Till now we have talked about Assets and Liabilities, and how to invest in assets. If you have not read about it you can read it here. But have you thought what are the different thought processes that go behind the mind when investing in these assets? in this post, we are going to look at some of these thought processes. These thought processes form an integral part of an investor’s investing and thus transform into their investment strategy.
So what are Investment Strategies?
So first of all let’s understand what is an investment strategy. An investment strategy is a systematic plan or set of principles designed to guide an investor’s selection of an investment portfolio. It helps investors achieve their financial and investment goals based on risk tolerance, future capital needs, and profit objectives. Strategies can range from conservative to aggressive and may include various approaches such as value investing, growth investing, or focus on specific industries or market segments.
Types of Investment Strategies
There are different investment strategies and investors use one or a combination of them depending on their risk appetite, experience, etc.
Value Investing
This strategy involves looking for stocks that appear to be trading for less than their intrinsic or book value. Investors seek out companies that are undervalued by the market and therefore expected to provide a good return on investment over time. Investors who follow this strategy believe that the market overreacts to news, both good and bad, resulting in stock price movements that do not correspond with the company’s long-term fundamentals. The discrepancy provides an opportunity to buy stocks at a discount.
Value investors use financial analysis to identify undervalued stocks and are typically long-term holders of their investments. they don’t follow the herd and instead look for quality companies that are trading below what they consider to be their true value.
The process involves looking at various metrics, such as price-to-earnings ratios, book value, debt-to-equity ratios, and free cash flow. The goal is to ascertain whether a stock is undervalued compared to its actual worth. A key concept in value investing is the margin of safety, which is the difference between a s stock’s market price and its calculated intrinsic value. A larger margin of safety may indicate a more attractive investment opportunity.
While value investing can offer significant rewards, it also comes with risks. It requires a thorough understanding of financial statements and the ability to withstand potential market volatility. Stocks may remain undervalued for extended periods, and there’s no guarantee they will appreciate.
Value investing is akin to shopping for bargains – it requires patience, diligence, and a contrarian mindset. It’s about buying a dollar’s worth of assets for fifty cents and waiting for the market to realize and correct the undervaluation.
Growth investing
Growth investors focus on companies that exhibit signs of above-average growth, even if the share price appears expensive in terms of metrics such as price-to-earnings ratios. The expectation is that the company’s growth will continue at an above-average rate, and the investment will therefore increase in value.
Growth investors often favor smaller, younger companies poised for expansion and increased profitability potential in the future. The primary goal is to earn profits through the increase in stock value, rather than through dividends or interest. This is achieved by selling the stocks after they have appreciated.
When evaluating growth stocks, investors look at historical and future earnings growth, profit margins, returns on equity (ROE), and share price performance.
While growth investing can offer impressive returns if the companies are successful, it also carries a higher risk as these companies are often untested and may not have a proven track record.
Growth investors typically look for investments in rapidly expanding industries where new technologies and services are being developed. Therefore disrupting industries such as Edtech, Fintech, and e-commerce can be included under this umbrella.
Growth stocks may trade at a high price/earnings (P/E) ratio, as they may not have earnings at present but are expected to in the future due to their potential and access to innovative technologies.
Momentum Investing
Momentum’s strategy aims to capitalize on the continuance of existing trends in the market. it involves buying securities that are rising in price and selling them when they appear to have peaked. It involves buying stocks that have had high returns over the past three to twelve months and selling those that have had poor returns over the same period. The idea is to ride the wave of market momentum, which is the ability of a price trend to sustain itself and to profit from buying opportunities in short-term uptrends.
There is a high risk of significant losses if market trends reverse suddenly. Reliance on past performance may not always be indicative of future results. Market volatility can disrupt trends, leading to potential losses.
It can include periods of underperformance, especially in bear markets or during market corrections. Moreover, constant monitoring of the market and quick decision making required, which may not suit all investors. Frequent trading is often involved, resulting in higher transaction costs.
Dollar-Cost Averaging
This is an investment strategy where an investor divides the total amount to be invested across periodic purchases of a target asset at regular intervals, regardless of its price. Over time, this can potentially lower the average cost of the investment, as more shares are purchased when prices are low and fewer when prices are high.
The aim is to reduce the impact of volatility on the overall investment by buying more shares when prices are low and fewer shares when prices are high, thus lowering the average cost per share over time. This strategy is followed when the investors have high faith in the stock and know that the fall is only part and parcel of the market.
The risk associated with this strategy is that if the wrong stock is selected then the downward averaging will only lead to losses for the investor.
Contrarian investing
It is an investment strategy that involves going against prevailing market trends. Contrarian investors look for opportunities to profit by buying when sentiment is bearish and selling when it is bullish. They believe that herd behavior among investors can lead to mispricings in securities markets, which they can exploit. This approach requires a long-term perspective and a willingness to make decisions opposite to the market sentiment.
As with other strategies this strategy also has certain risks associated with it. If the visible mispricing is not a mispricing but the correct value of the stock then the investor would face losses in such a case.
Dividend Investing
This strategy focuses on generating a steady stream of income through dividends, which are payments made by a company to its shareholders out of its profits. Dividend investing is often considered a safer, more stable form of investing, particularly appealing to those seeking regular income, such as retirees.
It’s associated with mature, established companies that have a history of distributing profits to shareholders. When selecting dividend-paying stocks, it’s important to look for companies with a history of stable and growing dividends. This indicates a commitment to returning profits to shareholders. A key metric in dividend investing is the dividend yield, calculated by dividing the annual dividend per share by the stock’s price. it provides a percentage indicating your annual return on investment from dividends alone.
While dividends can provide consistent income, they are never guaranteed, and companies can change their dividend policies at will. In summary, dividend investing can be a key component of a balanced investment portfolio, offering the potential for regular income and lower risk compared to other strategies.
So in summary the above are some famous investment strategies. Contemplate on the above and tell me in the comments section which of these investment strategies you would follow.
This is all for this post, comments your thoughts below. Don’t forget to follow my Facebook and Instagram pages for regular updates. See you all in the next post, till then keep learning.