Dave Deruytter takes a look at the financial markets’ investment strategies from growth picking to bottom fishing. There are many ways to try to outperform the market indices of the financial markets. Still, common wisdom states that one cannot beat the market consistently over a longer period of time.
Looking for growth stocks, searching for companies with potential, or that are operating in fast growing industries or activities worldwide, are well-known investment strategies. Investment company Berkshire Hathaway, with its paramount leader Warren Buffett, is very famous for this approach. It uses a process whereby companies are followed, studied and scrutinized for their good management, good products or services, and for their potential – and, that are undervalued by the financial market because those elements are (still) unknown.
It can be as simple as buying a good local company with great products and an important pipeline, that has easy potential to scale the business outside its home market, but has not yet done so. All of this requires a lot of study of course. That is why quite a few people buy the shares of Berkshire Hathaway, or their competitors, instead of venturing themselves in such detailed, and sometimes complex, analyses for stock picking.
Other growth-picking investment strategies bank on the investment in the future new Google or Facebook companies. In the process they buy a lot of shares in potential candidate companies, only slowly but surely, whilst studying each of them in detail, adding money only to those that keep on increasing their chances of winning in the quest for stardom. Often this strategy is only successful if you can buy those shares before the company is actually listed on a Stock Exchange.
Although with the likes of Google or Facebook this was not necessary; even after the IPO their share-price multiplied over a short period of time. Private equity companies are very active in this field of scanning for future winners – big time. Also, large conglomerates that look at optimizing their product offer, the countries in which they operate, or that are searching for synergies or advantages of scale in takeovers, are very actively searching the market for potential scale-ups or partners.
Bottom fishing is a very different technique whereby you follow companies that, for non- fundamental reasons, are oversold on the stock market and go under their real value in price. The investors hope that after they buy the distressed shares, they will increase in price, back to fair value at least. This approach often requires patience as one does not want to buy too soon in the downfall. Still, when the price is bottoming out, or the reasons for the overselling ebb away, it is a question to act fast.
It is very important to really study the reasons why the share of the company is over-sold. Because, if the sell-off is justified, you do not want to step in at all. Then the rule is: “Do not throw good money after bad.” Still, if the long- term profitability of the company is good and if it should be able to withstand the current shock, because panic sales seem to happen, one should, after thorough analysis, swiftly act upon the buy opportunity.
The best situations are those where the share price has been decreasing already over a rather long period of time and then, all at the sudden, extra bad news has the bottom fall out of the bucket and the share price drops further, sharply and fast. That is when panic takes over from reason with mainstream investors. And, at least if it is fundamentally a good company, you can step in to buy.
This bottom-fishing strategy is difficult and can be dangerous. For one because it is not always easy to know all the reasons for the weak performance of the company. Secondly, how do you know that the bottom of the share price has really been reached? The key element here is to be as sure as possible that this company is fundamentally a good one and will not only survive but even thrive in the future. Because you want people to keep buying the share after you bought it. It must really be a panic sell-off of a solid company with potential. There is the important rule of shying away from deals that look too good to be true. So, do your homework well.
You can imagine that these bottom fishing cases are more occasional opportunities than the search for growth stocks are. Still, when successful, bottom-fishing stocks can also double in value.
All in all, the growth stock approach is the better one in terms of investment strategies. And if you do not have the capability or time to do it yourself, you can still buy shares of companies that do that for you. Anyway, if you buy a mutual fund of a financial institution, according to your risk profile, you also want to know the quality and performance of the fund manager behind it. Luckily, the likes of ‘Morningstar’ rate the funds of fund managers on their historical performance and management. But historical performance is no guarantee for future performance of course.
The conclusion for investing is always the same: diversify, invest in what you understand or know, according to your investor profile and, shy away from too good to be true offers. If you really want to take more risk, do not borrow for it and do so with money you can afford to lose.