It could be the overly high expectations of growth from high-tech companies or the excessively large loans that were given to home buyers; every recession is caused by different reasons that cannot be predicted in advance. However, there are always stocks that perform well even during these bearish periods. They are usually called ‘defensive’ companies, and if you have never heard of them, you should carefully read what comes next to be prepared for the next recession.
Looking at the year-to-date performance of the 30 Dow Jones members (taken from Bespoke Investments) can teach us an important lesson about investing during a recession. Without looking at the chart below, can you guess which company’s stock had the best performance?
No matter what the reason for the recession, people will always have to buy home equipment and groceries; also, since your budget is limited during these periods, you’ll probably choose to buy in a discount store. This is exactly why sellers of cheap goods and food such as Wal-Mart (WMT) and McDonald’s (MCD), have thrived. The defensive stock story is a common recession theme, but it was clearly a winner this time.
All seven stocks that had positive returns for the year are defensive stocks. We already mentioned Wal-Mart and McDonald’s; IBM, the (relatively) cheap computer equipment seller is also placed higher on this list, as well as the giant healthcare products manufacturer Johnson & Johnson (JNJ), and the home improvement retailer Home Depot (HD). Despite the recession, people always have to have at least some fun during their vacations, and it should be not too pricy; thus, it is not surprising that we see the most well known entertainment company Walt Disney Company (DIS) closing the list of successive stocks.
Finally, if you want to remember only one thing from this short article, remember this: during a recession, the companies with the highest chance of yielding a positive return are the low-priced retailers with the most recognizable brands.
Tags: Recession, stocks
September 4th, 2008
There are lots of services on the Net claiming they can ensure that you’ll beat the market. Beating the market means achieving an average return higher than the market performance during the same period. It might seem easy to do, but it’s a very hard task that only a few services manage to do in the long run. So, where can you find such successful services?
It turns out that one of the best places to look for stocks that will beat the market is stock picking communities. These communities gather many excellent traders and investors that trade and invest using various strategies, trying to achieve the highest returns possible over time. They hold virtual portfolios that can be tracked and followed. One of these stock-picking communities is Yalicoo.com, where investors compete against each other, aiming to yield the highest return during the competition period (daily, monthly and quarterly competitions). The unique advantage that Yalicoo has over other sites is that every thing is done in real time. This means that you trade stocks (virtually) in real market prices and can see all the other investors’ moves in real time. This allows you to copy the moves of the investors you like into your real money portfolio.
The statistics shown in Yalicoo are quite impressive and hard to ignore. The winner of Yalicoo’s last monthly stock market competition had a return of 40%; in the previous monthly competition, the winner ended with a return of 17%. One month earlier – 22%, and the month before – 14%; and this goes on and on… If you followed these winners’ moves (and it’s easy, since you can see every thing they do in real time at Yalicoo), your real money portfolio could have grown dramatically.
In the last year or so since Yalicoo was launched, Yalicoo investors have been consistently beating the market in almost every time frame I checked (!). Obviously, there is no guarantee for future success in the stock market, but in light of the results shown here, these higher returns of Yalicoo’s investors definitely show a clear trend of success.
The number of educational sites on the Internet is enormous, but I encourage you to visit as many of them as you can to continuously educate yourself. Still, places like Yalicoo are excellent complementary arenas for investors who aspire to maximize their returns over time.
September 4th, 2008
Did you ever heard of Fibonacci, moving averages or candlestick charting? Well, these are few of technical analysis basic tools. Technical investors believe that all the information about a given stock can be viewed by reviewing its past and present statistics, such as the trend in the volume of stocks traded and the stock price chart (the graph of the stock price change over time). Then, by mathematically analyzing the behavior of the graph and using statistical analysis they (hypothetically) can identify patterns suggesting the future behavior of the price.
Usually, technical analysis is used for the short term, since it is too hard to predict patterns way into the future (although there are some who try).
There are three basic assumptions behind technical analysis. The first states that stock price reflects everything you need to know; therefore, technical analysts assume that fundamental factors and the market psychology are already priced into the price. Second, technical analysis assumes that price of a stock moves in trends. This means that after a trend has been established, the future trend is more likely to continue in the same direction than going against it.
Finally, technical analysis is strongly based on the underlying assumption that historical patterns tend to repeat themselves. In simple words, it means that investors tend to react more or less the same way to similar market events over time.
Although it may seem straightforward, there is almost infinite number of mathematical techniques and tools for technical analysis. Most of the technicians are first trying to figure out the overall trend of the price change in order to conclude if it is an uptrend or downtrend. Mathematical pattern descriptions such as moving averages, oscillators and other indicators are the tools which assist the technical investor to apply this analysis.
Then, the investors start to understand the smaller details inside the trend and see if there is any support or resistance to this trend. For example an uptrend with a support in trading volume could be a good indicator for the stock price to continue climbing up. This might be a good time to buy the stock. On the other hand, if there is a strong resistance to the uptrend, it might be a good time to sell if you hold the stock.
Technical analysis is not simple and definitely not absolute. In addition technical investors want to know even more details. They also want to know for example the specific shape of the graph pattern; it could be classified as having a head shape, a shoulder, a cup or even a handle.
Feel confused? It is OK. Technical analysis is complicated at first sight. The large variety of techniques requires you to educate yourself regarding its basic rules. Then, if you choose to use it, you will have to improve your skills by practicing the different techniques. Yalicoo is a great place for this purpose (and we will get to that shortly).
There is a vast debate both in the academic and in the private world about the capability of these technical techniques to beat the market. Studies tend to show that technical analysis does not work for the long run, but it is much harder to test it on the short run, since many of technical analysis conclusions are not that conclusive.
June 26th, 2008
When you buy a stock you are actually buying a proportional share in a business. There are therefore investors who believe that in order to figure out how much a stock is worth, one should determine how much the whole business is worth. This is done, for example, by examining the financials of the company in terms of per-share values; this in turn helps calculate how much the proportional share of the company is worth. This analyzing philosophy is the basis of fundamental analysis.
In addition, fundamental investors have to consider other aspects of the business, such as the quality and experience of the management, the competitive environment, future growth prospects and many other fundamentals issues which may affect the success of the business.
While the above analysis may seem reasonable and appropriate, there are other methods investors use, each with its strengths and weaknesses. These approaches have some issues in common, while they may differ in other aspects. Some investors therefore use a blend of approaches to achieve optimal valuation or growth.
In the following paragraphs we briefly summarize the most common types of fundamental analysis approaches, and explain the general description of each one of them.
Value investing
The foundation of value investing goes back to the 30’s, when Benjamin Graham first published his widely known book ‘Security Analysis’, which for the first time suggested quantitative measurements of valuing a business. The goal of a value investor is to buy shares of companies traded at a large discount to their intrinsic value. This means that while the company and therefore its shares may be worth more than the current price of the shares, for one reason or another the shares are sold cheaper than they “should”.
Valuing the intrinsic value of a company is not an easy task and there are many paths you can elect to do so. In general, value investors are using the financial sheets, such as the balance sheet and income and cash flow statements, in order to find those undervalued companies.
One way to value a company can be done by comparing the ratio between various financial parameters of the business to those shown in other companies from similar sectors or in the entire market in general (a ratio means to divide one parameter by another one). For example, a price to earning ratio (P/E – dividing the price of a stock by the company earnings of last 12 month) below a certain limit, or a book value at relatively low level, can give an indication of the company stock traded at a discount level.
Growth investing
As the name implies, growth investing deals with the potential of a company to grow relatively rapid in sales and earnings in the future. Investors choosing this method of analysis usually plan to hold their stocks for a long (and sometime even very long) period of time in order to “ride” on the increment in stock price as further into the future as possible.
As in value investing, there are many different ways to measure growth. Usually, growth investors are looking at the quality of the business and try to predict if measures such as sales and earnings growth rate will continue to be well above the industry or market average.
Growth method of investing is often considered as the opposite method of value investing, since the main interest is not the company’s current value, but its future growth potential. A better way to view these two strategies is may be to consider a quote by Warren Buffet: “growth and value investing are joined at the hip”. The confirmation for this statement is the commonly used hybrid GARP (Growth At Reasonable Price) method which combines the two strategies (see next paragraph).
GARP investing
GARP is the acronym for Growth At Reasonable Price. The world according to GARP investors combines the value and growth philosophies - looking for undervalued companies with high growth potential. Thus, GARPers do not just hold a portfolio of value stocks and growth stock; they select stocks which have both the characteristics of value and growth. For example, they are using the not well commonly known PEG (Price to Earning Growth) ratio, which compares a stock’s P/E ratio to its expected EPS growth rate (the P/E divided by the annual Earning Per Share growth).
A PEG below 1 implies that the stock’s present price is lower than it should be given its earnings growth. This stock could be interesting for GARPers, since the analysis may give an indication that the stock is undervalued compared to the company’s growth. Plainly put, the GARP investors are searching for companies that will be cheap tomorrow if the growth occurs as expected.
One of the biggest supporters of the GARP approach is Peter Lynch, who is considered to be the most successful fund manger of all times, due to his phenomenal average return of 29% in the 13 years he managed the Fidelity Magellan fund, turning 20 million to more than 14 billion dollars.
Although GARP might sound like the perfect strategy, combining growth and value investing is not as easy as it sounds, and success in the GARP strategy requires a thorough understanding of the involved strategies.
Income investing
One of the most straight forward strategies is income investing (called sometime dividend investing). Income investors concentrate on companies providing a steady stream of income. Don’t confuse steady income with fixed income securities, such as the interest you will get by investing in bonds. In income companies, the income is paid by dividends. A company’s excess net profit can be either reinvested in the business in order to expand it, or it can be distributed among shareholders in the form of dividends.
Profitable large companies, like Johnson & Johnson, which are not rapidly expanding, generally pay high yield dividends to their shareholders (calculated as the annual dividend per share divided by the stock price). Income investors are looking for those companies and enjoy their dividends stream as a part of their current income.
Qualitative investing
Qualitative investors are focused on the quality of the company- its financial quality as well as its human resources quality. The ROE (Return On Equity) or the ROA (Return On Assets), for example, are two commonly used measures determining the quality of the company, as they measure how much profit it generates using the money shareholders have invested in it or relative to the assets it holds.
Qualitative investors believe that behind every successful business there is great management. Thus, quality can also be measured by the excellence of the company’s executives. These people are the visionaries and leaders who make the strategic decisions regarding the company’s future and therefore determine the fate of the business. Therefore, it might be crucial to evaluate their “value” since ultimately it will affect the price of the stock.
Obviously, a person can not simply be valued quantitatively; but, you can try to figure it out by checking past and present performance, and the future plans of the management. Qualitative investors look for answers to questions such as who are the managers, where did they study and where did they work before joining the business and what is their track record in this or other companies.
For example, if the CEO (Chief Executive Officer) has worked in a successful oil company before joining the company, it could be good indication of his capability to run a company in the oil industry (whether drilling, equipment, distribution, etc). Additional questions, such as what is the management’s philosophy and what are their plans for the future, can give further insights of their chances to successfully grow the business.
Quantitative Analysis
Quantitative analysis is all about numbers. The underlying assumption behind this philosophy is that the conclusions based on different measures rather than the pure numbers, such as the quality of the management or the competitive environment, are based on subjective judgments. Quantitative investors believe that the numbers themselves are the only data that can be analyzed objectively.
Benjamin Graham, who is also known as the “father of value investing”, was the pioneer of quantitative methods. After the 1929 market crash, he developed a simple technique to analyze the numbers rising from the financial sheets of the company. He popularized the examination of well known ratios such as the price to earning (P/E) ratio, debt to equity ratio, book value, earning growth and others. Graham was focused on the objective numbers rather than other fundamental subjective data such as the quality of the management.
During the years, a significant amount of academic and actual research has been conducted in order to uncover the optimal method to crunch the numbers. The fast development in computers makes it easy today to analyze quickly the numbers of companies using a simple automatic tools or manual screeners. This has lead to variety of quantitative methods.
For example, there are investors who choose to trade companies by their size (their market capitalization – the stock price multiplied by the number of outstanding stocks); some investors choose small cap companies (companies with market cap between $100 million to $500 million), since history shows that small cap companies tend to have higher returns on average compared to larger ones. One reasonable explanation for this result is the fact that smaller companies have got much room to grow; thus, they could have much larger growth rate.
On the other hand, small companies usually reinvest most of their excess profits in the business itself, and don’t pay regular dividends as do some larger companies.
Most quantitative investors today use a set of screening criteria to screen for their winning stocks. There are various criteria used, from the simple P/E ratio to more complicated ratios.
The use of strategies to evaluate and pick stocks has become so popular today that most financial internet sites have their own designated screeners and ranking methods.
Among the variety of quantitative methods, there is the well known CANSLIM method, developed by William J. O’Neil, which is a hybrid of quantitative analysis and technical analysis (the analysis we will discuss next). Each letter in the acronym stands for a key factor to look for in a company. The “C” and the “A” stands for Current quarterly and Annual increment in earnings. The “N” stands for New things in the business such as new products, new management and so forth. “S” is the short for Small market cap with big demands for its stocks.
The next, “L”, tells you to verify if the company is a Leader or it is Laggard compared to other companies in its industry. The “I” symbolizes the Institutional sponsorship (meaning which financial institutions hold a significant percentage of the company’s stock) and the “M” stands for the direction of the Market.
As previously mentioned, this strategy also includes various components of technical analysis such as cutting all losses at no more than 7% or 8% below the buy point (i.e. if the price of a stock you hold falls more than 7-8% from the original buy price it should be sold).
June 26th, 2008
Some investors like to compare the stock market to a supermarket: you go through the isles, pick up the products you like based on marketing and price comparison and buy it. In case you do not like the product- you return it for (hopefully) a full refund of the purchase price.
Needless to say, in spite of the similarities the two markets are not exactly the same. When you buy (or sell) stocks, options, bonds and other securities, you pay commission to your broker for executing your orders. Unlike the supermarket where a full refund can be expected upon return of a defective item, when selling a stock in one of the exchanges you will get a “refund” at the current price of this stock. This could be higher than the initial buying price, in which case you profit; on the other hand, it could be much lower and you lose a part of your savings.
The purpose of investing in the stock market is to choose winning stocks, sell them at a profit and increase your capital. Therefore, it requires that you develop a trading strategy or blend of strategies in advance, a strategy that will fit your plans and tolerance for risk. This can help you avoid making mistakes while potentially bring you profits.
Yalicoo is a unique arena that can assist you achieve this purpose. We do it by letting you practice variety of strategies using real time quotes, and without the risk involved in investing real life savings.
In general, there are two main branches of analyses which are used by investors: fundamental analysis and technical analysis. The fundamental method concentrates on the business and the financial numbers while the technical strategy deals with the technical details such as the behavior of the stock price over time or the trading volume. Each strategy is composed from many sub-methods. For starters, let us first understand the general concept behind each strategy and review the sub-methods used by investors in the stock market.
June 26th, 2008
