When selecting stocks for their portfolio, many investors employ certain style strategies based on past performance and price changes of the stock. These strategies include:
i. Value stocks
ii. Growth stocks Price momentum iii. Price strength
iv. Bottom fishing
Many investors have a preference for a particular method, while others change methods as their preferences and market conditions evolve.
i. Value stocks
Stock selection based on the search for undervalued companies offers extremely favorable values in fundamental terms. Usually value stocks have a low price to earnings ratio or alternatively a low price to sales ratio. The classic rationale behind this strategy is buying stocks at a fraction of what they are worth and waiting for the market to fully recognize the hidden value.
This "look for cheap stocks" strategy is a popular theme among defensive investors since the reasonable price multiples offer a good hedge against future adversity. It is usually a sound, solid strategy that might, however, require an extra dose of patience and fortitude. The market may take months, quarters, if not years to discover and appreciate pure value plays. On the other hand the ratio of upside and potential versus downside risk is often very appealing
ii. Growth Stocks
Growth stocks usually belong to companies with superior track records or prospects in terms of earnings growth and/or revenue growth. The idea is to buy stock in companies that grow fast regardless of the price one has to pay to acquire them. Classic examples of this investment approach are high tech stocks or stocks of small but rapidly expanding and well managed Banks.
This strategy is usually quite risky. Protection against negative company surprises or stock market dips is minimal, leaving the investment vulnerable to steep losses. On the other hand, if the expected growth materializes in the future, the stock price appreciation is substantial.
Many of the best performing stocks over the last 5 years have been pure growth plays, for large caps as well as small cap stocks.
iii. Price Momentum
Price Momentum is usually referred to as trend following This investment strategy focuses on stocks whose price action is strong, often outperforming the relevant stock index. Stocks with positive price momentum tend to rise faster than the market, showing continuous price appreciation for weeks or months. The philosophy behind momentum investing is along the lines of the belief that "the trend is your friend". A number of market forces can be behind the continuous price strength of a momentum play, but what really matters is that when a strong price trend is in action, it often carries through for a while-enough to make a good profits riding the momentum.
Statistically speaking, this is a sound strategy, although a number of
things can go wrong such as unexpected negative company surprises, abrupt price trend reversals, sharp price corrections, or a dramatic shift in investors' psychology. The previously strong momentum may disappear overnight.
iv. Price Strength
Price Strength is a variation of Price Momentum because it is calculated against the appropriate market or sector index. It is referred to as a
"relative" measure of the same momentum. The idea is to buy only stocks that are performing stronger than relevant competing companies.
v. Bottom Fishing
Bottom Fishing is an opportunistic investment approach focusing on stocks that, after a dramatic plunge in price (usually across a few quarters), seem to be poised for a rebound. These are usually out-of- favor stocks, appropriate for contraries investors that have been neglected from the investment community for some time. The basic idea is to go against the crowd and buys stocks (usually at very discounted multiples) in hopes of participating in the expected rebound.
The price rebound may take a long time to materialize, but usually when it comes dramatic and sharp. The ensuing profits can be significant in percentage terms. Distressed securities sometimes fall in the category or stocks with troubles in fundamental terms. However, some of these companies may never recover. For this reason, bottom fishing should be always associated with careful fundamental review.
4.0CONCLUSION
We have seen from this unit that generally, the objective of holding portfolio of financial asset is to generate income or capital appreciation or both. Investors desiring immediate income for current consumption will go for securities with propensity of high dividend rate. Investors having preference for capital appreciation will go for securities, which pay little dividends, but with high growth potentials.
5.0 SUMMARY
You have learnt in this unit the various factors to consider in Portfolio Planning, Investment Timing and the different stock Selection Strategies 6.0TUTOR-MARKED ASSIGNMENT
1. State the factors to Consider in Portfolio Planning 2. State the stock Selection Strategies
7.0 REFERENCES/FURTHER READINGS
Akinsulire, O. (2008). Financial management (5th Edition), Lagos : El- Toda Ventures Ltd
Dunmade, A.A (undated). Investment analysis and portfolio management, Lagos: Elite trust Ltd
Igbinosa, S.O. (2012). Investment analysis and management , Lagos:
Elite Trust Ltd
Osaze, E.B. (2007). Capital markets, Lagos : The Bookhouse Company Osuoha, J. (2010). Portfolio management, Lagos: Emmaeth Printing and
publishing
Osuoha, J. (2010). Equity valuation and analysis, Lagos: Emmaeth Printing and publishing
UNIT 2 IMPLICATION OF EFFICIENT MARKET