Different investors have different styles of investing. Investing styles can be classified in various ways. One of the classifications is (a)Technical analysis (b)Fundamental analysis
Technical analysis means looking at the chart of the security and attempting to use past prices, volatility, trading volume among other things to predict the future price of the security. A technical analyst believes that all the company fundamentals are already accounted for in the stock price. They have a comparatively shorter time horizon. Some refer to this style of analysis as speculation.
Broadly speaking the difference is that fundamental investors look at financial statements whereas technical investor look at price charts. It is my belief that is not possible to consistently predict the future price movements. Hence, I choose fundamental analysis when investing personally and would focus the blog on this aspect. Fundamental investors usually take one of two approaches : top down investing and bottom up investing.
Top down investing starts by looking at the economy and identifying the sectors and industries within the sectors that are expected to perform better in the coming months and years. After that, they pick companies within the industries.
Bottom up investing starts by looking at the company fundamentals first and then overlaying the economic outlook. These investors would typically ‘screen’ companies based on their criteria and then evaluate one company at a time.
Fundamental investors are also commonly classified into ‘growth investors’ and ‘value investors’.
Growth investing: Growth investing seeks to invest in companies whose sales and earnings are growing rapidly or are expected to grow rapidly in the near future. Such investors are ready to pay a premium price for shares of the company with the belief that the shares will continue to rise as the growth story continues or accelerates and other investors jump in. Such investors looks for sales growth, profit margin expansion, eps growth, market share growth for their products/services. Often a ‘growth stock’ is one that sports higher multiples on earnings , sales , book value, cash flows. An example of such a company in current times would be Netflix (NFLX). Netflix trades at about 53 times trailing earnings.
Value investing: Value investors seek to invest in companies whose shares are trading at a discount to their intrinsic value. Simply speaking, value investors look for bargains. Typically, such companies sport lower multiples on earnings, sales, book value, cash flows. Value investing also comes in various flavors. One approach is to consider large companies whose shares have been beaten down due to some recent issues whether its sales and/or earnings slow down, some legal issues etc. Another approach is to look at special situations or one-off events that push down the shares of the company. Two such events immediately come to mind One is the recall of Toyota cars due to brake-pad and other issues. The second one is the disastrous oil spill in the Gulf Coast that has sharply affected the share prices of BP, Anadarko and Transocean. Needless to say, special situation investing is not easy and needs considerable expertise.
A good and simple comparison between the value and growth investing can be found on Wikipedia. Wikipedia points out that in the past, one style of investing has outperformed the other for several years and then under performed for several years. Warren Buffett once said that this classification between growth and value investing does not make sense and that growth is a component of value. However, you will often find that professional investors and fund managers will align themselves with one style or the other. Mutual funds will be named like ‘XYZ Growth Fund’ or ‘ABC Value Fund’. It is good for an investor to know the difference between the two so that you can use that when reading up a mutual fund prospectus and see if the manager is following the style he claims.
This is a rich topic of discussion and often heated. I will continue this topic in a series of future posts. So watch this space…..