Over the years of working with clients, their initial response to hearing the word “stocks” or “equities” is “that is a super risky investment option”. This is the doing of marketing and news media (thank you very much for your “contributions”). Although they are correct in the sense that equities are relatively riskier when compared to bonds or term deposits, it is wrong to believe that all of them are the same. Not all types of equities have the same risk exposure and are equally volatile in your portfolio. Companies react differently to various fundamental factors. Therefore, I will go over the characteristics when evaluating and selecting stocks into a portfolio.
A growth stock is where a company’s earnings are expected to grow at an above average rate of return when compared to the overall market. Technology and new start-up companies are examples of growth equities. They usually do not provide dividend payments because they reinvest the earnings into the company to further expand and develop new products/services. The returns are greater but the risk is also greater when compared to value equities because the expected return is dependent on how successful the new product/service is when launched to public.
A value stock is where a company’s current stock price is below the intrinsic value that is calculated from evaluating its financial statements. They are also referred to as undervalued stocks. Companies in the financial and telecommunication industries are examples of value equities. They provide periodic dividend payments to investors. Typically, they are less volatile when compared to growth equities. However, there are also risks associated with them. The management of the company has to have long-term vision and a solid plan to ensure it achieves long-term and sustainable profits over time. The company has to continue being innovative and delivering new solutions to consumers. Failure to do so will lead to a significant drop in value.
When the government provides stimulating monetary and fiscal policies, it is trying to grow the economy by printing money, lowering interest rates, and spending on government programs. As a result, consumers and businesses are in spending mode. This is known as expansion phase. During this period, we should invest in interest rate sensitive industries (such as consumer discretionary and financials) and economic sensitive industries (such as real estate, industrials, and technology). The spending of consumers and businesses will boost the profits of these companies. In turn, they earn more profits and achieve a higher stock price.
As the economy expands, the aid from the government is no longer needed. In fact, the government needs to do the opposite to control inflationary pressure in the economy. It will change the policies and make them more restrictive by increasing the interest rates and reduce spending on government programs. If the government does not control it, then there is a potential for the economy to overheat and blow up. This phase is known as contraction phase. During this period, we should invest in defensive industries such as healthcare, utilities, telecommunications and consumer staples. Consumers will continue to spend money in these companies regardless of how good or bad the economy is.
There is always the debate in regards to which method of analysis is better. There are a lot of articles on the internet that provide reasons to support each method and why they are superior than the other. However, I firmly believe that they are equally important and should be used as complements when buying/selling specific equities.
Fundamental Analysis assists us in identifying which equities are undervalued and are cheap to buy. In addition, it helps us evaluate and determine whether a company has reached its fair value (potential value) or not. Once it has, then it is time for us to sell.
Technical Analysis assists us in gauging the upward/downward momentum of a stock and the overall market. Furthermore, it helps us with finding entry points to buy and exit points to sell a particular stock.
I am not a day trader or a market timer. However, I am an advocate of adjusting the investment portfolio by allocating funds into the proper areas to take advantage of the constant changing market conditions. In my opinion, the buy-and-hold strategy provides an easy strategy to follow. However, you will only achieve average returns. Like anything else in life, you get what you put in. Therefore, to add-value and earn alpha (excess return over the return of a benchmark), we would have to put in the extra time and effort, and adapt to changing conditions.
Joseph Tang is an Investment Advisor at BMO Nesbitt Burns and holds the Chartered Financial Analyst (CFA) Designation. He has been working in the financial industry for over a decade. His passion is to provide comprehensive wealth management strategies and build customized investment portfolios for his clients. He firmly believes in fundamental investing and in active management of assets by adapting to constant changing economic conditions. Furthermore, proper diversification in asset classes, industries, and countries is vital to achieve sustainable wealth for his clients in the future. Joseph Tang can be reached through his email address: [email protected]
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