5 mins read . 11 Jan 2023
Stock market investing has to be always a plan. There are several models for investment strategy and investors normally adopt any of these models or a mix of these models. While the list can go on, such equity investment approaches can be classified into 5 broad buckets.
You must have often heard the term value investing, but have you wondered what it is all about? The essence of this strategy is to identify stocks that are beaten down and, hence, available at very low P/E ratios or low P/BV ratios. P/E ratios are used as a benchmark for non-financials while P/BV ratios are a proxy for financial services companies. Value companies are the ones that are beaten due to a mix of internal and external factors. The company may have advantages like a strong brand, high dividend pay-out ratio or high-profit potential, but that is not reflected in the stock price. Typically, value investing is done in of favour stocks. Investors must be prepared for a longer waiting period in value stocks.
While a growth stock is in contrast to value stocks, it has been often known to intersect with value stocks too. Growth investing is less about low P/E or low P/BV ratios. The driving force here is growth and if the company can sustain growth in revenues and profits, then even higher P/E ratios are justified. For instance, private banks may have higher P/E ratios, but they also have grown to back it up. Growth stocks tend to have momentum in their favour and institutional investors often prefer this growth-based approach. Returns are much quicker in growth stocks but such stocks are susceptible to sectoral and macro shocks.
This is also popularly called an income-based approach to investing and is more conservative. While conservative investors prefer bonds with regular interest, there are several large stocks that pay regular high dividends. For example, companies like Coal India and IOCL have dividends of 8-10%. Vedanta has a dividend yield of over 15%. The dividend yield approach works for companies that have stable dividend pay-out track records. Companies that pay one-off special dividends are excluded from this list. One of the big advantages of this approach is that dividend yield also acts as a price support system for the stock.
This approach is popular among short-term investors. Such investors use sophisticated tools like divergence, oscillators, RSI, supports/resistances, MACD etc. Better known as charting, this approach is based on the premise that past patterns will repeat in the future and hence past charts can be used to extrapolate future price movements. This approach may not be too conducive to long-term wealth creation, as the assumption is that price reflects it all. This approach normally works only in the case of companies that have a price and trading history and also have substantial volumes.
Interestingly, many large institutions and proprietary desks adopt this approach to investing since it captures long-term value, momentum and charts. It bets on event outcomes like the implications of monetary policy, union budget, quarterly results, Fed policy etc. It not only captures momentum but also focuses on top-of-the-mind stocks. Hence, it is a more pragmatic way to capture the momentum surrounding specific events. This approach can, at times, be fraught with risk, if the outcomes are not assessed properly.
Normally, the intrinsic approach is one of the first 2 approaches to investing viz. growth or value investing. The dividend yield approach has very limited popularity. However, the trend-based approach and the event-based approach are normally used to ratify the findings of previous models.