Thursday, October 21, 2010

How to pick those winning stocks - Overview (II)

Overview - Part 2
Continuing from our previous post where we look at the overview of fundamental analysis and quantitative analysis, we take a brief look at the rest of the stock picking strategies. 

Value Investing
Value Investing is about finding fundamentally strong companies that are currently undervalued by the market. A value investor is not interested in all stocks that has a low price, otherwise they will end up buying all the penny stocks. Value investors can use fundamental or quantitative analysis techniques to identify stocks with high intrinsic values. The relative merit of stocks with high intrinsic value can be identified by low P/E values or low price to book values ratio.
Value investing is a long term investment strategy, a value buy during a bull run might be profitable only when the market starts to correct. So value investor will have to do through analysis before investing and have the discipline not to take emotional investment decisions.

Contrarian Investing
Contrarian or contra investing is a investment strategy that believes in bucking the trend. The contrarian investor takes the opposite view of the prevalent  market trend. In a bull market the contra investor will be looking for opportunity to sell stocks, rather than buying new holding. Likewise the contra investor, looks for buying opportunity in a bear market. The basis of contrarian investing is that crowd behavior among investors will lead to over valuation or under valuation of stocks.
Contrarian investing is similar to value investing, in that both tries to identify stocks that are valued under its intrinsic value. The main difference between contra investing and value investing is that contra investing take the market sentiment into account while identifying stocks whereas in value investing the market sentiment is ignored.

Growth Investing
Identifying stocks that have potential for growth and investing in them is known as growth investing. Growth investors usually buy stocks that are priced more than their current intrinsic value in the hope that the growth of the intrinsic value will exceed the high cost. In other words growth investors believe that high price of a stock reflect the positive market sentiment for the stock.
Grow investors invest in relatively new companies and new technologies which have high growth potential rather than established companies. Grow investing is not for everyone as it is a high risk, high return investment strategy.

GARP Investing
GARP stands for Growth AReasonable Price and is an investment strategy that tries to capture the merits of both growth investing and value investing. In GARP, a potential buy is a value stock which is undervalued now and one that has great potential for growth. Unlike growth investors, GARP investing view very high P/E values in negative light. Too high P/E value is seen as paying too much for very high risk. 

Income Investing
Income investing involves finding and investing in stocks that payout dividend regularly. The idea is to ensure regular cash flow for a long period of time. The stocks that selected for this style of investment is know as income stocks. A typical income stock will have a high dividend yield in the range of 5-6%.  Dividend yield is obtained by dividing the yearly dividend per share by the price of the stock.

This is an investment strategy that lays down strict guide lines about picking stocks. CAN SLIM is a strategy devised after studying the performance of more that 500 top performing shares The name is a mnemonic derived from the strategy guide lines. Following are the guide lines for picking a stock.
C - Current quarterly earnings per share must be at lest 18-20 % up compared to the previous year's same quarter.
A Annual earnings growth for the share should be in the 25-50% range  for each of past 5 years
N - Newness associated with the company,  it can be a new product, new management team, new market, new price
S - Supply and demand for stocks, stocks with relatively smaller number of outstanding shares show better results
L Leader in the market is always preferred over laggards
I  - Institutional ownership of stock is essential but should be limited to few above average institutional investors  
M - Market direction, or the momentum of the current market needs to be understood before picking a stock

Dogs of the Dow
This is one of the simplest stock picking strategy and was developed based on the 30 stock of the Dow Jones Industrial Average (DJIA). In the Indian context, the base index can be the BSE Sensex stocks or the NSE Nifty stocks. The strategy is to pick the 10 stocks of the DJIA that has the highest dividend yield and construct a portfolio with equal weightage for each of the ten stocks. The investor should rebalance the portfolio on regular intervels to make sure that weigtage and selection criteria is always met. It is seen that this sort of investment strategy has out performed the index by about 3%.

We have covered the gist of some of the popular stock picking strategies. This meant to kindle your interest in stock picking strategies. One would have to understand the details each of the discussed strategy before it can be used as an investment tool. Therefore we will dig deeper into each of these strategies in detail in our subsequent blogs.