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Finding the best strategy in share investing

In the lead-up to The Sunday Times Invest Seminar on May 10, we are running a three-part series on how you can start on that investing journey. This week, a look at various strategies popularly used to buy shares.

Published on May 6, 2014 11:02 PM
 
-- ST ILLUSTRATION: MIKE M DIZON

Higher returns come with higher risk

The stock market is often touted as an accessible way for beginners to grow their money, but there are plenty of traps for the unwary.

First the good news: You can get started for $1,000 or less, compared to possibly $1 million or more if you want a brick-and-mortar investment like a condominium.

The tricky part starts when you decide to take the plunge as there are many strategies to go about share investing.

The jargon does not make things easier - "value investing" and "dollar cost averaging" probably sound like Greek to most people.

The Sunday Times examines some of the more common strategies used to decide what shares to buy, and when to buy or sell.

Value-investing strategy

This aims to buy "cheap" companies by estimating their value and buying if the price is below this figure.

The most famous proponents are billionaire investor Warren Buffett and his late mentor Benjamin Graham, who is considered the "father of value investing".

Unlike many before them who viewed shares as pieces of paper to be bought and sold for a quick buck, Mr Buffett and Mr Graham stressed that shares should be viewed as what they are - documents that give you part-ownership of a company.

So investors should think of themselves first and foremost as company owners, they argued.

Value investing is used alongside "fundamental analysis" - the study of a company's health and profitability.

Fundamental analysis studies the management and competitive advantages of companies, their competitors and markets, and their strategies to thrive.

A major component is an analysis of the company's financial statements - and the possible forecasting of future profits and cashflow.

The investor can then derive a figure of what the company's share price should be valued at. Value investors will buy in if the market price is lower than this by a certain "margin of safety".

"The focus of this strategy is the value of the firm and how the firm creates such value," says Mr Roger Tan, chief executive of Voyage Research, a Singapore-based stock research firm.

Value investing applies more to firms with a track record, rather than new companies or those boasting a turnaround strategy.

There is a lot of academic literature that investors can rely on when attempting fundamental analysis, so valuations can be treated with some confidence, say advocates.

However, it is time-consuming to learn fundamental analysis and apply it. Because analysis is both an art and a science, you may be way off the mark in your valuation without even knowing it.

There is also the danger of the "value trap" - that good, undervalued companies remain cheap for a long time.

In this case, you won't be able to realise your profits.

Used By:

This method is famous thanks to big-name investors like the late Mr Graham and Mr Philip Fisher, best known as the author of Common Stocks and Uncommon Profits.

Mr Buffett, who runs his Berkshire Hathaway investment firm, is also credited as a great value investor.

But Voyage Research's Mr Tan says the trio simply implemented existing theories in economics and finance.

"Many of their methods and theories are derived from academia," he notes.

Some active fund managers use value investing. Their investment mandates may say that they aim to invest in "value stocks".

Ms Teh Hooi Ling, head of research at Aggregate Asset Management, is a believer.

"Value for us is paying just 60 cents for something that is worth $1," she says.

"We look at fundamental data about a company, the tangible assets within the company, be it cash, real estate, machinery or inventory.

"We want companies with a long track record that pay consistent dividends. And we don't like companies with high debt levels."

The firm manages the Aggregate Value Fund with 190 stocks in five markets - an unusually large number of stocks.

Ms Teh said this ensures that more stocks will deliver returns, compared with those that don't.

Suitable For:

Those willing to put in the time to learn fundamental analysis. It may also be suitable for people seeking regular income as it can identify undervalued, dividend-rich shares.

You will need to keep an eye on market prices, but far more attention should be spent tracking company developments and results announcements.

Growth-investing

strategyGrowth investors buy shares of firms they expect will achieve above-average growth in the years to come.

As opposed to value investors, they don't care if the share price seems high on various indicators when compared to other companies.

Because of this, value and growth investing are often regarded as opposing ways to approach the stock market, but Mr Buffett has said that there is no theoretical difference between these two concepts.

"The two approaches are joined at the hip," he famously declared.

Growth investors also use fundamental analysis to check what companies and sectors are most likely to grow.

They may also make predictions about future value. Growth investors are more likely to put money in new companies in nascent industries than value investors who typically require some form of track record.

But growth investing got a bad reputation after the bursting of the dot.com bubble in 2000.

The years leading up to it were marked by feverish investments in any tech company, regardless of whether it was making money.

The expectations at that time were that these firms would grow exponentially in the years to come.

The lesson is a reminder that growth investors may get caught up in a huge speculative market bubble - and may suffer huge losses if it bursts.

Used By:

The late American investor Thomas Rowe Price Jr was commonly regarded as the "father of growth investing", and his firm T. Rowe Price still manages funds using this strategy.

Many other fund managers also have unit trusts with "growth" mandates.

Suitable For:

Those willing to put in the time to study companies. If you plumb for growth companies with no operating history, it may be higher risk than value investing.

You can diversify and reduce risk by owning a portfolio of shares or investing in a unit trust.

Dollar cost averaging

This method has been gaining popularity in recent years, but it is more of a way to buy into the market rather than to choose stocks.

After you have identified a long-term investment opportunity, possibly from fundamental analysis, it may make sense not to throw in your money all at once, says Mr Tan of Voyage Research.

Rather, investors may put aside a set amount to buy the shares, either once a month or once a quarter.

"In this case, you will buy more units of the investment when prices are low and fewer when prices are high," he adds.

"The result is that the long-term average cost would tend towards the lower end of the price spectrum."

Mr Vasu Menon, vice-president of Singapore wealth management at OCBC Bank, says that dollar cost averaging is a good way to invest in volatile markets, and upcoming global events mean that markets are going to be volatile.

"If we wait to try and catch things at the bottom, we may miss the boat," he says. "I would recommend dollar cost averaging."

Some people who don't want to analyse companies might use dollar cost averaging to buy low-cost index funds like exchange-traded funds (ETFs).

These track a stock index, like Singapore's Straits Times Index, by buying the index's underlying shares, allowing you to diversify your holdings.

OCBC Bank, POSB Bank and brokerage Phillip Securities offer investing plans utilising dollar cost averaging.

Used By:

Not many active fund managers use dollar cost averaging because you are, after all, paying them for their ability to pick shares and time the market.

But there are some experts who advocate this strategy for retail investors, such as American financial adviser and television host Suze Orman.

Suitable For:

Investors who don't want to monitor the stock market. Use dollar cost averaging to buy individual shares if you have done some research and are confident about the stock.

Otherwise, buy ETFs or actively-managed funds like unit trusts.

Other strategies

There are several other strategies in the market, such as "momentum trading".

This involves identifying patterns in price or volume charts of shares, a field known as technical analysis.

"The theory is that consistent patterns exist and if such patterns are identified, a market timer can foretell how prices would move next," says Mr Tan.

In general, each strategy of approaching the stock market has its proponents, who often stubbornly believe that theirs is the best way.

Stocks are considered a high-risk asset class, especially when compared to bonds.

But within this asset, dollar cost averaging is seen as a lower-risk strategy, followed by value investing, with growth investing and momentum trading considered higher risk.

A high-risk strategy normally promises higher returns and vice versa. Whichever strategy you choose, this should be the one rule of thumb you must remember.

jonkwok@sph.com.sg

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