Saturday 24 July 2010
How to Invest: Growth vs. Value
When it comes to investing in stocks for capital gains, there are two different approaches that can be taken in order to ensure that your stocks increase their worth: growth investing and value investing. (There are other rationales for investing, such as investing for dividends, but for now let’s stick with growth and value investing.) These two methods represent two different ways of viewing stocks and trying to profit from them. So, what sort of considerations do you have to make when considering which method to use when choosing your investments?
Horse Racing - An Ideal Stock Metaphor
Investing Rationales
Growth Rationale – The growth investor is looking for companies that growing their business (which you probably guessed). These could be small, upstart companies that have a great deal of potential, or large companies that continue to expand into new areas and increase their business at a much faster rate than their rivals. If stock investing were horse racing (a reasonably apt metaphor), growth stocks would be those that are the reigning champions or the quickly rising upstarts. The growth investing model essentially involves trying to find some of the fastest expanding companies, and tethering your fortunes to their growth.
Horse Racing - An Ideal Stock Metaphor
Value Rationale – Value investing, on the other hand, focuses on finding stocks that have been knocked below the true value of their respective companies, then buying and waiting for the broader market to recognize their worth. As with growth investing, these companies can be either large or small, and the reasons they are currently undervalued can be diverse: bad news that took the stock prize below a reasonable level, a run of bad luck that decreased the company’s perceived value, or even a broader economic storm that dragged everything down at once (like we’ve just experienced). To go back to our horse racing metaphor, value stocks would be akin to the strong finisher who’s failed to win the past several races and wound up as the long shot.
Why Does This Matter?
The difference between growth and value might seem academic, and in a way, it is. There are those people who have argued that assigning stocks to the ‘growth’ or ‘value’ columns have nothing to do with the actual value of the companies, but instead such dividers display their own ignorance. (’Those people’ in this case include Warren Buffet, as you can see at the bottom of this linked page, so perhaps they have a point.) On the other hand, when looking at the performance of broad segments of the US economy, it appears that the value investing style has beat out the growth style in the past.
The results, if you are a mutual fund investor (particularly a passive indexer like me), is that your portfolio should attempt to lean more towards value and less towards growth in terms of your funds’ orientation. This does not mean that every value stock will outperform every growth stock; on the contrary, because the faster increase in value of growth stocks is sometimes deserved, the top performers in the growth category can and will outperform the best of the value classification. Rather, it means that taken as a whole, stocks that are categorized as value will outperform those in the growth column over time. Unless you fancy being a stock picker (and make a good job of it, as well), sticking to a portfolio that leans toward value stocks will lead to a much richer future for you and yours.
I hope you enjoyed this rather brief introduction to value and growth stocks, as well as the difference between the two. Good luck with your investing, whichever option you decide to choose.
http://www.theamateurfinancier.com/blog/how-to-invest-growth-vs-value/
http://www.theamateurfinancier.com/blog/how-to-invest-growth-vs-value/
Value Investor versus Speculative Investing
http://www.theintelligentinvestor.net/
While you contemplate a major investment decision, you need to ask yourself if you will be making a value investment or a speculative investment. You can use Benjamin Graham’s extensive writing about the difference between value and speculative investments to categorize potential investments you are considering.
Speculative investors buy a stock with a hunch that the price will go up or down quickly.
Value investors buy a stock after determining the long-term value of the business.
Although value investors outperform speculative investors in the long-run, value investors do not expect to outperform the market. Value investors accept the reality that no one can predict market behavior; instead, value investors work to control their own investment behavior.
So before I make a trade I ask myself how easily I will be able to sleep at night, or as Benjamin Graham puts it, I ask myself if the trade promises “safety of principle and a satisfactory return.”
5-Year Closing Price. Can this be predicted?
Be rational in facing market uncertainties.
Many good quality growth stocks have a price pattern quite similar to the above chart. Many have even rebounded to reach their old highs or new highs.
Three possible futures for the economy in this recession and the consequences for investors.
Three futures…
This article sees three possible futures for the economy in this recession, and discusses the consequences for investors….
Three futures
Posted on March 12, 2009 by Richard Beddard
Filed Under Investing, Markets |
Two out of three ‘aint bad
Filed Under Investing, Markets |
Two out of three ‘aint bad
From the desk of James Montier:
In a research note earlier this month, Mr Montier postulates three futures:
- The optimistic path, in which government stimuli create inflation,
- A Japanese style protracted work out with low growth and low inflation, and a…
- Great Depression modelled on the 1930’s.
He concludes:
In the first two outcomes, value should do well. In the third, holding any equity is likely to be a poor decision. Since I don’t know which of these paths is more likely, I continue to believe that a slow steady deployment of capital into deep value opportunities in the face of market weakness is the most sensible option.
How value investing, buying shares in companies on low price to book (net asset value) ratios, would have worked in Japan:
Investors who bought and held would have earned a 3% annual return versus a market return of -4%. Investors who sold the most expensive stocks short, would have earned a return of 12%.
But in the Great Depression, cheap stops and expensive stocks both lost badly and buying shares was, quite simply, a bad idea.
The difference was the severity of the economic crises. In Japan, growth has been flat. In the 1930’s in the US, industrial production declined by 50% peak to trough.
His strategy, to buy value stocks gradually:
…Represents a regret minimisation approach - I end up with some exposure, and I’m dollar cost averaging down if this turns out to be the Great Depression 2. Alternatively, if the stimulus works, or the US follows the Japanese example, then as Jeremy Grantham says, “If stocks look attractive and you don’t buy them and they run away, you don’t just look like an idiot, you are an idiot.”
Characteristics of Value Stocks
Value investing is finding a good quality stock that you are proud to own for an inexpensive or bargain price.
Besides being potentially profitable, value investing is popular because it’s a hands-on way for investors to be actively involved in their stock selections. It’s literally scavenging the internet or digging through annual reports and news articles trying to find that bargain stock. It’s like trying to find a valuable antique at a garage sale. Many people love doing this!
I call value investing the cookbook approach to investing. Adjust for this, adjust for that, and see what you have. Over time, by using value-investing techniques you probably will become good at understanding financial statements and business concepts. Value investing uses fundamental analysis to determine the value of a company, the financial, operational and market risks involved in the business, and the approximate price one should pay for the stock. Contrary to what many people believe, you do not have to be a math wiz, but you will need a basic understanding of practical math, some knowledge of accounting principles, good reading skills, and a skeptical mind.
Basically, a value stock has a low price to book value and a low price to earnings ratio. In determining whether a stock is inexpensive or not, one needs to analyze the company’s book value, also known as shareholders’ equity. You need to determine what the true net worth of a company is by calculating a tangible book value.
Tangible net worth is the equity of a company’s hard assets. This is the portion a company’s equity that hopefully can be converted into cash somewhat easily. Intangibles, however, are “soft” assets that may not have readily available resale values. Intangibles should be subtracted from book value: examples are goodwill, prepaid expenses, deferred acquisition costs, etc. These assets often have no cash value. Goodwill, for example, “evaporates” as earnings decline. Prepaid expenses, normally, are non-refundable deferred costs that are impossible to convert to cash. If an asset has no cash value, new investors should not bail out the old shareholders by paying for them. The main focus is to be conservative with your money.
Over the years I found that if one doesn’t understand a complicated asset type, it usually has no cash value. Don’t pay for anything you don’t understand.
Also, adjust for what I call economic accounting valuation differences. These are more common sense type accounting adjustments that should be made to get a clearer picture of the true market value of the company.
For example:
- The financial statements of bank stocks in a recessionary period may not fully reflect the severity of a deteriorating loan portfolio. In such situations, try to calculate what you feel is a truer picture of the bank’s loss reserve and subtract the additional amount (net of taxes) from book value.
- If a company has a large unrecorded pension liability, or is using unrealistic future investment return estimates, estimate the projected short fall and reduce book value by that amount.
- Try to give a company credit for undervalued assets. If a company has land that has greatly appreciated in value but is valued on the books at cost, add the unrecorded appreciated value to book value.
- If a company has written off its fixed assets, but market conditions have improved and those same fixed assets have become valuable, then add back the appreciated amount to book value.
When finished, recalculate the per-share book value. If the stock is selling at a substantial discount to its tangible book value, that is one of the signs of a value stock.
Remember, you are looking for economic value, not accounting value; focus on the equity of the hard assets. Historically, soft assets tend to lose their value in a downturn.
True value investors only buy if a stock is trading substantially below its tangible book value. I understand the reasoning, but it’s hard finding these types of situations in all your investments, while maintaining diversification and balance in your portfolio. I just use this as a guide and not as a “must have.” Over the years, I have noticed these types of values in the banking, energy and chemical industries, among others.
Another factor you need to find in a value stock is a low price to earnings (“P/E”) ratio. You are looking for a beaten down stock in an out-of-favor industry. A nice P/E discount is 20% to 50% of the industry average over a few years. You then have the potential to make a nice return on both the natural rotation of the industry to a higher timeliness, as well as the stock regaining market favor. Many investors view cyclical stocks as value stocks. Cyclical stocks are value stocks only if they sell at an earnings discount to their peers and meet the book value criteria as mentioned above. If the company is selling at a discount to its tangible bookvalue, but its earnings have disappeared, it becomes a possible turnaround situation and not a value stock.
In addition to earnings, look for a decent dividend yield, so that you are earning a cash return while you are waiting for the stock to increase in value. This limits your down side because of the yield protection and makes it emotionally easier to hold the stock longer to realize its full return. It’s also a reflection of the company’s intent and ability to return excess profits back to its shareholders.
After your review, if the company still has a low price to tangible book value and low price to earnings ratio, it becomes a serious potential value play.
It’s now essential to analyze the company’s solvency status. Companies need to be able to pay their bills to stay in business. Try to find a company where current assets exceed current liabilities by 1½ to 2 times. The 1st time is used to pay off the company’s current creditors; the 2nd time is the equity needed to replenish the company’s working capital requirements, if supplier financing dries up. It can also be used to pay off the longer term obligations of the firm. It’s hard to find a company with a current ratio of two or more, but under one times means the company has a negative working capital and may need to borrow money to fund the shortfall.
The assets decline in value, but the debts still need to be paid back. Look for a company whose tangible book value exceeds its debt.
Additionally, you need to be ensured that the company has emergency availability under its credit facilities. It’s surprising, however, that credit lines tend to dry up and disappear quickly when a company has a downturn in business. When a company really needs money, it’s often hard to come by and expensive. Lastly, regarding liquidity, analyze the company’s debt maturity schedule to ensure that the company can meet any long-term debt payments that may be coming due. Basically, try to get a comfort level that the company can pay its obligations as they come due and that they are not over leveraged.
Other key statistics are the company’s bank covenant ratios. The covenants normally specify shareholder equity levels that a company must maintain, as well as, among other restrictions, cash flow to interest expense and cash flow to debt ratios that must be met. If a company falls short in its financial covenants, or misses a filing requirement, the banks can, and often do, substantially increase interest rates and fees. The bankers can also call the loan and put the company into bankruptcy. Currently, however, covenants are rarely disclosed and many young adults don’t even know that they exist, or don’t realize their importance to the survival of a company. I hope the accountants will make loan covenant disclosures a mandatory requirement.
It’s critical to pick a company with an excellent management team. Investor conference calls are increasingly popular and are very interesting to listen in on. At the end of the day, however, you need to be cautious. Pleasant looking executives with good communication skills, command over the numbers, and a rehearsed script, does not necessarily equate to managers who can grow a company and increase its stock price. Nonetheless, this is a very good starting point in understanding a company and its management.
Message boards are informative, but often participants have hidden motives, or grudges against management, that might make their comments suspect. They should be read skeptically.
CEO's personal lives can also affect investment returns. Studies in Denmark linked "CEO family deaths to companies' profitability over a decade. In two years after the death of an CEO's child or spouse the profitability of their companies slipped 15% to 20%." - wsj 9/5/07
CEO's personal lives can also affect investment returns. Studies in Denmark linked "CEO family deaths to companies' profitability over a decade. In two years after the death of an CEO's child or spouse the profitability of their companies slipped 15% to 20%." - wsj 9/5/07
It’s also important to see some sort of upward trend in revenues and earnings growth.Value Line Investment Survey is found in most libraries and does a nice job showing long-term company trends. No one likes a company that constantly does worse than the year before, no matter what the value is! Every company needs some sort of “curb appeal” for you to profit from your investment. At some point, you need to sell in order to make money from your investment. Upward trends help on the resale side of your investment.
Many investors find it hard to distinguish between “cheap” stocks and value stocks. Most times, stocks are low because they deserve to be low. There is nothing wrong with buying a “cheap” stock as long as you know and understand the risks. There are many stocks out there that have large annual losses, high debt levels and no equity. That does not necessarily mean you can’t make money on them, but you should call it gambling rather than investing.
Last, but most important, take a step back from the numbers. Look at the big picture. How does the company fit into the economy; and is there a need for the company’s products or services. Look at the company’s business model (found in the company’s SEC form 10k) and determine if it coincides with your thinking, your goals and your investment objectives.
Value Investing is a time tested investment strategy that works in most market environments.
Nouriel Roubini 2009 - Stock Market Calls
Back Peddling Bears
There is a reason bears such as Nouriel Roubini, David Rosenberg, and now Doug Kass are offering a more tame outlook. The data doesn’t support an all-out economic collapse.
For the record, we are not bulls. We see a lot of major problems in the global economy. However, we see a much more mixed picture than the apocalyptic bears who seem to have blinders on when it comes to anything disproving their case.
A recovery starts slowly. First companies cut costs. Then they spend. Then they hire. Then the economy heals. Seems like the first two phases are taking root.
Do you think the economy is about to fall off the cliff? Do you think we are amidst a textbook recovery? Is it more complicated than that? Let us know in the comments below …
Dollar-cost averaging: The bear market solution investment strategy
With the stock market down 52% from its recent peak in October 2007, maintaining dollar-cost-averaging through the bear market proved to be worthwhile. By buying more shares at lower prices throughout the equity market downturn, an investor was able to reap bigger gains when the market recovered."
https://news.fidelity.com/news/article.jhtml?guid=/FidelityNewsPage/pages/mare-dollar-cost-averaging&topic=investing-stocks
https://news.fidelity.com/news/article.jhtml?guid=/FidelityNewsPage/pages/mare-dollar-cost-averaging&topic=investing-stocks
Friday 23 July 2010
Yen Carry Trade
Traders have been shorting the Yen and using the funds to purchase stocks,
http://www.marketoracle.co.uk/Article11784.html
Volatility Play Investing
Volatility Play Investing
A method of trading stocks that myself and my team have developed. It involves buying and selling the same stocks, again and again, as they undergo repetitive fluctuation in price.
Short-Selling
Short-Selling
Short selling is the strategy of selling the shares first, then having the commitment to buy them back at a later date.
Sell Urgently when the Fundamentals Deteriorated
Averaging Down
Buying more shares of a stock you already own, and getting the new shares at a lower price because the stock has been dropping.
Averaging Down is not advisable in this situation.
Remember:
Transmile, Nam Fatt, Kenmark, Carotec
Country GDP as US States
Fascinating stuff: Carl Størmer points us to this amazing map of the United States. Each state's economic output is analogized to another country's GDP.
click for larger chart:
Notable omissions: U.K., Japan, Germany, China,
Russia
, Italy.
Russia
, Italy.
I cannot vouch for the precision of this, but by eyeball, it looks about right.
http://bigpicture.typepad.com/comments/2007/01/countries_gdp_a.html
Subscribe to:
Posts (Atom)