Below are some answers to our most commonly asked questions regarding the Stock Wealth Safely investment approach.
Frequently asked questions
Why invest in the stocks ?
The stock market has performed better than any other asset class over time. For the past 100 years, the average annual return of the SP 500, a measure of overall stock market performance, has been 9-10%. This is about double what corporate bonds would have returned over the same time and much higher than interest bearing accounts such as treasury bills or money market funds. The stock market is volatile and may not be the best every year, but over time it produces the highest returns. Stocks should be a major component of your investment portfolio.
Why try to select individual stocks instead of just buying a broad market index fund ?
Buying a fund that tracks the overall market, such as the SP 500, avoids the risk that a particular company may do poorly, but also does not allow you to gain as much when a company does very well. In every year, there are a number of companies that do much better than the market as a whole and identification of these companies is where the real profits are made. Smart money does exist – think of all the hedge fund billionaires. Accurate stock selection will be more profitable over time than just buying the market. The key is to choose the correct stocks and that is where Stock Wealth Safely can help.
What is value investing ?
Value investors believe that the stock price should reflect the intrinsic value of a company. Intrinsic value is estimated using a variety of measures to asses the long term prospects of the company. At times, the market underestimates this true value of a company and the stock price becomes discounted. Buying a stock when it is “on sale” should yield good profits. Benjamin Graham and Warren Buffet are well know examples of value investors.
What is growth investing ?
Growth investing focuses on finding companies that are likely to grow faster than average. The stock price may appear expensive by standard measures such as P/E ratio but the company is expected to grow fast enough to justify the price premium. This strategy can be very successful if the right company is identified – think of Amazon, Google or Facebook.
What is momentum investing ?
Momentum investing is based on the principle that market trends are more likely to continue than to reverse. It is captured in statements like “make the trend your friend” and “don’t fight the tape”. Investors use various rules to decide when to buy a particular stock with the expectation that it will continue to rise long enough for them to make a profit. While lacking the theoretical models supporting value or growth investing, this approach has been shown to be successful in a number of studies.
What is technical analysis ?
Technical analysis focuses on assessing patterns in the movements of prices and volumes to generate signals to buy a stock. It believes that analyzing past trading activity will provide valuable predictors of the future price of a stock. It relies heavily on patterns identified in stock charts. It does not incorporate any measure of a company’s intrinsic value or growth prospects, but focuses on the market’s assessment of the stock as reflected in the price and volume patterns that have been created by previous trades. Studies have shown that this can be successful, especially for relatively short term trades.
What is behavioural finance ?
Behavioral finance believes that most investors are not completely rational and that psychological biases can explain aspects of stock market prices, especially those that appear to be anomalous. A classic example is that investors tend to overreact to both good and bad news, leading to excessive price swings in response to the news. These biases eventually correct and the stock price returns to a more appropriate level. Identifying when a stock price has changed because of an incorrect bias can result in a buying opportunity.
What is top down investing ?
Top down investing assumes that a company can do well and its stock price increases mainly when the overall economic picture is favorable. The analysis begins with macroeconomic factors such as GDP, inflation, interest rates etc and determine which types of companies will be successful. For example banks tend to earn more when long term interest rates are high. Since banks cannot control interest rates, a top down investor would first look at interest rates before deciding whether to buy a bank stock. The opposite might apply to home builders. Investors will choose stocks that are most likely to do well in a particular macroeconomic environment, where the rising tide can help lift all boats.
What is bottom up investing ?
Bottom up investing takes the opposite approach from top down. This strategy believes that fundamentally analysing a company is the key to predicting its stock price. This analysis includes financial performance, growth rate, management quality, market position and other factors. A company that scores highly in these areas should perform well, even if the overall economy is not good. There are always some companies whose stock price will increase during a recession.
What is sector investing ?
Business cycles have predictable patterns that recur over time. The characteristics of the economy are different in each stage of the cycle and this tends to favor particular sectors. For example consumer discretionary and industrial stocks tend to do well in the early recovering stage of a new business cycle while health care and consumer staples perform better later in the cycle. If the correct stage of the business cycle is identified, investors will choose companies that are in the sector that should be favored in that stage. Investments will change as the sector likely to benefit changes – a process called sector rotation. This approach can be refined to also analyse the best performing industries in that sector before moving to individual companies.