Stock investing strategies provide a framework and discipline for finding and making investment buy and sell decisions. An investor does not have to subscribe to any one strategy. However, everyone should have knowledge of each strategy and develop a belief system to guide them.
It is important to understand what you believe and maintain a consistent methodology. If you want to be a value investor but you are participating in momentum investing you will probably crash and burn.
Here are five widely used stock investing strategies followed by my analysis of the best investment strategies for the self directed investor.
Stock Investing Strategies
1. Value Investing
Value investing involves buying stocks at a discount to their intrinsic value. Value investors estimate the discounted value of all distributions and attempts to purchase a stock below that value, providing a margin of safety to the investment. The price you pay for an asset will have a profound effect on your returns.
Value investing employs the most important concept of investing: valuation matters! You can buy the the best company in the world but if you pay too much, the probability of achieving your goals is greatly reduced. On the other hand you can buy a poor company, but if you buy it cheap enough, the probability of achieving your expected rate of return is greatly increased.
2. Contrarian Investing
Contrarian investing, like value investing, attempts to buy stocks that are undervalued. However, a contrarian investor attempts to exploit studies in behavioral science which measures sentiment regarding the stock among investors.
When investors are particularly positive or negative a contrarian would consider doing the opposite. The theory is if 95% of investors believe an investment is going to move in a particular direction, then they have already acted and there is little impetus left to propel the asset in the same direction.
3. Growth At a Reasonable Price
Growth At a Reasonable Price (GARP) is a middle ground between value and growth investing. GARP investors attempt to invest in companies with above average growth but exclude stocks with high valuations. Growth at a reasonable price includes the important concept of valuation in buy and sell decisions.
4. Growth Stock Investing
Growth stock investing is a strategy of buying companies of above average growth regardless of valuation that might cause a value investor to exclude the stock for consideration. Growth at any price makes no sense to me. Even if you buy a quality growth company, if you pay too much for the stock you are depending on someone else to pay even more; which is not a wise investing strategy.
5. Momentum Investing
Momentum investing is a strategy of buying stocks that have done well over a short period of time (i.e. 3 – 12 months) and selling stocks that have not done well. Momentum investing was popular in the 1990’s but was largely discredited as the dot.com crash exhibited the downfall of following the herd.
Stock Investing Strategies – My Analysis
I believe the best strategy is value investing. Personally, I like to buy stocks at prices low enough to make the odds of achieving my expected rate of return very high. But I like to use contrarian investing too; particularly on the macro level (stock market), to help determine my asset allocation.
In reality most investors will use multiple stock investing strategies. But you should understand each strategy so that you know what you believe. Don’t let other investors or the crowd cause you to make decisions inconsistent with your belief system.
What is your favorite stock investing strategy?
Related Reading: Investment Analysis: High Probability Strategies