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"You buy the wrong business at 25 percent less than you should, and you take a little longer to go broke.  You buy the right business at 25 percent more than you should, and you make five times your money instead of six." 

Theodore Fortsmann

Investment Strategies

We have seen that the most important factor in investment is compounding over time, and a winning mental attitude backed by learning, saving and making your own investment decisions.

This page is dedicated to giving your performance an extra boost by reviewing more investment ideas, and trading techniques of the pros.

My readers should be aware of my preferences for researching and buying quality companies for the long term.  Researching thoroughly, buying carefully and selling reluctantly.  Jesse Livermore a legendary investor  is quoted in John Trains classic book  The Money Masters  " After spending many years on Wall Street  and after making and losing millions of dollars, I want to tell you this:  It never was my thinking that made the big money for me.  It was always my sitting.  Got that?  My sitting tight."

For the your consideration I  am including herein several of the more popular investment strategies and a brief discussion of each.

• Buy and hold - This approach suggests buying a diversified portfolio of stocks hold for a long period of time while reinvesting all dividends.  Few investors ever follow this strategy to the letter.  Usually new capital is added to the portfolio, assets are sold in order to take advantage of hopefully better investment opportunities, or to prevent erosion of portfolio value during a bear market.  The benefits of this approach are low transaction expenses, and tax efficiencies, deferring capital gain taxes that are triggered on the sale of securities.  This approach is supported by the concept of the efficient market hypothesis which states that the prices of publicly  traded stocks are set by the competitive market place, and those prices reflect fairly accurately the true value of the security,  For further information on this approach read A Random Walk Down Wall Street , by Burton G. Malkiel.  Arguments against this approach point out that the security markets are not entirely efficient but instead have pockets of inefficiency and overlooked or inflated values that may create opportunities for investors to exploit. (This is especially true in real estate investing).
• Investing in index funds.  Index funds are pools of investments that are designed to track the performance of specific market indexes i.e. the Standard & Poors 500 or the Dow 30.  You should do no better than the market you are indexed to, but you will do no worse.  History shows that there is a strong upward bias to the stock market over time.
• Dollar cost averaging - in this strategy the investor makes periodic investments of equal size.  This approach works well with investments into a diversified mutual fund with payroll deduction plan.  Investment companies can also debit an investors saving or checking on a regular basis.  The dollar cost averaging approach has the effect of purchasing more shares when the prices are lower and fewer when the prices are higher.  This approach works best in market environments in which share prices, in the long run, have an upward bias, which has been the historic experience with stocks.
• Sector rotation -  past performance indicates that some sectors of the economy do better or worse than others at different phases of the economy.  In this strategy the investor identifies what he thinks are major trends that will last for at least a year or more and selects investments that he thinks will benefit from these trends.  This approach is known as a top down approach because the investor first determines the phase of the economic cycle the economy is moving through, then determines the industry or sector that he sees benefiting and then purchases the stocks in those sectors and industries that he believes will benefit most.  See the Market Environment Page for a list of the economic trends and the sectors that benefit from them.

1. One way to use this strategy is to buy sector funds.  Sector funds are mutual funds that invest in a specific industry such as telecommunications, biotechnology, or regional banks.  There are also a number of international and single country funds that can also be considered.  It seems that at any given time there is a stock market booming somewhere in the world and a market crashing somewhere else.  Country specific funds allow you a chance to take advantages of this.  At last count Fidelity had sixty-three sector and single country or regional funds. funds Since you will be trading these funds it is best to hold them in a tax deferred account. 
2. William E. Donoghue has a clever little strategy.  He suggests that you buy the top four funds in the Fidelity specialized fund universe based on the total return in the last week, this information is available in financial newspapers like Barron's or at SmartMoney.com.
3. When a fund falls out of the top ten, replace it with the highest rated fund you do not currently own. 
4. This strategy pays attention to only one advisor, the market itself.  You get in and out of the hot markets when the market  tells you.  Talk about inside information. 
5. The best thing about this strategy is that it is straight forward.  You will often get whipsawed, in and out of the same fund, but the funds give you a level of diversification, and most hot sectors stay hot for some time, and when they cool off, you are out of there.

• Contrarian - this strategy made popular by John Templeton suggests that the wise investor should be willing to buy securities that are out of favor and sell those that have become popular.  This strategy is based heavily on the psychology of group behavior.  A number of technical indicators have been identified to measure the levels of group think in the market place.  

1. Short selling -an increasing volume of short selling (borrowing from your broker and selling them in the market place with the hope that you can buy them back at a later time for less than you sold them) suggests that investors believe that the market will decline.  Contrarian should consider an opposite move.
2. Mutual fund cash positions drop which means that the funds are more fully invested and do not have new money to move into the market, Contrarian see this as a bearish sign.
3. Smart money - contrarians invest along with the specialists on Wall Street not against it. 
4. Average investor - contrarians look to see what the average investor is doing and then move the opposite way.

• Low P/E strategies- The P/E (price divided by earnings) it is believed to contain information of investor belief of the quality of the earnings and the growth prospects of a company.  Companies have high P/E's relative to the market P/E because investors believe that these company prospects are bright and have bid the prices up relative to the companies current earnings.   Contrarian investors look to stocks who have solid performance but have low P/E's.  These stocks are seen to be good companies that are currently out of favor but they reason that when market sentiment changes investors will return to these stocks and bid their prices up.  If you are considering this approach remember many stocks that have high P/E's are the best stocks in the market, and many stocks that have low P/E ratios are indeed inferior companies.  This approach usually takes a lot of time for the market to recognize the opportunities and react to the merits, if at all, to your low P/E stocks.  If you are going to use this approach do not short stocks simply because they have high P/E's nor simply buy because they have low P/E's, remember that the market is unusually efficient with pockets of opportunity.

• Value Investing - This strategy attempts to buy companies that are selling in the market for less than there true value, hold on until the true value id recognized.  The rub is that how do you determine the true value.  Benjamin Graham developed analytical methods of investing and pioneered the strategy of value investing in his classic book The Intelligent Investor.  Graham was a careful and thorough bargain hunting investor.  His approach is a 'bottoms up approach' looking at the intrinsic value of the company with little consideration given to the market or the economy at large.  He looked at net current assets debt levels, dividend payment record and earnings growth.  Graham believed that buying companies for less than there net current asset values assured the safety of the investor's principal.  Dividend payments would provide return until such time as the market recognized the true value of the stock and bid up it's price.
• Growth stock - This strategy invests in companies whose sales and profits are expanding at a much faster rate than the overall economy.  Growth stocks are the companies  that get it are the next new-new thing.  Wal-mart and Home Depot revolutionized retailing.  Apple and Intel revolutionized the way we work.  Growth companies are often young companies often with a great idea but little or no real profits.  They evolve from a development to a growth stage and finally become a mature company with lots of competition and declining profit margins and profits as their innovative products become familiar and indistinguishable from those of competing firms. One of the great growth stock investors was T. Rowe Price, who recommended that growth stocks be purchased during the development stage and sold during their latter growth stage when companies stop competing at the wow level and start competing on the price level..  Remember that growth stocks, especially in the development years are very susceptible to price swings, new competitors, or by a better substitute product or technology.  See the discussion of disruptive technologies in the market environment page.  

Stock Selection

CANSLIM is an acronym that describes a philosophy of screening, purchasing, and selling common stock
as described and developed by William O'Neil  a growth stock investor, in his book How to Make Money in Stocks.

This has to be one of the finest outlines of what an investor should consider before investing their money in a stock.  You will increase your chances of finding a superior growth stock by following Mr. O'Neal's outline, and I invite you to visit the  Investors Business Dailey  web site for elaboration on his technique.

This is the outline of the CANSLIM formula taken directly from Mr. O'Neil's book (without permission).  This is one of the best overall approaches I have found to value a stock.

C = Current quarterly earnings per share. They must be up at least
18-20%. 

A = Annual earnings per share. They should show meaningful growth
for the last five years. 

N = New. Buy companies with new products, new management, or
significant new changes in their industry conditions. And most important,
buy stocks as they initially make new highs in price. Forget cheap stocks --
they are usually cheap for a good reason. 

S = Shares outstanding. They should be small or of reasonable number,
not large capitalization, older companies. 

L = Leaders. Buy market leaders, avoid laggards. 

I = Institutional sponsorship. Buy stocks with at least a few institutional
sponsors with better than average recent performance records. 

M = The general market. It will determine whether you win or lose, so
learn to interpret the daily general market indexes (price and volume
changes) and action of the individual market leaders to determine the overall
market's current direction.

What about risk?

Risk means many things to many people. 

Most people associate risk with loss.  Risk is the volatility of investment returns.  You can not have high rates of return with out assuming a certain degree of risk.  There is a great deal of real risk, in safe investments, savings accounts, certificates of deposits, and government bonds.  There may not be the level of volatility that you will have in stocks, but you will have real loss in purchasing power caused by inflation and taxes that are often higher than your return.  There is also the opportunity costs associated with using you money in poor performing assets rather than higher performing assets.

The longer your holding period the less the volatility in the stock market.  Buy good stocks and do not worry too much about market timing. 

See the risk page for further discussion of risk.

What I look for in a stock

1. Sales growth greater than inflation
2. Stable or increasing profit margins 20% plus
3. Return on equity 15 to 20%
4. Rising earnings per share
5. Debt less than 50% of equity
6. Institutional holdings less than 40%, (potential for institutional buyers to move the stock)
7. Price/earnings less than two to three times projected five year growth
8. Special industry concerns: look for technology companies to reinvest at least 10% of their sales in research and development to protect their leading edge.  Retail companies must show same store sales rising.
9. Stocks in industries that are on the leading edge of long term growth curve.  Good stocks in good industries.

There are thousands of stocks to chose from, why settle for less?

What to do now

• Start saving now!  Pay your self first, 
• Establish a goal, any goal improve it as you gain experience
• Establish a strategy that will help you meet the goals you set.
• Review and modify your goals and strategy as needed.
• Keep learning, develop confidence and an unshakable winning attitude.
• Maximize your contributions to any tax deferred accounts you have access to
• Open a brokerage account with a discount or full service broker
• Begin to invest in solid investments: stocks, mutual funds and real estate
• Limit  your risks.  Buy good quality investments.  Companies that have the staying power to weather the financial storms and market challenges.  Investing in too many speculative stocks and "hot tips" is dangerous to your investment health.
• Invest regularly, in up and down markets.  It is impossible to consistently time the market.  You may guess the top but will you invest at the bottom when fear is the highest.  Invest each and every month.
• Keep good records. Limit the tax bite and improve your compounding ability by maximize your retirement account opportunities.  Invest in an IRA if you are not covered at work.
• Stick to your plan.  Do not expect to get rich overnight, we are talking about a life time commitment, and the earlier you begin the greater your returns.  At a fifteen percent rate of return your investments will double every five years.
• Teach someone else the menus for success.  You will both benefit and as a teacher you will learn more than your student.  Teaching is a great way to learn

Misc. Notes

Buying quality companies on declines can give you a advantage over time.  Professional investors are restrained from exploiting these opportunities because they are much more concerned about short term performance and stocks that decline are considered dead money because it may take several quarters to recover.  Do not use this strategy on speculative issues, only with quality companies with specific identifiable solvable problems.  An example would be the price of Exxon which fell off a cliff after the Exxon Valdez oil spill.  This was a quality company with good cash flow, low debt, good future prospects, and identifiable but serious acute problem, incompetent tanker captain, environmental damage, and damaged public relations.  Do not be quick to buy damaged stocks.  In the market terms this strategy is called 'catching a falling knife'.  Stocks often fall, appear to base or recover and fall again.  Wait until you believe that the stock has formed a base, then wait some more before you act.

Reading List::

The Money Masters - John Train

A Random Walk Down Wall Street - Burton G. Malkiel

How to Make Money in Stocks - William J. O'Neil

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