11.6 Investment styles
VARIOUS INVESTMENT STYLES
This refers to the composition and character of investments in a portfolio influenced by investor or investment manager. The composition could be of different investment avenues like debt, equity, derivatives and real assets. The style can be seen within equity investments too. The investment style should have relevance to the investment objectives of the investor. It is different for different investors and depends on the personality of the investors.
Who are growth investors? They look for companies with great projected earnings, supported by solid history or earnings’ improvement over the years. Through the growth investing strategy, investors focus on rapidly growing companies which are witnessing a signifi cant increase in revenues and profi ts. Investors who focus on this strategy aim at making money from the significant increase in the share prices of particular companies they choose to invest. Normally, returns from growth stocks are substantially higher than that of other types of stocks. However, the risks involved in this type of stocks are high as compared to others. Growth investors pick young and fast-growing companies, despite the expensive stocks, as the investors bet on the future growth potential of the companies. The basic idea of growth investing may differ from industry to industry and company to company.The signs of high-growth companies are: high earnings growth forecasts for the next one to five years, strong historical earnings’ growth, high quarter-over-quarter earnings’ growth rates, regularity of positive earning surprises, recent upgradation of earning estimates and directors and management buying their own company’s shares. Although the PE ratio is usually high in relation to the market (minimum 15-20 times), it should be reasonable compared to earnings’ growth.
Value investing is opposed to growth investing. Value investors focus on stocks which are trading below their intrinsic values. Value investors look into the fundamentals of the companies carefully and they believe that the market undervalues these stocks. Value stocks are cheaper as compared to the net asset value of their respective companies. Value investing does not mean choosing a cheap stock. Rather, it means investing in undervalued stocks that have good growth potential. They often trade on low PE ratios relative to the projected earnings’ growth rate to historical earnings and to industry and sector earnings – and also usually have low price-to-book (price-to-assets) ratios. Probably because of recent earnings’ disappointment, these stocks are often perceived as boring, with prices below their long-term price trends and moving average. But like growth investors, value investors believe that earnings will outstrip the shares’ current PE ratio. Please note that Warren Buffet has been one of the greatest advocates of this investment strategy. Here you are looking for a longer time horizon, a business with real long-term prospects.
Growth At A Reasonable Price (GARP):
GARP is a combination of value investing and growth investing strategies. Through the GARP investing strategy, investors focus on stocks that are reasonably priced and at the same time possess robust growth potential. In layman’s terms, GARP investors do not go for either high-growth stocks that have high risks or cheaply priced stocks which are in trouble. So, GARP investors avoid expensive high-growth stocks. The important barometer for GARP investors is PEG ratio, which is PE ratio divided by growth.
This is an investment strategy that aims to capitalize on the continuance of existing trends in the market. This strategy looks to capture gains by riding ‘hot’ stocks and selling ‘cold’ ones. The common features of momentum stocks include high relative percentage price changes over one day, week and month, the share price breaking out of an extended narrow trading range, high short-term earnings growth quarter-over-quarter; upward change in analysts’ earnings estimates and high money flows into shares which indicates institutional investor buying. The momentum should ideally be underpinned by solid foundations – positive earnings revisions, or, at worst, by widespread belief in a new fashion or trend. But here the risk is failing to get out of the share before its momentum dies.
Income investors look for shares paying high, secure dividends. They will sacrifice capital appreciation, but not the capital itself. This is a long-term, low-risk style. A variation – the growth and income strategy – demands a moderate earnings growth rate, translated into growing dividends.
Fundamental analysis is a stock picking strategy through which an investor or analyst tries to estimate the intrinsic value of a stock based on fundamentals. Although this strategy takes time and effort; it is best suited for long-term investors. Through fundamental analysis, investors try to understand the earning trends of a company and expected earnings in the future, rather than market sentiments. Apart from earnings and revenues, investors also focus on factors such as ROIC (Return on Invested Capital), ROE (Return on Equity), cash flows and PE ratio etc.
We have already covered market cap. The size of a company as measured by market capitalization can be classified as large, mid, small-cap companies. There is a style difference between large-cap investment and small-cap investment. Large-cap investors generally look for diversified stability, diversified revenues, predictable earnings, and for matching the broad indices while small-caps can offer rapid growth potential and are often niche earners in weak economic environments, but have little research coverage compared to large-cap companies.