Stocks Selection A lot of attention has been paid to different methods of stock selection. Lately momentum investing has been all the rage, and many have been suggesting that the old methods are no longer valid. But, as we have indicated all along, in the long run, the old rules will apply and those who ignore them may look great for their 15 minutes of fame, but in the end, they ignore the old rules at their peril. Two methods that have stood the test of time are value and growth investing. These are the two methods that we should pay the most attention to.
You can use one or the other, or a combination of the two. We should apply both to our decisions, however, in each case we apply them to differing degrees. After all, every stock is an individual and should be treated as such. Normally, a value investor is considered to be someone who tries to find shares that are undervalued, and then buys them for a bargain. The reason for the share being undervalued could be an industry that is not currently popular, some recent bad news or just market neglect. The investor believes that due to this current unpopularity, the shares can be bought at a bargain, and one-day their true value will be realized.
The most successful value investors are prepared to wait years for this true value to be realized, as long as they believe that the economic value is still there. Growth investors are investors who are looking for shares of companies that are growing and expanding. Their belief is that the current price is not that important, as by expanding and growing, these companies are constantly increasing their economic value, which will translate into increase share price. It is often their position that if you wait for a lower price, you may miss the ride, because, as the companies grow, so will their price. Consequently, todays price which may seem high, will be considered a bargain when compared to tomorrows. The most successful of these investors are also prepared to hold onto a share for a long time.
After all, as long as the company is growing, its value should continue to go up. The above two styles both have merit, and when exercised correctly, they also emphasize quality. As indicated above, while it may sound like you can use one of these approaches, or the other, but not the two together, I do not believe this. I think that quality shares can be chosen for a number of reasons, one being growth, but once you have selected a quality share, there is no need to run right out and buy it. The next step should be to value it, to see if it can be purchased for a reasonable price. After all, market hype can cause even the best companies to be overvalued.
This is true of all companies, especially fast growing ones. I should point out that this does not mean buying the share at the best price, or the bottom, it means satisfying yourself that the current price is economically justified. If you wait for the bottom, you will miss it nearly every time, or may never invest, as a better price may be coming. This could cause you to miss most of the best opportunities. On the other hand, if you value a share, then you will have the comfort of knowing that you have purchased some economic value, which should eventually be realized. You will not always be right, and your evaluations should be redone fairly regularly, but on the whole, this should add significant stability to your portfolio.
Also, when your shares do drop, it will be easier to hold on to them and sleep at night, knowing that your investments still hold true economic value if not market value. Finally, from a purchasing point of view, valuing the shares, makes the decision easier. Presumably, you will be adding to your portfolio over time, so when you have new money to invest, you can review the companies in which you would like to increase your holdings, and add to the ones that are well priced at the time. When it comes to pricing, there are two main approaches. One uses empirical methods that use market prices to calculate ratios. The ratios are then used to determine the reasonableness of the share’s price. The other calculates the intrinsic value, by determining the present value of the future cash flows generated by the share.