Introduction:
Investing, like many things, should have a general philosophy about how to do things to avoid careless mistakes. How about making a soufflé without a recipe? Without sheet music, would you play the cello in the London Philharmonic Orchestra? Aim for the discs on the shuffleboard without deciding whether you’re trying to hit your suit or your opponent’s suit I hope not.
Investing isn’t as difficult as these other challenges (especially soufflé), but it does require thoughtful planning before investing your hard-earned savings.
Fundamental Analysis — Buying a Company (Value, Growth, Income, GARP, Quality)
Many people rightly believe that buying a stock is buying a proportionate stake in a company. Therefore, to know the value of the stock, we must determine the value of the company.
Investors usually do this by assessing the company’s financial condition on a per-share basis and calculating the value of the company’s proportionate shares. This is what’s called “fundamental” analysis, and most people who use it consider it the only way to reasonably analyze stocks.
Analyzing a company may seem like a simple task, but there are many different types of fundamental analysis. Investors often create contrasts or subcategories to better understand a particular investment philosophy.
Ultimately, most investors end up with an approach that combines several different approaches. Many of the differences are academic inventions rather than actual practical differences.
For example, value and growth are codified by economists who study the stock market, but market experts do not find these designations useful.
The explanations below focus on what most investors mean when they use these terms, but always be careful to check what those who use them actually mean.
Value. A cynic is, as the saying goes, someone who knows the value of everything and nothing. However, an investor’s goal is to know both the price and value of a company’s stock. A value investor’s goal is to buy a company at a significant discount to its intrinsic value (what it would be worth if sold tomorrow).
In some sense, all investors are “value” investors. They want to buy stock worth more than what they paid for. People who call themselves value investors usually look at the liquidation value of a company, or what it would be worth if all of its assets were sold tomorrow.
However, value can be a very confusing label, as the idea of intrinsic value is not specifically limited to the concept of liquidation value. Beginners should understand that while most value investors believe in certain things, not everyone who uses the word “value” means the same thing.
The man who laid the foundation for modern value investing was Benjamin Graham, whose 1934 book Security Analysis (with David Dodd) is still widely read today.
Other investors include value-oriented investors such as Sir John Templeton and Michael Price.
These value investors usually have very strict and hard-and-fast rules on how to buy shares in companies. These rules are usually based on the relationship between the company’s current market price and certain business fundamentals. Some examples are:
- Price to earnings ratio (P/E) below a certain absolute limit
- Dividend yield above a certain absolute limit
- Book value per share at a constant level relative to stock price
- At constant level total sales in the company market cap or
market cap
Growth. Growth investment is the idea of buying stocks of companies with excellent sales and profit growth potential. Growth investors tend to focus on company value as an ongoing concern. Many people plan to hold these stocks for the long term, but this is not always the case. At some point, “growth” becomes a dysfunctional label just like “value”. Because few people want to buy a company that is not growing.
The concept of growth investing took shape in the 1940s and 1950s through the work of T. Rowe Price, who founded the mutual fund company of the same name, and Phil Fisher, who wrote Common Stocks, one of the most important investment books of all time. it was done. and extraordinary profits.
Growth investors look at a company’s underlying quality and growth rate to analyze whether they should buy it. Growth investors excited about new companies, new industries, and new markets typically buy companies they believe have the ability to grow sales, earnings, and other key business metrics by a minimal amount each year. To do. Growth is often argued against value, but in practice the line between the two approaches can sometimes blur.
income.
Today, common stocks are widely bought by people who expect the stock to appreciate in value, but there are still many who buy stocks primarily for the dividend stream they generate. Called these individuals, they often forego stock holdings that could increase the capital value of high-yield, dividend-paying companies in slow-growing industries.
These investors focus on companies that pay large dividends, such as utilities and real estate investment trusts (REITs), but are also likely to see companies facing significant business problems or stock prices that have fallen significantly. Because of this, they often invest in companies with very high dividend yields teeth.
Garp. In addition to being the name of the title character in John Irving’s The Post-Garp World, GARP is an acronym for Growth at a Reasonable Price. According to GARP investors, the world is combining value and growth approaches and adding numerical bias.
Practitioners look for companies with solid growth prospects and current stock prices that don’t reflect the company’s intrinsic value, and look for earnings growth and the price/earnings ratio (P/E) at which those earnings are valued. create a game. will also rise. Peter Lynch, best known for his starring role in the Fidelity Investments commercial starring Lily Tomlin and Don Rickles, is the most famous practitioner of GARP.
One of his most common GARP approaches is to buy stocks if the PER is lower than his future earnings per share growth. As a company’s earnings per share increases, the company’s P/E ratio decreases if the stock price remains constant.
Fast-growing companies can typically maintain high P/E ratios, so GARP investors buy companies that will be cheap tomorrow if growth happens as expected. However, if growth doesn’t materialize, the bargain GARP investors perceive could quickly disappear.
GARP offers so many opportunities to focus solely on the numbers, rather than looking at the business, that many, such as the almost ubiquitous PEG ratio or the study of Jim O’Shaughnessy, who works on Wall Street.
His GARP approach is a hybrid of fundamentals and fundamentals. Analysis and another type of analysis — quantitative analysis.
Quality. Most investors today use a combination of value, growth and GARP approaches. These investors are looking for quality companies that can be sold at a “reasonable” price.
There are no hard and fast rules about what numerical relationship should exist between stock prices and business fundamentals, but it is important to look at a company’s valuation and the company’s inherent qualities, which are quantitatively measured by concepts such as returns. We share a similar philosophy.
Evaluate ROE and qualitatively through management competence. Many of them call themselves value investors, even though they focus more on company value as an ongoing concern than liquidation value.
Berkshire Hathaway’s Warren Buffett is perhaps the most famous practitioner of this approach.
He studied under Benjamin Graham at Columbia Business School, but was eventually guided by partner Charlie Munger, who also listened to Phil Fisher’s message on growth and quality.
Rebuttal to Fundamental Analysis. A person who does not use fundamental analysis has two main reasons he opposes it. The first is that they believe that this kind of investment cannot provide real returns because it is based on the exact kind of information that all major participants in the listed market already know. If you can’t do all this basic work that your business understands, don’t bother.
Second, much of the basic information is “vague” or “vague.” That is, it is often up to the viewer to interpret its meaning. Talented people can be successful, but this group argues that the average person can be better served by ignoring this type of information.
Buy the Numbers. A pure quant analyst looks at numbers and gives little consideration to the underlying business. The more we talk about numbers, the more likely we are to use a purely quantitative approach.
Fundamental analysis also requires some numerical input, but the primary concern is always the underlying business, with a focus on management expertise, competitive landscape, market potential for new products, etc. Quantitative analysts view these things as subjective judgments and instead focus on objective data that is analyzable and undeniable.
Benjamin Graham, one of his key brains behind fundamental analysis, was also his one of the original proponents of the trend. While leading the Graham-Newman partnership, Graham told analysts never to talk to management when analyzing a company, and focus only on numbers because management can always be misleading. warned to do so.
In recent years, when computers are used for much of the calculations, many so-called “quants” have become completely native and buy and sell businesses only on a purely quantitative basis.
Actual business or current valuation — a radical departure from fundamental analysis. “Quants” are often mixed with ideas such as the relative strength of a stock, a measure of how well that stock is performing compared to the broader market.
Many investors believe that they can always find a profitable investment if they find the right numbers.
D.E. Shaw is widely regarded as the current king of quants, using sophisticated mathematical algorithms to find the smallest price gaps in the market. His partnership also accounts for his 50% of his daily trading volume on the New York Stock Exchange.
Company size. Some investors deliberately focus on companies of a certain size, either by market capitalization or earnings. The most common way to do this is to categorize companies by market capitalization and call them micro-cap, small-cap, mid-cap, and large-cap. “Cap” is an abbreviation for “capitalization”.
Companies of different sizes have achieved different returns over time, with smaller companies earning more. Some believe that revenue is a much better way to divide the corporate universe, as company market capitalization is as much a factor in market enthusiasm as company size. There is no one set of breakdowns that all investors use, but most of the distinctions are as follows:
- MICRO — $100 million or less
- SMALL — $100 million to $500 million
- MID — $500 million to $5 billion
- LARGE — $5 billion or more
Most publicly traded companies fall into the micro or small category. Some statisticians believe that the perceived superior performance of these smaller firms has more to do with their tendency to “survive” than their actual superiority.
This is because until recently, many of the databases used for these performance tests regularly wiped out companies that had gone bankrupt. Smaller companies have higher bankruptcy rates, so eliminating this factor allows you to “draw out” past earnings. However, this factor is still debated.
Screen based investment. Many quantitative analysts use “screening” to select investments. That is, we use a set of quantitative criteria and look only at companies that meet those criteria.
As computers have become more widely used, this approach has grown in popularity due to its ease of use. Screens allow you to look at different factors about a company’s operations and stocks over different time periods.
Some investors use screens to generate ideas and apply fundamental analysis to evaluate specific ideas, but they see the screen as a “mechanical model” and only focus on what they see on the screen. Some investors buy and sell based on These investors claim that using a screen takes emotion out of the investment process.
(Those who do not use screens will argue that using screens mechanically removes most intelligence from the process.) One of the proponents of using screens as a starting point is Eric Ryback, One of the screen’s most famous supporters.
Mechanical. James O’Shaughnessy. One of his most popular screens is the Dow Dividend Approach, also known as Dogs of the Dow and Beating the Dow. For more information on screening.
Momentum. Momentum investors look for companies that are not only performing well, but are flying nosebleed-high. “Good” is defined in relation to investor expectations or in relation to all publicly traded companies as a whole.
Momentum companies routinely beat analyst estimates in earnings or earnings per share, or outperformed quarterly and yearly relative to all other companies, especially if growth accelerated quarterly revenue and revenue growth are often high.
Such growth is considered a sign that the company is doing very well. High relative strength is often included in the momentum screening category, as these investors are looking to buy stocks that have outperformed all other stocks over the past few months.
Kanslime. CANSLIM is a hybrid of quantitative and technical analysis developed by William J. O’Neil and detailed in his book How to Make Money in Stocks.
The ‘C’ and ‘A’ in the CANSLIM formula tells investors to look for companies with growing current and annual earnings, according to Investor’s Business Daily, according to O’Neil newspaper. “N” stands for New, like new products, new markets, or new management.
“S” stands for small capital and high demand. “L” tells investors to find out if the company is a leader or a laggard. ‘I’ allows you to look for institutional sponsorships, while ‘M’ focuses on market direction.
O’Neil originally developed Investor’s Business Daily as a tool that investors could use to practice his CANSLIM, but it has grown to become a very widely used business publication for all types of investors. bottom. CANSLIM also includes a component for technical analysis, which is the next type of analysis.
Objections to quantitative analysis. Because quantitative analysis relies on screens that are available to everyone, as computing power becomes increasingly cheap, many of the price inefficiencies that quantitative analysis discovers are wiped out as soon as they are discovered.
If a particular screen generates a 40% annual return, becomes widely known, and a lot of money pours into the company that screen identifies, the returns get worse.
Fundamental analysis is vague, but it can be very helpful to know a little bit about the company you’re looking to buy.
For example, if you’re using a high-relative powerful screen, you should always check to see if the company you find has increased in price as a result of a merger or acquisition. In that case, the price is likely to stay that way even though the “screen” used to select that company had a history of high annual returns.
Purchase:
All information about listed companies is efficiently distributed and I truly believe that no one can gain an advantage over others by understanding the business or by analyzing the charts. If so, what do you do? Numbers? You might consider simply giving up on trying to beat the market returns by buying index funds. I’ve tried to create different tools that can let you know what you’re thinking. Extreme price volatility.
Investors who look to this kind of psychological information call themselves technical analysts and believe charts can sometimes provide insight into the psychology surrounding stocks. While there are many pure chartists, some investors use charts to time their investments after considering them from a fundamental or quantitative perspective.
Technical analysis does not have a clearly defined set of approaches, but there are many different tools. The most important indicators seem to be certain chart patterns that show certain price movements when trading volume is at certain levels. The most common types of charts include scatterplots and numerical charts, logarithmic charts, Japanese candlesticks, and more.
Discussion against technical analysis. Technical analysis assumes that certain chart patterns at key points can indicate market sentiment for individual stocks or for the market as a whole. But most of the statistical work done by scientists to determine whether chart patterns are in fact predictive, as detailed in Burton’s Malkiel’s A Random Walk Down Wall Street, was inconclusive at best.
Much of our reliance on technical analysis relies on anecdotal experience rather than long-term statistical evidence. This is in contrast to certain quantitative and rudimentary methods that often prove to be fairly predictive. Critics of technical analysis say that technical analysis is basically as useful as reading tea leaves.
Trading — Doing What Works:
As trading fees come down and more people have access to instant data on stock prices, trading will become more popular and will likely become more popular, just like Madonna and Beanie. It’s too popular. — baby.
Traders typically use a hodgepodge of fundamentals, quants, and technical techniques with short-term bias. Trading is usually a very taxing experience trying to score a few percentage points on every trade. Although trading is widespread, it is far from a codified philosophical body of knowledge that can be easily explained in a few paragraphs.
Many novice investors settle for profits that can be made in seemingly simple casino-like trading before realizing that there are often thousands of other traders looking for the same thing, tend to lose a lot of money.
The fastest, most experienced, best geared, making money — usually not people just starting out. All traders emphasize that successful trading requires meticulous care, discipline, and a lot of work.
Arguments Against Trade. Trading is clearly a time-consuming adventure. There are many very famous and successful traders out there, but many ignore the fact that these traders are well prepared and have to trade all day long.
Given the amount of time and effort most successful traders invest in trading, the chances of an amateur getting the same reward with less effort and resources are very slim. By competing, one is more likely to succeed in finding a company that can be owned for the long term with a minimal investment of time and will not engage in a high-octane, little game behavior like.
Summary and Next Steps:
At this point, you can probably cycle back and forth through all the elements of an alphabet soup investing approach like GARP or CANSLIM. They also get a general feel for their investment philosophy without fancy acronyms. We’ve laid out the basics of a fundamental, quantitative, and technical approach to stock selection.
As with most investors, you can find a few items that suit your investment style. During the course of your training, you will develop a unique investment philosophy that is precisely tailored to your needs and goals. If you’re looking to put your newfound philosophy into practice, join us for Step 7. Choose a broker that covers the basics to find the best broker to implement your investment idea. See you later.
The Fool’s Glossary:
Book value. The present value of assets on a company’s balance sheet according to accounting rules. A company’s balance sheet equity is the book value of the entire company. When investors refer to book value, they often mean book value per share. It is a shareholder’s equity (or book value) divided by the number of shares outstanding. This book value figure is sometimes used as a rough indication of whether a stock is undervalued because the book value is theoretically the amount at which the company can be sold (liquidation value).
Capital appreciation. Capital appreciation is one of the two components of total return and measures how much the underlying value of a security has increased. If you buy a stock at $10 and it rises to $13, you’ll make a 30% return on your initial invested capital. Dividend yield is another component of total return.
Dividend Yield. The ratio of a company’s annual cash dividend divided by its current share price, expressed as a percentage. To get the expected annual cash dividend, take the next expected quarterly dividend payment and multiply it by 4.
For example, if a $10 stock is expected to pay a quarterly dividend of 25 cents next quarter, simply multiply 25 cents by 4 to get to $1 and divide by $10 for a dividend yield of 10%. Become.
- Dividend Yield = Ann. Div.
- Price = $0.25 * 4
- $10 = 0.10 = 10%
Many newspapers and online listing services include dividend yield as one of the variables. If you’re not sure whether the dividend yield currently listed reflects the company’s recent dividend increase, you can call the company and ask what his expected dividend per share is next quarter.
Earnings per share (EPS). Revenue, also known as net profit or net income, is the money left over after a business pays all its bills.
For many investors, earnings are the most important factor when analyzing a company. Earnings per share (EPS) is used by those looking at earnings to allow apples-to-apples comparisons.
Calculate earnings per share by dividing the company’s reported earnings in the last 12 months by the number of shares currently outstanding. XYZ Corp. has 1 million shares outstanding in the last 12 months, made $1 million, and EPS is his $1.00.
- $1,000,000
- 1,000,000 shares = $1.00 in earnings per share (EPS)
market cap. Current market value of all outstanding shares of the company. To calculate market value, multiply the number of shares outstanding by the current price of each share. Information on outstanding shares can be found in the company’s most recent quarterly report or online course service.
For example, if a company has 10 million shares outstanding and trades at $13 per share, its market capitalization is $130 million.
Market cap. = Shares Outstanding * Stock Price = 10 Million * $13 = $130 Million
Price Earnings Ratio (P/E). Earnings per share means nothing. To get an idea of how high or low a stock is, we need to look at these gains relative to the stock. For this purpose, most investors use the price/earnings ratio (P/E).
PER divides the stock price by the last four quarters of earnings. For company XYZ, if it’s currently trading at $15 per share and $1.00 earnings per share (EPS), that would be a PER of 15.
- $15 share price
- $1.00 in trailing EPS = 15 P/E
A real estate investment trust (REIT). A REIT is a special form of stock that allows an investor to own a portion of a real estate group, but many investors see his REIT as an alternative to bonds. Over the past decade he has seen the popularity of REITs grow.
REITs have been granted special tax status by the Internal Revenue Service, pay out at least 95% of their profits to shareholders in the form of dividends, and often offer healthy dividend yields on par with bonds. Even better, as the REIT acquires more properties and increases the value of the properties they own, so does the value of their stock, delivering superior total returns.
Relative intensity. Relative strength, also known as relative price strength, measures a stock’s performance relative to overall market performance over a period of time.
A rating system gives a numerical grade to a stock’s performance over a specified period of time, usually the last 12 months. This is the same thing Mr. Spicer scribbled in bright red ink on his algebra quiz. Therefore, relative strength is an indicator of momentum.
The most common form of relative strength rating is the 1 to 99 rating published in the Investor’s Business Daily. For example, a relative strength of 95 indicates a great stock, outperforming 95% of all other US stocks over the past year.
However, since relative strength is nothing more than a mathematical relationship between stock performance and index performance, many others have developed their own relative strength measures.
Earnings. Revenue, also called turnover, represents how much a company sold in a given period of time. Annual sales are sales for a specific year, and quarterly sales are sales for a specific quarter.
Sale. Revenue, also called sales, is literally the amount of money a company has sold in a given period of time. Annual sales are sales for a specific year, and quarterly sales are sales for a specific quarter.
Utility. A company that provides one for nearly every essential service is called a utility company. These companies are almost always regulated in some way by the government and usually have monopoly positions in certain geographies. Electric power companies, natural gas companies, and local telephone companies are often referred to as utility companies.
Volume. The number of shares traded in a day is called volume. Many investors look at volume over a month or year to determine their average daily volume. A market watcher will say that a firm is trading a certain number of his average daily trading volume.
This allows investors to see how active the stock price was on a particular day compared to the previous day. When major news is released, it can trade 20 to 30 times the average daily volume, especially if the average daily volume is very low.
The average number of shares traded gives investors an idea of a company’s liquidity, or how easy it is to buy or sell a particular share. Highly liquid stocks can be easily traded in bulk at low transaction costs. Less liquid stocks are rarely traded, and large sales often lead to dramatic increases or decreases in price. Less liquid stocks on the Nasdaq tend to have the widest spreads, the difference between the buy and sell prices.
Originally published at https://businessdor.com on February 6, 2023.
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