Subject: Strategy - Survey of Stock Investment Strategies
Last-Revised: 20 Jan 2000
Contributed-By: John Price (johnp at sherlockinvesting.com)
This article offers a brief survey of several strategies that investors use to guide their stock purchases and sales.
Before we start the survey, here's a golden rule of investing: Know why you are buying a particular stock -- donít wait until its price goes up or down to think about it. Many investors are not sure why they bought a stock in the first place, so when a dramatic fall in price happens, they're not sure what to do next.
Here's an example. Let's say you bought Intel. When you know why you bought Intel you will have a stronger basis for knowing what to do when its price goes up, or down, or even stays the same. So if Intel starts to go down in price and you bought it as a momentum play, then you will probably want to sell as quickly as possible. But if you bought it as an undervalued stock, and if the fundamentals have not changed, then you might want to buy more."
Of course, every investor and every stock presents a different reason for contacting your broker. But we have to start somewhere, so here is my analysis of the six main investment styles.
- Brother-in-law investor
- Technical investor
Moving averages, candlestick patterns, Gann charts and resistance
levels are the sort of things the technical investor deals
with. Technical investors were once called chartists because their
central activity was making and studying charts of stock
prices. Nowadays this is usually done on a computer where advanced
mathematics combines with grunt power to unlock past patterns and
correlations. The hope is that they will carry into the future.
- Economist investor
This type of investor bases his decisions on forecasts of economic
parameters. A typical statement is "The dollar will strengthen over
the next six months, unemployment will decrease, interest rates will
climb -- a great time to get into bank stocks." Random walk investor
This is the area of the academic investor and is part of what is
called Modern Portfolio Theory. "I have no idea whether stock XYZ will
go up or down, but it has a high beta. Since I donít mind the risk,
Iíll buy it since I will, on the average, be compensated for this
risk." At the core of this strategy is the Efficient Market Hypothesis
EMH. There are a number of versions of it but they all end up at the
same point: the current price of a stock is what you should buy, or
sell, it for. This is the fair price and no amount of analysis will
enable you to do any better, says the EMH. With the Efficient Market
Hypothesis, stock prices are assumed to follow paths that can be
described by tosses of a coin.
- Scuttlebutt investor
This approach to investing was pioneered by Philip Fisher and consists
of piecing together information on companies obtained informally
through wide-ranging conversations, interviews, press-reports and,
simply, gossip. In his book Common Stocks and Uncommon Profits, Fisher
Go to five companies in an industry, ask each of them intelligent questions about the points of strength and weakness of the other four, and nine times out of ten a surprisingly detailed and accurate picture of all five will emerge.Fisher also suggests that useful information can be obtained from vendors, customers, research scientists and executives of trade associations.
- Value Investor
In the fourth edition of the investment classic _Security Analysis_,
the authors Benjamin Graham, David Dodd, and Sydney Cottle speak of the
"attempts to value a stock independently of its current market price".
This independent value has many names such as `intrinsic value,í
`investment value,í `reasonable value,í `fair value,í and `appraised
value.í They go on to say:
A general definition of intrinsic value would be "that value which is justified by the facts, e.g., assets, earnings, dividends, [and] definite prospects, including the factor of management." The primary objective in using the adjective "intrinsic" is to emphasize the distinction between value and current market price, but not to invest this "value" with an aura of permanence.Value investing is the name given to the method of deciding on individual investments on the basis of their intrinsic value as contrasted with their market price.
This, however, is not the standard definition. Most authors refer to value investing as the process of searching for stocks with attributes such as a low ratio of price to book value or a low price-earnings ratio. In contrast, stocks with high price to book value or a high price-earnings ratio are called growth stocks. Investors searching for stocks from within this universe of stocks are called growth investors. These two approaches are usually seen to be in opposition.
Not so, declared Warren Buffett. In the 1992 Annual Report of Berkshire Hathaway he wrote, "the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive."
- Conscious Investor
- This type of investor overlaps the six types just mentioned. Increasingly investors are respecting their own beliefs and values when making investment decisions. For many, quarterly earnings are no longer enough. For example, so many people are investing in socially responsible mutual funds that the total investment is now over one trillion dollars. Many others are following their own paths to clarify their investment values and act on them. The process of bringing as much honesty as possible into investment decisions we call conscious investing.
Most people invest for different reasons at different times. Also they donít fall neatly into a single category. In 1969 Buffett described himself as 85 percent Benjamin Graham [Value] and 15 percent Fisher [Scuttlebutt].
Whatever approach, or approaches, you take, the most important thing is know why you bought a particular stock. If you bought a stock on the recommendation of your neighbor, be happy about it and recognize that this is why you bought it. Then you will be more likely to avoid the "investor imperative," namely the following behavior: If your stock rises, claim it as your ability; if it falls, pass on the blame.
Do all that you can to avoid going down this path. Write down why you bought a stock. Tell your spouse your reasons. Tape them on your bathroom mirror. Above all, if you want to be a successful investor, donít kid yourself.
For more insights from John Price, visit his site:
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