Wednesday, April 21, 2010

Stock Investing Strategies

Dear Investor Juan

Dear Investor Juan,

Hello sir, how are you? I have an investment question for you. Last year I invested in BPI’s index fund, but I’m unsatisfied with the returns; I also own Globe Telecom bonds which I think yield only 6% for three years. I’m thinking of shifting my investment to one which provides higher returns, and I’m considering investing in individual stocks because of the possibility of better returns. Do you have any tips or suggestions? I used to love reading finance books by Benjamin Graham until I discovered how they can be too deep and complicated. And yeah, I don’t have any patience at all to read annual reports and financial statements of listed companies.

Take care, sir! More power to Investor Juan! :)

Your number one student,

Jane Lao Lim

Hi Jane!

If you still have your BPI Index Fund investment now, then you have already earned around 50% on your investment, so I really don’t understand how you’re unsatisfied with that. But your Globe investment does kind of suck, so you might want to shift that to another vehicle.

Yes, if you’re interested in better returns that what you’re currently earning, then one way to go about is by picking and investing in individual stocks (another is by buying high-risk derivative instruments that I’m currently still not very familiar with).

Choosing between stock picking and holding a diversified portfolio of stocks (like the index fund you own) is one very important decision point in stock investing. Stock pickers typically invest in the short run (although many also buy and hold stocks) and employ speculative investment strategies; index investors tend to invest in the longer term and rely on a general expectation that the stock market as a whole will appreciate in the long run.

Picking stocks often involve any one or a combination of two techniques: technical analysis and fundamental analysis. Technical analysts or chartists base stock price predictions exclusively on historical stock prices and stock price trends; the premise of this technique is that the stock prices go though cyclical (and therefore, predictable) movements that can be exploited by making correctly-timed buy and sell decisions. Technical analysts do not care at all about what business a particular company is in, or how attractive the prospects of a company are: all that matters are historical price movements and trends.

So does this strategy work? It depends on who you ask. If you ask my former boss and a couple of other friends I know, they’ll tell you that charting is based on gospel truth; you’ll often hear them brag about a couple of lucrative short term plays, but you’ll never hear anything about a bad loss. Which makes me wonder whether I’m actually talking to a true-blue investment whiz, a very, very lucky person, or someone who just knows when to shut up and keep his reputation (and that of his investing style) intact. Personally I think this strategy is baseless and ultimately futile: historical prices alone would not provide enough information about what will happen in the future. And I still have not seen an investor both here and abroad who was able to consistently beat the market index just by using charts.

Still, most of us know that the market can be beat, even a market as efficient (or maybe it isn’t as efficient as many academicians believe, but this is something better discussed in another post) as what they have in the US; most of us do know that Warren Buffet has been able to consistently and convincingly beat the S&P 500 index (something like our PSEi, but for the New York Stock Exchange and consisting of 500 stocks instead of 30) for more than three decades. But Warren Buffer is not a technical analyst: actually I would like to think of him as the anti-thesis of a technical analyst. He’s also a stock picker, yes (he thinks investing in diversified portfolios is for people who don’t know what they’re doing) but he employs a wholly different strategy called fundamental analysis, which is something he got from his mentor, Benjamin Graham, the person you mentioned in your question. I won’t go into the details of fundamental analysis (because our good friend Ange will discuss it in greater detail next post), but in a nutshell, it involves determining the “intrinsic” or “true” value of a stock by analyzing the company’s financial statements and annual reports (yes, even the best of them do this) and looking at the firm’s competitive and macroeconomic environment. Once you have this value, you compare it to the current stock price: if the intrinsic value is greater than the stock price, then the stock is underpriced and you should buy; if it’s the other way around, then the stock is overpriced and you should not buy or if you own the stock, you should sell (or if you can, short sell—that is, borrow the stock, sell it, and pay for it with the same stock in the future when the stock price drops). It’s actually even more complicated than it sounds, and takes a shitload of research and time to do. That’s why I don’t do it. Even if I decide to, if I just invest, say, 100,000 pesos, the returns that I could earn may not be worth the effort; it only makes sense to do this if you have a lot of money play with, either your own or other people’s (your clients if you are a fund manager, for example).

So if technical analysis is a no go, and so is fundamental analysis, then what are you to do? Warren Buffet had it right when he said that investing in diversified portfolios is for those who don’t know what they’re doing: the funny thing is that most of us really don’t know what we’re doing most of the time. That’s why I suggest that you just keep on doing what you’re doing and invest in a diversified, unmanaged portfolio of stocks and hold on to it in the long run (meaning after three decades or four). If you don’t want to take my word for it, maybe you would listen more to someone who definitely knows what he is doing: John C. Bogle is the 80-year-old founder of Vanguard Investments, one of America’s largest mutual fund companies. His advice is simple and concise: “Invest consistently and for the long haul in a widely diversified portfolio of stocks and bonds. Pay attention to taxes and costs. But leave your investments alone.” You’re still lacking on the bond side, but at least you’re halfway there. Happy investing! :)
Related Posts Plugin for WordPress, Blogger...