Often people think investing is for the rich or it is equivalent to gambling. Until you make your first stock purchase, you will never understand the potential of investing.
For beginners, mutual funds have remained the only way of getting exposure to equity. While mutual funds offer diversification, expert management, flexibility, and the likes, but there is a more rewarding instrument.
Buying individual stocks is more rewarding. You can get far higher returns by investing in individual stocks than you get in mutual funds.
But is this process so simple?
Not really. Your investments work for you only if you pick the right stocks.
So how should you pick your bet?
In this blog, I’ll discuss various strategies of investing. I shall explain how to approach investing to avoid careless errors.
Let us start with the various methods people use to analyze stocks.
In this article
Fundamental Analysis – Buying value
Fundamental analysis is to do with business.
In the investing community it is said that when you buy a stock of a company, you technically buy a proportion of the business.
Thus, the logical question is how do you assess what is the value of the portion you are buying? Would you randomly pay any amount for the proposition you are looking to buy?
The answer is no.
You need to arrive at a valuation of the proportion and then decide if you would buy or not.
The process of arriving at the valuation of a business is called fundamental analysis.
Investors use a company’s financials to compute how much the worth of the company is. Eventually, the investor arrives at the value the investor is willing to pay.
You may feel that analyzing a business is simple and straightforward, but there are many flavors of fundamental analysis. The goal of a value investor is not only knowing the price and value of the company’s stock but also to ensure that the stock which he/she is interested in is available at a discount to its intrinsic value.
Following are some of the methods of evaluating a stock:
- Price-to-earnings (P/E) ratio
- Price-to-book value (P/B) ratio
- Dividend Yield
- Return on Equity (ROE)
Quantitative analysis – Buying numbers
Quantitative analysis purely involves numbers with no factor concerning the business of the company.
Even fundamental analysis requires some numerical inputs, but the primary focus remains more on qualitative factors such as management expertise, competition intensity, market opportunity, substitution, etc.
A quantitative analyst views these things as supportive subjective judgment instead of the primary driver for buy/sell.
In recent years, with the improving technology, number crunching is primarily done using computer and tools and quants (as the analysts are famously called) have started to use only the buy/sell signals based on a quantitative basis, without regard for the management or actual business.
D.E. Shaw is one of the firms that use mathematical algorithms to find minute price discrepancies in the markets.
Quant analysts use “screens” to finalize on the investments.
The screen tends to look for a pattern and throw the companies fulfilling that criteria. Screens can look for any number of factors about a company’s business or its stocks.
Screens are also used widely to generate ideas and then apply fundamental analysis or technical analysis models to evaluate each of the names before arriving at a final call.
Investor’s claim that using screen removes emotions from the investing process.
Momentum investors look for companies that are not just doing well but are flying high enough to capture share/profits. Momentum companies tend to beat analyst estimates of earnings per share or revenue or has a high growth rate when compared to the industry average.
These parameters indicate that things are working in favor of the company.
Organized retail was a momentum segment until a few years. Similarly, carbon black and electrodes sector were momentum segment starting 2017 where companies like Rain Industries Ltd, Graphite India Ltd, HEG Ltd saw tremendous growth.
It is a method for selecting stocks that are created by Investor’s Business Daily founder William J. O’Neil. It is a hybrid of quantitative analysis and technical analysis.
- “C” and ”A” indicates accelerating Current and Annual earnings.
- ”N” indicates New products/markets/management
- ”S” stands for small capitalization and big volume demand
- ”L” stands for Leader or Laggard (left on the discretion of investor)
- ”I” is Institutional sponsorship, and
- ”M” focuses on the market direction
Technical Analysis – Buying the pattern
Technical analysis has everything to do with charts. If the market was efficient and all information about a company is available publicly at all times, and instantly, no one would get an edge over anyone else.
But this scenario is not possible.
This gives rise to technical analysis where an investor focuses on psychological information and charts out a pattern.
Investors believe charts often provide insight into the psychology surrounding a stock and trends in the chart can give rise to buy and sell signal.
There is no clear approach to the method, but you have some tools that can be used to find the signal. Some of the tools are:
- Bollinger Band
- RSI Crossover,
- Moving Average, etc.
You would probably rejoice reading about different strategies, but the chances are that, like every other investor, you will find some approach that suits your requirement and style based on your risk appetite. Also, investing can’t be learned in a day, and it is a never-ending process that keeps evolving.
Thus, you will have to develop your investing philosophy that suits you while meeting your goals and minimizing your risks.
Disclaimer: the views expressed here are of the author and do not reflect those of Groww.