4 Main Investing Strategies You Should Know
In the professional investing world, there is a popular saying that all the portfolio managers and analysts talk about: “there’s more than one way to skin a cat.” This refers to the concept that there is no such thing as the absolute “best” investment strategy. Instead, every investment strategy has its own unique set of strengths and weaknesses, and it’s up to the investor to choose and evolve one that best fits his style and personality.
If you are considering investing your money into stocks or bonds, it is worth spending time to learn how to invest and to come up with a strategy that you can adhere to. But what are the main strategies out there, and which one is the right investment strategy for you? Here are options that are definitely worth delving into before making up your mind.
Fundamental Investing
Fundamental analysis investing is the more traditional approach to investing popularized by the likes of Warren Buffett. The main rule of this investment strategy is to first understand how a business operates and makes money on a fundamental level. This involves studying company’s historical financial statements, as well as competitive landscape and regulatory influences, among other things. What will happen to this company’s revenue and profit for the next few years? What happens if a competitor tries to take its market share with an aggressive pricing strategy? By attempting these kinds of questions, an investor seeks to assess the true “fair intrinsic value” of a company by evaluating, and investing in a company whose stock price deviates the most from its fair value. Within fundamental analysis, there are three main “strategies” that employ this framework in different styles.
Value Investing: For Conservative Investors
Value investing is a fundamental investment strategy where an investor buys stocks that trade for less than their intrinsic values. The emphasis of value investing is in downside protection. By buying assets that are grossly undervalued compared to their cash profits or net assets, a value investor seeks to limit the amount of money he could potentially lose in his investments. Investors who use this strategy believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with a company’s long-term fundamentals. When the market overreacts to a bad news and a company’s stock price declines well beyond its fair value, a value investor seeks to purchase stock and wait for it to return to a more “normal” level.
Given this nature of the strategy, value investing strategy is ideal for those who are conservative with their money and are always looking for bargains with all their purchases.
Growth Investing: For Aggressive Investors
Growth investing is a more aggressive version of fundamental investing that is focused on capital appreciation. Growth investors invest in companies that exhibit signs of above-average growth, even if the share price currently appears to be expensive (in terms of metrics like price-to-earnings or price-to-book ratios). Growth investors are betting on the growth of a business to more than offset the premium that they are paying for their stocks. For instance, they might pay 20x PE ratio for a stock that are growing earnings at 40%, which could potentially lower the multiple to 14x or 10x in terms of future earnings, if the growth materializes.
This is an aggressive investment approach that is typically regarded as “high risk & high reward.” To justify paying a high price today for low price in the future, growth investors have to be very confident about a company’s growth potential and competitive strength. Therefore, this strategy is ideal for futurists who spend a lot of time researching how an industry and companies will evolve over time.
GARP Investing
GARP stands for “Growth At a Reasonable Price,” and it is a hybrid of value and growth investing. However, notable investors such as Warren Buffett have often stated that “growth and value investing are joined at the hip.” Theoretically, there is little difference between the concepts of value and growth, since how well a business can grow will always influence the assessment of its fair value. GARP, as a hybrid strategy, best embodies Buffett’s saying that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
This strategy is the most comprehensive of the fundamental investing camp. By identifying great companies that are priced reasonably (or sometimes unreasonably cheap), investors can enjoy peace of mind in terms of downside protection while also benefiting from the company’s growth potential.
Quantitative, Algorithmic Trading
Quantitative trading is an investment strategy based on picking investments solely on mathematical analysis. To trade quantitatively (or algorithmically), an investor does not need any understanding of how a business operates. Rather, he seeks to find different variables and data points that correlate with one another, thereby creating an algorithm that can predict how certain securities will move over time. This is the newest of the main investment strategies, and have been rising rapidly in popularity in the recent years.
Unlike fundamental investing, quantitative investing is not divided into a few main camps. Instead, every investor engages in a different style of investing by coming up with her own set of data, variables and thesis about how to identify and exploit inefficiencies in the market. This could consist of a strategy that looks at a few factors like PE ratio, leverage ratio and earnings beat among hundreds of companies, while others can be looking at thousands of variables around the world to predict how gold prices move. Largely, it is up to the trader to come up with a theory, back test it with historical data, and run it with real capital to see if it works. Naturally, this strategy is ideal for quantitative minds with some technical background in math, statistics or computer programming. If you are not the best quantitative mind but you still want to participate in this investment strategy, you could check out a few robo advisors.
Parting Thoughts
When discussing investment strategies, it is important to note that there’s no single best strategy. What’s most important is that you find a strategy that is a good fit with your personality and capability. The worst thing to do in investing is to be inconsistent with each of your trades. If you make every trade with different philosophy each time, you can’t find the source of “error” that could be making you lose a lot of money.
Also, it is extremely important for you to minimize your trading cost regardless of the strategy you use. It could cost you meaningful amount of money each time you trade, so it’s important to find an online broker with the lowest commission and a user interface that’s the easiest to use.
Note: This article was contributed to ValueWalk.com by ValuePenguin.
Category: Investing in Penny Stocks
