead to decisive investment focus are growth, quality, sentiment, and value:
Growth is investing in accelerating earnings-per-share growth (EPS), relative growth, growth momentum, rising expectations and enterprise sales growth.
Quality is investing in turnover speed, industry leadership, return on investment (ROI), and strong operating margins.
Sentiment is investing in consensus, high price-earnings multiples (PE), insider buying data, institutional ownership and lesser-known stocks.
Value is investing in contrarian opportunities, favorable values, EPS to growth (PEG), income stocks, and relative value.
Before deciding on an investment approach, know that one approach must predominate. The reasons are legion. Using all four at once may diffuse and dilute earnings. The separate strategies have different holding patterns, time horizons, and fit differing investment objectives. Finally, profitable investment requires a focus. Focus on the approach that fits with goals, style, and level of risk comfort.
It is possible to combine elements in a central strategy from the other three strategies. For instance, a value investor should consider sentiment because analyst's expectations can change equity values. Likewise, a growth investor concentrating on momentum and ignoring quality may run into trouble by not considering return-on-investment. Find, Analyze, Buy, and Sell
The strategies assume a more than a passing knowledge of the financial markets, financial ratios, and accounting. Once an approach is adopted, there is more work to do.
All equity investors need to;
- Find stocks
- Analyze Stocks
- Buy Stocks
- Sell Stocks
First, when finding stocks, it is a mistake to fall in love. Stocks and love do not mix. Find stocks that are performers. If they top-out or have stopped performing, then sell them. When choosing stock candidates, base choices on good data and good business reasons not hearsay, broker advice, or emotion. One way to do this is to use a good stock screen. The primary function of screening is to boil down stock choices to a select few based on preferences. Many screens filter the market based on pre-set parameters. Some screening tools are better than others. For instance, a value-oriented screen may filter 9,000 stocks down to only 23 stocks that fit certain criteria. Search the Internet for stock screens, there are several to select from.
The following are some places to get started with stock screening;
- Bloomberg, http://www.bloomberg.com/analysis/monitor/,
- Morningstar, http://screen.morningstar.com/StockSelector.html?tsection=toolsssel,
- Reuters, http://www.investor.reuters.com/ArticleEntry.aspx?target=%2fopinion, Yahoo, http://screen.yahoo.com/stocks.html,
- MSN, http://moneycentral.msn.com/investor/finder/predefstocks.aspx,
- Marketwatch, http://www.marketwatch.com/tools/stockresearch/screener/default.asp?siteid=mktw&dist=10rt&.
Many on-line brokers provide relevant information, analysis, and screening. Suggested on-line brokers are;
- ScotTrade, http://www.scottrade.com/index.asp?supbid=27452
- AmeriTrade, http://www.tdameritrade.com/welcome1.html
- ChoiceTrade, http://www.choicetrade.com/
- TradeKing, https://www.tradeking.com/
- TD Waterhouse, http://www.tdameritrade.com/welcome1.html
- ThinkOrSwim, http://www.thinkorswim.com/tos/client/index.jsp
Secondly, properly analyze stocks. Determine values, earnings, and discover the market expectations for stocks. Compare the stocks to other stocks; resolve financial positions for safety, margin, and cash flow.
Consider earnings estimates reports, valuation tables and ratio comparison reports, earnings estimates reports, performance reports and trends in financial statements. Throughout the preliminary investigation, maintain the major investment strategy. Thirdly, purchase the stocks that meet analysis criteria. The relevant questions to ask are; - does it fit a strategy of growth, quality, sentiment, or value? Does it meet long-term and short-term goals? Are principles of diversification used? Are there any negatives to consider?
Lastly, sell the stock. Sell it when it meets the criteria for being sold. Avoid riding out winners and dumping losers. Develop a set of parameters under which a stock must be traded. Has the stock met return objectives? How much does it have to lose to cut losses? This analysis is similar to the analysis for buying stocks.
For example, an investor may sell all stocks that have appreciated by 20%, sell all stocks that have depreciated by 8%, and hold all stocks that meet criteria for future growth or quality. If such a strategy is exercised, the investor never loses more than 8%, gains are 20%, and holds are to be determined. No love lost, trade it and start over again at step one. Buy a new one, do the homework, and score a winner.
Bear Market, ain't no Sunhine ...
For those who can do sums without counting their fingers, or their toes for that matter, the current interest rates, energy prices, and employment numbers sing the same old song. Itâ€™s sung to the tune of the old Bill Withers; â€œAinâ€™t no Sunshine when sheâ€™s goneâ€� and â€œsheâ€™s always gone too long anytime she goes awayâ€�. Of course, â€œisnâ€™t any sunshineâ€� would be proper English but we arenâ€™t quibbling about sentence structure as much as the financial structure of the market.
The term to back and fill comes to us from sailing ships, where it signifies alternately backing and filling the sails, a method used when the wind is running up against a ship in a narrow channel. The sail is hauled back against the wind and braced so that the tide or current carries the ship forward against the wind. The same term applies now to the market. For a brief moment the market rallied at the end of March as major mutual funds and investment houses put in a last ditch effort to make the first quarter look good. Then the market was backing and filling against a wind of fundamentals that donâ€™t look as promising as the rally.
The aforementioned fundamentals we are talking about, among other things, are the up-ticks of interest rates. The measured approach of the Fed is finally altering the market. The Federal Funds rate now sits at 2.75% up from 2.5%. The Prime rate followed suit and is now 5.75%, up from 5.5%. So are mortgage rates up? Yes, 5.12% and 5.52% for the 15 and 30 year respectively, up 4.25% and 3.18%. The 30 year T-Bonds were down 0.12% at 4.73% on April 4th. See http://www.bloomberg.com/markets/rates/
for current news.Oil, Interest Rates and Jobs
Oil, too, has come a long way baby. Goldman Sachsâ€™ bank recently envisions oil going up to $105 a barrel, (http://www.rte.ie/business/2005/0331/oil.html
)! While this prediction may sound unbelievable there are murmurings out there about shortages and production short-comings. Oil was trading up to $58 a barrel on Monday. It was $51 a barrel back in February when I was predicting $60 a barrel and it appears I may have been too conservative. According to John S. Herold Inc., http://www.herold.com/research/disp_weekly.home
, things donâ€™t look rosy for reserve replacement coupled with an increased demand of two million barrels a day.
The Fed chairman has this to say about oil reserves; "Markets for oil and natural gas have been subject to a degree of strain over the past year not experienced for a generation," Greenspan reported to the National Petrochemical and Refiners Association Conference in San Antonio Texas. "Increased demand and lagging additions to productive capacity have combined to absorb a significant amount of the slack in energy markets that was essential in containing energy prices between 1985 and 2000." (See the Dan Ackman article in Forbes, http://www.forbes.com/home/energy/2005/04/06/cx_da_0406topnews.html
Only 110,000 jobs were added to the economy in March. (See http://www.washingtonpost.com/wp-dyn/articles/A20166-2005Apr1.html
). The seers were expecting 231,000 jobs. It appears the soothsayers arenâ€™t any better than Nostradamus and may be a little more obscure at hitting their targets. Many pundits consider that over 200,000 new jobs are needed in order to grow the economy. The story is bad enough, but when you consider that the jobs created were largely bar, restaurant and health-care jobs you realize that wages in those sectors donâ€™t add much to the consumption capacity in the economy. Consider also that while 110,000 jobs, of a kind, were added we also lost 8,000 much needed manufacturing jobs in March.What to do until the sun comes out again
So for normal folk, and I suspect those not so normal, we can expect higher prices in interest rates, gas prices and in general prices on goods and services. For businesses trying to make ends meet, do they ever, it means that the cost of doing business will be higher making it more difficult to add personnel or consider expansion. Whatâ€™s in store? Well, there are higher prices in the store. A little inflation may follow and Iâ€™m not even going to get into the deficit or the savings rate.
What should you do with your investments? There are many reactions out there. You can pick from complete withdrawal and take everything out of the market, put it in Certificates of Deposit to wait for the sun to shine once again on the market. In the other extreme, you can take the approach that this is the time to buy cheap stocks which will eventually, read hopefully, appreciate in value. (The latter choice may be a poor one making an allowance for the position that stocks are considered to be over-valued at the present time). Then, there is a vast middle-ground where you can look for value, buy gold or invest in energy stocks and funds.
Be careful if you go totally into the energy sector. It will do well into the coming months but, historically, it will drop off just as dramatically and possibly unexpectedly. Be careful out there and remember that itâ€™s always darkest just before it goes totally pitch black, especially when it comes to oil. The sun will shine again one great day.