A correct investment approach By: Andy GeorgeAfter a horrendous two-year period from
turn of new century, world stock markets would appear to have come back from dead with prices rising albeit in a not so spectacular fashion. The purpose of this article is to offer advice to investors as to correct investment approach. I believe that by following advice given investors will be successful on a long-term basis. This article is not intended for day traders or speculators who use alternative investment approaches to ones proposed by myself. The objective of this article is to assist investors in making money from now on or in other cases to help investors in task of reversing their losses caused by decline in share prices in recent years.
I have noticed that a number of “experts” have been advising investors to be careful at current levels of share price. I take a different approach to these people. In my opinion investors should be careful to identify those investment opportunities that will them significant gains on a long-term basis. There are probably not many in number and are investments that are undervalued when compared to their future prospects. The article aims to point investors in right question by identifying key questions that should be asked that would lead them to these investment opportunities. Before doing this I would first like to start with some general advice to investors.
ONLY INVEST SURPLUS MONIES: A few years ago I wrote an article regarding approach investors should adopt when investing on Stock Exchange and I mentioned that investors “should not invest all their savings” on Cyprus Stock Exchange. Unfortunately many investors in Cyprus did worse than this. They borrowed to buy shares when CSE Index was at astronomical levels.
Hence let me stress again advice that was given by me many years ago. ONLY EXCESS FUNDS SHOULD BE INVESTED IN SECURITIES. Some cash should be retained in a savings account to meet any possible emergencies.
DO NOT PUT YOUR EGGS IN ONE BASKET: Another investment strategy that investors must follow is that they “should not put their eggs in one basket”. They should hold a diversified portfolio of shares. In other words they should have a number of holdings in various sectors. If they believe that a particular sector will outperform market then they will have a greater proportion of their portfolio in that sector. I do admit that this strategy did not work on many of international stock markets during 2000 and 2001 since nearly all sectors registered sharp falls. However events over these years were extraordinary and may not occur in our lifetime.
If investors invest all their money in one sector and if a disaster should strike that sector then effect on value of their investments will be significant. An example of this is if an investor had a large holding in Technology stocks on London Stock Exchange (LSE) during 2000/2001 then he/she would have suffered heavy losses. If investor held a diversified portfolio then their losses would have been a lot less since other sectors on LSE did a lot better than Technology stocks. For example companies such as Tescos (Food Retail) and Centrica (Oil) have actually seen their share prices increase during corresponding period.
KEY QUESTIONS: Before investors make an investment decision then there are a number of key questions that need to be answered. The answers to these questions will give an indication as to possible future share price direction of company. The key questions that need to be answered are as follows:
1) Does management team have a good track record? 2) What are growth prospects of Company in relation to its Price Earnings rating (PEG factor)? 3) How does Price Earnings Ratio compare to other companies both domestically and on other international stock exchanges? 4) Does company rely on debt finance? 5) Is net asset value per share higher than company’s share price? (One way this can be known is by looking at whether Price to Book Value (PBV) of a share is less than 1 times. 6) How is liquidity of Company? Is it satisfactory?
If management has a good track record (i.e. earnings per share increase steadily year by year) then investors should have extra confidence in management and should increase possibility on investing in that company. If opposite is true then this should make investors reconsider whether or not to invest in company.
Research has shown on other more developed stock exchanges that significant capital returns are generally made on companies whose Earnings per share figure increases on a year-by-year basis at a satisfactory rate. A satisfactory rate is something around 15% per annum. Hence investors should try to identify investment opportunities that do this. In table below two hypothetical companies have provided their EPS for past few years: EARNINGS PER SHARE INFORMATION: YearCompany AEPS (cents)Company BEPS (cents) 19961.51.4 199721.5 19982.41.7 19992.91.5 20003.51.8 Company A produces a consistent increase in EPS of more than 20% per annum. This a what’s known as a growth stock and investors should invest in such company since it is very likely that if present trend continues it will produce excess capital gains for its investors. However for Company B EPS past trade record is disappointing since there is virtually no growth. Hence it would be extremely difficult for investors to make significant gains from holding this share since growth in this share is minimal.
Another point investors should be on guard is some of new companies listed on CSE have seen massive jumps in their EPS in past few years. Previous to this EPS for these companies was at lower levels. I would tend to advice investors to avoid such shares unless there is a good explanation behind increase in EPS and that this is not a temporary phenomenon.
