Page 37 - DIY Investor Magazine | Issue 40
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 Contrarian investing has been likened to eating alone in a restaurant; are you the only one that believes that stock will go back up?
Emotional attachment to a particular stock or strategy can cost contrarians dear - doggedly hanging on in the belief of the inevitability of its renaissance, as it goes bust. This is not a simple strategy – some stocks may be unloved because their potential is not noticed; some are just heading for the buffers.
‘Special situation funds’ offer access to unloved companies, diversified across different regions and sectors.
Growth investors forensically research a company’s balance sheet, fundamentals such as its price-to-earnings (P/E) ratio and prospects for the sector it operates, looking for companies whose value is set to rocket.
They target companies with the ability to grow and outperform; the risk is that they don’t grow as much as you thought, at all, or even fall in value.
Value investors also want growth, but at the right price; a value stock is a company that is underpriced by the market with a key measure being its P/E ratio; a company’s share price compared with its earnings, then compared with other companies within its sector.
A lower P/E could indicate a stock is good value, if fundamentals such as its balance sheet and management strategy are sound. Another metric is a company’s net asset value (NAV) - whatever the company owns, minus whatever it owes; if share price x the number of shares is lower than NAV the company could spell potential to the value investor.
Quality investors combine growth and value strategies and may be just a little contrarian; they see growth potential and price
as important, but also want to find something of quality but undervalued.
They buy when share prices are below their intrinsic value and seek to distinguish between quality stocks and those that are low quality; better to buy a quality stock at a high price than a low quality one at a price that seems good value. An example is the tech bubble when investors put money into businesses with good ideas, but with poor fundamentals such as strategy, management or finance and therefore failed.
Quality investors compare P/E ratios and also consider a company’s future prospects such as its market outlook and its management strategy; the risk is that a stock may look cheap because it is on the way out.
The world’s most illustrious investor Warren Buffett has amassed a $134 billion fortune by employing a combination of growth, quality and value investing strategies.
The ‘Sage of Omaha’ identified companies he believed were worth more than their market value, and invested in them for the long-term; Buffett believes an investor should buy into a business with the mindset that they own it, not just a slice of it – look for quality management, a durable competitive edge and low capital expenditure.
He favours market leaders with a strong brand name – Coca Cola, McDonalds and Gillette; a good history of solid earnings growth.
A portfolio fully diversified across sectors and businesses could comprise around thirty individual stocks, which could require a lot of research and trading commissions; it may be cheaper and less time consuming to let a fund’s manager and its analysts do the heavy lifting.
An actively managed unit trust, OEIC or investment trust will deliver an instantly diverse portfolio of between 30 and 60 stocks, thereby spreading the amount of risk you are taking. You can diversify by investing in a number of funds that do different things in different regions, but you can also add diversity in terms of the investment strategy employed by the manager of the funds you select.
April 2024
DIY Investor Magazine ·

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