The stock market has had an impressive rally. Those who chose the right stocks a few years ago have done very well. Anyone who bought Apple in November of 2008 for $12.88 a share has a stock that today is selling for $189 a share. Likewise, Alphabet (Google) sold for $142 a share in December of 2008 and sells for $1,120 today. On the other hand, General Electric sold for $8 a share in January of 2009 and sells for $13 today. How could you have predicted which of these investments would go up in value and which would stagnate? What are the most reliable criteria for picking investments?
Most Reliable Criteria for Picking Investments: Fundamental Analysis
This approach looks to the future of an investment as determined by its current status. Is a company making money and is its business plan such that it will continue to make money, and more of it, in the future? The intrinsic value of an investment is a reliable guide to investing.
The intrinsic value of a stock is the expected company cash flow discounted to current dollars. It is a discounted cash flow valuation. An inherent weakness in this concept is that too often the medium and long term prospects of a company and its stock price are not clear.
Warren Buffett, who uses this concept, and learned from its creator, Benjamin Graham, said something interesting in this regard. He said that he tended to avoid tech stocks because he could not accurately predict how their products would be doing five years hence in the fast moving tech world. On the other hand, he was pretty sure how a Coca Cola or Snickers bar would cost and that they would still be popular. To the extent that you can accurately predict business success a few years ahead this can be the most reliable criteria for picking investments.
Most Reliable Criteria for Picking Investments: Technical Analysis
Technical analysis uses price patterns to predict the future rise or fall of investments in the stock market. Followers of this approach say that all available information in the stock market is immediately priced into a stock. But, there are price patterns that are repetitive. And, if one can accurately recognize the first part of the pattern, they can profit as the rest of the pattern evolves. This approach is used in day trading but can also be effective in swing trading a short term investment.
Short term investment in stocks can be extremely profitable. It can be more profitable, over the years, than long term investing. This is because the rate of return on long term stock investment is typically not linear. Market volatility, market trends, and market reversal all affect stock prices, even of the most stable of stocks.
This approach requires that the investor pay closer attention to a given stock than with long term value investing. The point is to identify when price bumps will occur and invest just before. Then, the usual course of action is to sell the stock and look for another opportunity. This can be a very profitable way to invest but even pros like Buffett say that they really cannot time the market.
Most Reliable Criteria for Picking Investments: Throwing Darts
Years ago a group for business reporters taped the stock pages of the Wall Street Journal to the wall and threw darts at it. The stocks that were “picked” using this method were noted. Then the reporters kept track of those stocks, assuming that they had purchased an equal dollar amount of each, commissions and all. Then, over the months and years they tallied the results. It turned out that their “stock picks” outperformed the S&P 500, the vast majority of money managers, and virtually every mutual fund.
Later, one of the reporters wrote the book A Random Walk Down Wall Street. There were several lessons from the dart throwing and stock buying exercise.
- All stocks are fairly priced given available information
- By purchasing a large number of stocks an investor can average out the high and low performers
- You need 10 blue chip stocks to average out
- And, you need 40 mini-cap stocks to accomplish the same purpose
- Either way, an investor who followed this approach had about a 12% per year appreciation of their investment portfolio
This approach incorporates cost averaging in which an investor invests an equal amount every month, quarter, or year. And, this system balances out companies that go bankrupt with those that experience spectacular growth.