aaaa
An Overview of Investing Strategies - A Beginners Guide
About Us
Disclaimer

An Overview of Investing Strategies


Investing Strategies

An Overview of Investing Strategies - Investing Strategies; Picture of an Investment sign with writing on large capital letters saying make money for stock investors with a bundle of money on the side.

Stock Investing styles

There are numerous stock investing styles that stock investors utilize, some of which are appropriate for the beginner stock investor while others are best suited to the more knowledgeable and experienced stock investor which involves speculative strategies.

Some of the most popular investing strategies are:

  • Growth Investing: Focuses on companies with sales and profits that are increasing at an above average rate.
  • Value Investing: Focuses on companies where the current stock price is less than what the company is worth.
  • Dividend Investing: Focuses on companies that pay reliable dividends. This style of investing is also known as Income Investing.
  • Blue-Chip Investing: Focuses on the largest companies by market-cap, especially those in the DOW index.
  • Small-Cap Investing: Focuses on the smaller companies by market-cap that have significant growth potential.

Some stock investors will concentrate on only one investing style while others will utilize a variety of investing strategies.

There is no right or wrong way to invest in the stock market and the strategy used is at the sole discretion of the stock investor.

Growth Investing

The growth investing strategy is the status symbol of the bull market and the booming economy. Under these buoyant market conditions, this style of investing produces some fantastic returns and there is only one catch - the inevitable bear market that follows which can destroy the value of a portfolio. As such, this strategy requires a thorough understanding of the stock market.

Value Investing

The value investing strategy is a double edged sword. On the one hand it is a relatively low risk strategy that provides one of the highest long-term returns available from the stock market when utilized correctly. However when utilized incorrectly, especially by inexperienced or unknowledgeable stock investors, this strategy can produce poor results and can even be downright dangerous.

Dividend Investing

The dividend investing strategy is a fairly conservative investing style that is mostly concerned with the steady income stream obtained from the stock dividend payments. This is a relatively safe strategy for beginner stock investors to incorporate into their investment portfolios.

Blue-chip Investing

The blue-chip investing style is considered the most conservative approach and many professionals recommend this strategy as a good style for beginner stock investors to start off with.

Small-cap Investing

Conversely, most professionals would advise the beginner stock investor to avoid small-cap investing until their knowledge and experience level is sufficient to manage the higher risks associated with small-cap stocks as these are could be speculative stocks.

Growth Investing

This is the strategy that investors love - High return, but High risk

An Overview of Investing Strategies - Growth Investing; Picture of a stock Investor placing his left hand under a growth chart displayed on a clear glass panel hanging in space.

Looking for Sales and Profit Growth

Growth investing is a popular investing strategy which uses fundamental analysis in order to determine a company's future sales and profit growth potential.

A company's recent historical sales revenue and profit growth is analyzed to determine whether the company has a proven track record of growth, thus providing confidence that the company can grow - this is the basis for growth investing.

The company's future sales and profit forecasts obtained from analyst's estimates are used to determine the company's potential for further growth into the future

Companies that have a proven track record of recent growth tend be quite expensive relative to their valuation, as investors are willing to pay high stock prices for this future growth potential. In other words, investors are paying for the company's future value today.

The stock price tends to grow faster than the business valuation, and this leads to a couple of issues with growth companies.

Those companies that do not meet analysts forecast earnings estimates when reporting time comes, can see their stock prices reduced dramatically by investors selling out as they perceive that the company's future growth prospects are over.

Simply having a notable analyst lowering their forecast estimates can lead to a similar stock price decline.

The same can easily occur if the industry group the company belongs to or the economy in general show signs of growth slowing.

Investors need to be careful when the

stock price grows faster than its valuation

Growth investing involves tracking each quarterly or annual earnings report to determine whether the company still has sufficient future growth potential and if not, then the shares are sold.

Growth investing is generally not suited for a buy and hold investment portfolio.

Characteristics of Good Growth Stocks

The characteristics of good growth stocks for a growth portfolio include the following.

Characteristics of good growth stocks:

  • Strong recent historical sales and profit, which has been growing at a significantly faster rate than the economy.
  • Are in an industry that is growing or the company has a new or improved technology, product or service.
  • Tend to be smaller companies which generally find it easier to expand than large established companies. A smaller company with a new product and an aggressive marketing campaign could potentially double its profit but a large blue-chip will find this extremely difficult to achieve.
  • Insiders such as directors and key employees may be purchasing stock. These insiders know the company and their own buying provides some additional confidence that the company has further potential to grow.
  • Analyst estimate downgrades are not desirable as there is now some doubt as to the company's future growth prospects.
  • Stock prices are generally in an uptrend which provides a lot of confidence to investors that this trend will continue.

Growth investing during buoyant economic times can be extremely profitable, which certainly contributes to this strategies popularity.

However caution needs to be exercised when any factor that would reduce or stop the growth of these companies emerges, which can make this strategy quite risky if the stock is not sold as the ensuing price declines can be dramatic.

Value Investing

This popular strategy is suited to the patient investor who loves a bargain

An Overview of Investing Strategies - Value Investing; Picture of a stock Investor holding a clipboard and pointing with a pencil showing the value investment returns he achieved from the stock market.

Looking for Value

Value investing is a popular investing strategy which uses fundamental analysis in order to determine a company's value.

The basis for the value investing strategy is that the stock price and the company's valuation are two different figures.

Only good quality companies with a history of producing reliable sales and profits are considered.

As this strategy involves buying when the stock price is below the company's valuation, investors need to be assured that the stock price can rebound higher again in the future, and it can not do that if the company's fundamentals deteriorate.

Value investing is essentially a bargain hunting strategy that involves buying fundamentally sound companies which can include growth companies, at a price that is less than what they are worth.

Generally the stock price of a company only drops below its valuation when some event caused investors to sell out, which could be anything from a company reporting less than expected profits, to a generally poor economic environment.

Historically, the stock price of most companies drop below their valuation at some stage and this is where value investors seek to buy their stocks.

Value investing is more concerned with the stability of the company than it is with its growth prospects.

Value investing is all about buying at a price

that is less than what the stock is worth

The stock price can remain depressed for quite some time and as such considerable patience is required.

Sooner or later the stock price rises above the company's valuation and the patient investor is rewarded as they purchased shares while prices were depressed.

Characteristics of Good Value Stocks

The characteristics of good value stocks for a value portfolio include the following:

Characteristics of good value stocks:

  • Fundamentally sound with a history of reliable sales and profits.
  • Mature companies that have been in business for quite some time are best. Newer companies that have been in business for only a couple of years have not yet proved their reliability.
  • Generally they are out of favor with the financial press who tend to focus only on the negative aspects of the company.
  • Insiders such as directors and key employees purchasing shares rather than selling shares. These insiders know the company and their own buying provides confidence that the company is fundamentally sound.
  • Stock prices are generally in a down trend which makes some stock investors nervous. Stock investors tend to be more confident if the stock's price is climbing rather than falling.

Value investing is a relatively low risk strategy for generating long term wealth for the patient investor and can be extremely profitable during periods of slow economic growth, as this allows investors to buy good quality company stocks at bargain prices.

Value investing is typically a long-term investment strategy that is generally suited to a buy and hold investment portfolio.

The long-term returns of this strategy are quite impressive and the effects of a bear market are fairly minimal as the stocks have already been sold down.

Dividend Investing

The best of both worlds - receive an income with your capital gains

An Overview of Investing Strategies - Dividend Investing; Picture symbolizing the Dividend Investment returns that were achieved from stock market investors by using stacks of gold coins.

Looking for an Income

Dividend investing is also known as income investing and is a popular investing strategy which uses fundamental analysis in order to determine a company's ability to pay a dividend reliably.

The basis for the dividend investing strategy is to purchase shares in a dividend paying company at an attractive price, thus providing a desired dividend yield on the capital invested.

The dividend yield is defined as the dividend divided by the purchase price and is expressed as a percentage. Dividend investing is also sometimes referred to as fixed income investing.

Only good quality dividend paying companies with a history of producing reliable sales and profits which are fundamentally sound are considered, as dividend investing requires the company to continue to pay the dividend well into the future.

Basically there are two ways for the dividend investor to obtain a reasonable dividend yield.

Firstly is to purchase companies that pay reliable dividends but without any significant growth prospects as these companies do not need to reinvest their profits to finance any growth. Utility companies and manufacturing companies are popular.

Secondly is to wait for the stock price of low dividend yield companies to drop to a level where the dividend yield is attractive.

Generally the stock's price will only drop low enough when some event caused investors to sell out, which could be anything from a company reporting less than expected profits, to a generally poor economic environment.

Historically, the stock price of most dividend paying companies at some point will drop to level that will provide a decent dividend yield and this is where dividend investors can add these stocks to their dividend portfolio.

Dividend investors can increase their yield

by buying stock at discounted prices

Reliable dividend paying stocks do not generally include growth stocks. However they can still provide good long term capital growth in line with the growth in the economy.

Characteristics of Good Dividend Paying Stocks

The characteristics of good dividend paying stocks include the following:

Characteristics of good dividend paying stocks:

  • Fundamentally sound with a history of reliable sales, profits and paying dividends.
  • Mature companies that have been in business for quite some time are best. Newer companies that have been in business for only a couple of years have not yet proved their reliability.
  • Generally are not growth companies as they tend to reinvest their profits.
  • Low dividend yield stocks can provide decent dividend yields when they are out of favor as the stock price is now sufficiently low to provide a decent yield.
  • Insiders such as directors and key employees purchasing shares rather than selling shares. These insiders know the company and their own buying provides confidence that the company is fundamentally sound.

Dividend investing is a relatively low risk strategy for generating long-term wealth for the patient investor.

Most fundamentally sound companies that pay dividends will still provide capital gains in line with the growth in the economy.

Dividend investing is typically used for buy and hold investment portfolios and most dividend investors rarely ever sell a stock.

The dividend income per year increases over the long term in line with growth in the economy, thus the yield increases over time based on the original capital invested.

Blue-chip Investing

Invest with the global leaders and the added security they provide

An Overview of Investing Strategies - Blue-chip Investing; Picture depicting financial strength with money with one dollar notes and silver coins lying on an invoice from a blue-chip stock.

Investing in the U.S. economy

Blue-chip investing is also known as Mega-cap investing and is a popular investing strategy which concentrates on the largest companies in the U.S. economy, especially those in the DOW index.

These blue-chip stocks are the bellwethers for the U.S. economy and as such ensure the investor that the value of their portfolio will increase over the long-term in line with the strength of the world's largest and most prosperous economy.

Thus investing in blue-chip stocks is investing in the future wealth of the nation.

Investing in blue-chips does not have any special requirements, as all the blue-chips are fundamentally very similar.

They generally pay a small dividend; however the yield is typically very low, although it is a bonus.

Stock market corrections and bear markets in general can provide some good barging hunting opportunities for blue-chips as the stock prices are subsequently temporality reduced.

Indeed many stock investors actively seek out blue-chips where the stock price has been sold down.

It still pays to check the fundamental soundness of a blue-chip stock before investing.

While they are the most financially sound stocks available, occasionally one might get into some financial difficulties. But as a general rule they are still the lowest risk stocks on the market.

Characteristics of Blue-chip Stocks

The characteristics of blue-chip stocks include the following:

Characteristics of good blue-chip stocks:

  • Fundamentally sound with a history of reliable sales, profits and paying dividends.
  • Mature companies that have been in business for quite some time.
  • Generally pay a small dividend and thus have a low dividend yield.
  • Growth in the blue-chip companies is generally more subdued compared to the smaller companies, but they are the lowest risk stocks available.
  • Insiders such as directors and key employees purchasing shares rather than selling shares. These insiders know the company and their own buying provides confidence that the company is fundamentally sound.

Blue-chip investing is the lowest risk strategy there is for generating long term wealth for the patient investor.

Many stock investors include blue-chip stocks into a buy and hold investment portfolio, while other stock investors seek to sell their blue-chip stocks with view of repurchasing these stocks during market corrections.

Small-cap Investing

The small end of the market - very high returns with high risks

An Overview of Investing Strategies - Small-cap Investing; Picture of the Investment returns shown next to a chart for stock investors with a calculator and a pen for analysis of the returns.

The Riskier Strategy

Small-cap investing is a riskier strategy that's not recommended for the beginner stock investor starting out, however the beginner who acquires a sound knowledge of investing in the stock market will fairly quickly developed the skills necessary to manage the risks associated with small-cap investing.

Small-cap Investing vs. Speculative Investing

Small-cap investing is sometimes considered to be a speculating investing strategy but these two investing styles have one important difference as discussed below:

Small-cap investing vs. Speculative investing:

  • Small-cap investing seeks out companies with solid fundamentals and a proven growth history. The idea is to invest in a smaller company with the potential to expand and grow into a larger company.
  • Speculative investing often seeks out small companies with questionable fundamentals that have the potential to rapidly grow their earnings. These speculative stocks do not have a proven growth history and are at a higher risk of bankruptcy.

Speculative investing is best reserved for the experienced and skillful stock investor as this is a very high risk strategy, and is not the topic of this article.

Small-cap investing is not as risky as speculative investing but it is still a higher-risk strategy. So why bother with small-cap investing.

The answer is simple; it gives one of the highest returns available from the stock market and with a manageable level of risk. In fact, most of the famous stock investors made good use of small-cap stocks in building their wealth.

The general rule is that the higher the returns, the higher the risk. To proficiently manage this risk is the key to being successful with small-cap investing.

Small-cap investing is a higher risk strategy

and there's no shortage of willing investors

The beginner stock investor may be wondering what the difference is between growth investing and small-cap investing.

Basically growth investing generally refers to large-cap companies which have been recently growing their earnings at a rate that is well above that of the economy.

Small-cap investing can also be thought as small-cap growth investing. Thus a small-cap stock that is successful will ultimately end up being a growth stock.

Characteristics of Good Small-cap Stocks

The characteristics of good small-cap stocks include the following:

Characteristics of good small-cap stocks:

  • Fundamentally sound with a history of reliable sales and profits.
  • Mature companies that have been in business for some time are preferable to newer start up companies.
  • Generally do not pay a dividend or have a low dividend yield. It is preferable for the company to reinvest its profits in order to expand future growth thus increasing its future profitability and value.
  • Growth potential in small-caps can be enormous compared to the larger companies, but they are also higher risk.
  • Insiders such as directors and key employees purchasing shares rather than selling shares. These insiders know the company and their own buying provides confidence that the company is fundamentally sound.

Small-cap investing during buoyant economic times can be unbelievably profitable, which certainly contributes to this strategies popularity.

It has the added bonus that these small-caps are bought before the stock price spirals higher, which was a favorite tactic of the famous investor Peter Lynch.

When a small-cap company becomes a larger company, its stock price typically goes through the roof.

The down side is that a large portion of small-cap companies never succeed in becoming larger companies and hence their stock price remains subdued.

An Overview of Investing Strategies - International Investing; Picture of an International stock Investing chart with global returns shown on a large wall mounted chart with price data shown on the bottom.

International

Investing

Investors are turning their attention to global markets

More Stock Investing Options

Stock investors have a variety of investing choices for investing internationally and most can be performed directly form the investors normal stock broking account.

Investors consider international investing for two main reasons - diversification and growth.

Diversification allows the stock investor to spread their risk amongst stocks from other countries with differing economies.

Growth allows the investor to take advantage of foreign economies that are growing strongly, especially the emerging markets.

By investing internationally, the investor's returns may move in a different direction or at a different rate than what a portfolio of purely U.S. stocks would.

One issue that international investing has is that of currency exchange. This means that even if a foreign stock performs strongly, the currency exchange may limit the returns when translated into U.S. dollars.

However, if a foreign stock performs strongly and the currency moves in the investor's favor, the returns in U.S. dollars will be magnified.

Investors should note that a lot of foreign economies cycle in synchrony with the U.S. economy, however their stock markets may not necessarily move as their economies suggests they should.

This can provide international investors will some unique opportunities. Merely having a currency move in an investor's favor provides a boost to their portfolio's returns.

There are several ways a stock investor can participate in international investments.

U.S. owned global companies

Investors may already have international exposure in their portfolio without being consciously aware of it. U.S. companies that primarily deal with foreign countries are exposed to the economies of those countries rather than exclusively that of the U.S. economy.

U.S. listed foreign owned companies

There are some foreign owned companies that are dual listed, meaning that they are listed on their home country's stock exchange and on a U.S. stock exchange.

The U.S. stock price will tend to follow the currency adjusted price of the foreign stock price. In other words, wherever the foreign stock price heads, the currency adjusted U.S. stock price follows.

Some companies have their headquarters setup in the foreign country and are listed exclusively on a U.S. stock market.

These stocks are the easiest foreign stocks to own as there are no currency issues to deal with and all the regulation is in accordance with the U.S. Securities and Investment Commission (SEC).

American depositary receipts

The most common method for foreign companies to access the U.S. stock market is via an American Depositary Receipt known as an ADR.

These ADRs provide a convenient means for stock investors to gain exposure to foreign stocks. ADRs are essentially a contract over the foreign company's shares (which are held by a U.S. depositary bank) and they allow the investor to buy and sell these ADRs on a U.S. stock exchange just like any other stock.

An Overview of Investing Strategies - International Investing; Picture of an International stock Investment returns data shown next to charts and tables with a blue boarder.

Buying directly on foreign stock exchange

Some stock broking accounts allow investors to buy and sell stock directly on the foreign company's home stock exchange.

These brokerage accounts are generally referred to as global brokerage accounts which allow stock investors to buy and sell stocks globally.

Some stock brokers may have provisions to allow investors to buy and sell foreign stocks in selected countries only, while other stock brokers will only deal with the U.S. stock markets.

Mutual funds and Closed-end funds

There are a large variety of mutual funds and some closed-end funds that invest internationally.

Some funds only invest in foreign stocks while others invest in other foreign investments such as bonds.

A distinction is made between global and international funds.

An international fund invests exclusively in foreign countries, whereas a global fund invests in the U.S. and in foreign countries.

Exchange Traded Funds and Index funds

Funds such as Exchange Traded Funds (ETFs) and the index funds available from Mutual funds and Closed-end funds provide numerous index funds that track a particular foreign countries market index.

The performance of the index is reflected in U.S. dollars which allows for the foreign country's currency exchange rate.

Issues and Risks of international investing

The first issue with investing internationally is the currency exchange rate variations over the term of the investment. These can significantly alter the returns, which can be good or bad.

Generally most foreign countries impose a withholding tax on dividends paid by the foreign company which lowers the effective dividend received.

Funds tend to have higher costs with international investing and these may be reflected in higher fees imposed on a fund investor.

The reporting of information such as annual reports and disclosures varies between countries and may not necessarily be consistent with what U.S. investors are used too. Some foreign companies do not even provide this information in English.

Investors tend to be more in tune with the domestic economic and political environment than they are with that of foreign countries, which can be a disadvantage.

The decision as whether to diversify internationally is ultimately determined by each individual investor's personal circumstances and objectives.

International investing can provide a more balance portfolio and can enhance the returns.

Hedge Fund Strategies

Investors are curious about the techniques used by these mysterious fund managers

An Overview of Investing Strategies - Hedge Fund Strategies; Picture of Hedge Fund sign shown as a stamp with purple writing on white paper for stock Investment management.

What are Hedge funds

Hedge funds are similar to mutual funds and are generally set up as private investment partnerships that pool investors' money.

Unlike mutual funds, the investor's share of a hedge fund cannot be readily sold as most hedge funds require a minimum time of commitment from the investor (which can be one year).

Hedge funds typically have high entry costs and are primarily aimed at the high net worth investor which restricts the ordinary investor from participating. They can be thought of as the rich mans fund.

The primary goals of hedge funds are to outperform the market when the market is rising and to provide positive returns when the market is falling.

They are aggressively managed and use a variety of advanced speculative investing strategies such as trading, margin, short selling and options.

Hedge funds may specialize in certain markets such as the stock market, the commodities markets or the currency market, or they may use any combination of markets.

The term hedge is an investing strategy used to reduce risk. In the early days of the hedge fund industry, hedge funds would hedge the downside risk in a bear market by short selling.

Nowadays, hedge funds have evolved and use a vast variety of strategies, most of which are actually not hedging tactics. Thus, they are for the most part no longer strictly hedge funds but most would be more accurately described as speculative funds.

Not all hedge funds are the same and they can use a large variety of strategies ranging from low volatility conservative strategies through to highly volatile aggressive strategies that utilize high degrees of leverage.

Hedge funds will often specialize in a particular strategy and some of the strategies employed by hedge funds are as follows.

Growth Stocks

The hedge fund invests in stocks that are expected to accelerate their earnings growth.

The stocks held in the fund typically have high PE ratios, pay no dividends and are often small-cap growth stocks or even micro-cap stocks.

The fund aims to hedge by short selling stocks that are expected to disappoint with their earnings results. They may also short selected stock indices.

This strategy is considered to be high risk.

Distressed Stocks

Hedge funds buy stocks and/or bonds that are facing bankruptcy and have negotiated an alternative creditor repayment plan rather than filing for bankruptcy.

These stocks have been heavily sold down to prices below what they are realistically worth.

The funds might sell their stocks when prices rebound back to its true value or they may hold them.

This strategy is considered to be high risk.

Emerging Markets

These hedge funds invest in stock markets of newer industries or countries that have the potential to significantly grow.

They may also invest in high yield corporate bonds or foreign government bonds. The hedge fund may not be able to short sell and thus may not be able to provide any hedging to offset the risks.

This strategy is considered very high risk.

Income Investing

The hedge funds primary focus is on yield rather than capital gains and they will typically buy stocks and bonds on margin to increase the yields.

They may include short selling options over a variety of markets such as stocks, commodities or currencies.

This strategy is considered to be low risk.

Value Investing

This type of fund invests in stocks that are considerable under undervalued and may be out of favor or not followed by analysts.

The hedge fund may take long term positions and hedge risks with short term positions.

This value investing strategy is considered to be low to moderate risk.

Global Economies

These hedge funds aim to profit from changes in a countries economic environment.

Changes in government policies, economic growth and interest rates provide hedge funds with opportunities and they can profit from the downside as well as the upside through the use of derivatives such as options and futures contracts over the stock market, commodities markets and the currency market.

This strategy is considered very high risk.

Arbitrage Trading

This style of hedge fund takes a market neutral approach by attempting to factor out most of the directional risk.

They achieve this by taking offsetting positions such as buying a company's bonds and short selling their stock.

They may buy under priced closed-end funds.

This strategy is considered to be low risk.

Market Timing

These hedge funds rotate the funds money from one market to another when a particular market provides more potential than the existing market does.

They may also rotate between different industry groups within the stock market by buying stocks in an upcoming industry and selling the stocks from the industry that may have peaked.

This strategy is considered to be high risk.

Event-Driven

These hedge funds invest in event-driven opportunities such as mergers, hostile takeovers and reorganizations.

They may buy stock in companies being acquired and short sell its acquirer. They may invest in IPOs or short sell overpriced stocks with earnings disappointments.

This strategy is considered moderate risk.

Summary

Hedge funds employ a vast variety of strategies that range from short-term to long-term.

Hedge funds can be quite active on the financial markets and even the long-term strategies can involve a considerable amount of activity.

There are many hedge funds that would be more appropriately considered to be trading funds rather than investing funds.

The aim of these hedge funds is to extract shorter term and positive gains under a variety of market conditions which is only possible by using active short-term tactics.

Stock investors can readily study their tactics and decide for themselves on the suitability of incorporating any of these hedge fund tactics into their own investing style.

Blog Articles