Company size
There are a number of
investors who intentionally limit their choice of stocks from companies of a
particular size, either in terms of revenue or market capitalization. This is
done ordinarily by classifying companies according to market capitalization (“cap”),
namely as micro caps, small caps, mid-caps and large caps. Over a long time
period, bigger companies show higher returns than smaller companies do. Some
investors thus believe that the size of market capitalization of companies has
a great bearing on how the market responds to these companies; and the actual
proportionate revenues provide a reliable indication of relative investment
potentials. The generally-accepted classification followed by investors is as
shown below:
Micro cap – Not more
than $250 million
Small cap -- $250
million-$2 billion
Mid cap -- $2
billion-$10 billion
Large cap – Not less
than $10 billion
Most publicly-traded
firms are classified as micro or small caps. Statisticians are of the opinion
that the apparent success of
smaller businesses can be attributed to "survivor" bias rather
than solid excellent performance, since the majority of the databases utilized
for the tests conveniently removed bankrupt companies, up to recent times. That
is, excluding bankrupt companies aided significantly in stacking the odds of
success in their favor. This issue, however, remains debatable.
Screen-based investing
The “screen” method of
investing is resorted to by many investors, which involves using
"screens" to choose investments while applying various quantitative
criteria to evaluate those companies that satisfy their criteria. Because of
the ease and convenience of the method through the use of computers, it has
gained a lot of practitioners. These screens can display various numerical values
describing a company's status as well as its stock through different time
periods.
While there are
investors who use these screens to come up with interpretations of fundamental
relevance to the business in general, many others utilize screens as “robot-like
models" that simply point them to which ones to buy and sell. They claim
that this process takes away the emotional factor in the investing process;
although others think otherwise and say what you remove is the intelligence
factor. Eric Ryback is widely known for his use of screens as a starting step
in investing; while James O'Shaughnessy among the known proponents of screens
as a pure mechanical system. As a beginner, you have to decide how you play –
with the heart or with the mind or with both.
Momentum
The momentum of
investing involves finding companies which do not only show good performance
but also doing so well that they deserve celebrity status. "Well" is
the term used to describe companies that stand out among all public companies
that investors expect to show positive performance? Momentum companies,
therefore, are those which frequently surpass estimated earnings per share or
revenue by analysts, or post high quarterly and annual returns and sales growth
compared to other firms, especially when the growth rate climbs from one
quarter to the next. Such growth is a strong indication that the company is
apparently doing the right things. Often, such high comparative strength is a
category in momentum screens, as these investors seek to acquire stocks
that have overtaken the rest of the stocks in recent months.
CANSLIM
CANSLIM is an approach
originated by William J. O'Neil, who merged quantitative analysis and technical
analysis, as contained in his book How to Make Money in Stocks. In O’Neil’s
newspaper, Investor's Business Daily, we are told that the "C'' and ''A''
in the formula CANSLIM urges investors to find companies with fast-growing
Current and Annual earnings. ''N'' is for New, to refer to business factors,
such as new products, new markets, or new management. ''S'' represents Small
capitalization and big volume market demand. ''L'' asks investor to determine
if the business is a Leader or Laggard. ''I'' helps to spy out for
Institutional sponsorship; and ''M'' focuses on the Market direction.
Originally, O’Neil published Investor's Business Daily as a means for investors
to apply CANSLIM; but it has turned into a general business publication
patronized by all kinds of investors. CANSLIM formula incorporates features of
another type of analysis -- technical analysis.
Quantitative analysis pitfalls
Since quantitative
approach depends on screens which all people can see and as digital technology
becomes more affordable and accessible, many of the pricing inaccuracies
quantitative analysis discovers are eventually erased. Hence, if a certain
screen has produced 40% yearly revenues and everyone hears about it, leading to
large inflows of money into the identified companies, the returns will suffer
gradually as a result.
As "unclear"
as fundamental analysis may seem, sometimes having a little insight about the
business you are buying can lead to a clear advantage. For example, if you
utilize a high-comparative-strength screen, you must check at all times to see
if the companies you discover have grown in price as a result of a merger or an
acquisition. In that case, chances are the price will remain as is, even if the
"screen" that picked this company had historically high annual
revenues.
Technical Analysis -- Buying the Chart
What happens if you
become fully convinced that all facts about publicly-traded companies were
completely disseminated, giving no one any advantage whatsoever by either
evaluating the business or interpreting the numbers? What does that leave you
to do? You can try forgetting about beating the returns in the market by buying
an index fund. There is another option which investors have taken: trying to
build a set of charts that might show how other investors evaluated a stock at
any certain time, specifically finding traces of large institutional investors
which often lead to very significant price fluctuations. This approach, which
some investors apply, is referred to as technical analysts and uses charts that
practitioners believe can bring information and insight into the psychology
affecting the behavior of a stock. As it is in other areas, many chart purists
exist, although some investors turn to charts only to time investments after
they have checked out the charts through the eyes of a fundamental or
quantitative analyst.
We cannot present a
step-by-step process to describe technical analysis; but various several tools
exist. The most significant indicators appear to be definitive chart patterns
portraying certain price fluctuations during times when the volume of trading
hits a particular level. Some of the often used charts are the following:
logarithmic charts, point-and-figure charts, Japanese candlesticks, and others.
Technical analysis pitfalls
Technical analysis is
based on the presumption that specific chart patterns confirm indications of
market psychology pertaining to either a particular stock or the market in
general at crucial points. So far, much of the statistical research academics
have conducted to assess whether indeed these chart forms really predict has
not confirmed the supposition, as discussed by Burton Malkiel in his book, A
Random Walk Down Wall Street. As with supposed new cure-all drugs or
supplements out on the market, much of the trust in technical analysis revolves
around anecdotal experience and not some form of durable statistical
validation, unlike some fundamental and quantitative approaches which have so
often successfully predicted future events. As one critic quipped, “Technical
analysis is essentially as useful as reading tea leaves.”
Trading -- Doing What Works
Trading has gained
such popularity, taking on celebrity status at par with such figures as Michael
Phelps and Pokemons. And this happened while trading commissions have come and
gone and growing numbers of people have gotten their hands on real-time
information about stock prices. Commonly, traders utilize a medley of
fundamental, quantitative and technical approaches with a short-term direction.
This tends to make trading a high-strung activity where an investor hopes to
catch a few percentage points from each trade. Hence, in spite of its
popularity, trading is never a structured, rational compilation of information
we can reduce into a small primer.
So many beginning
investors who started out hypnotized by the perceived pie-in-the-sky appearance
of trading, often lose a lot of money
before discovering that with thousands of other traders running after the same
pie, oftentimes, the fastest, most experienced, and most well-equipped
technically are the ones who make money -- and these are usually the veteran
investors and not novices. Successful trading, as every trader will
emphatically say, demands meticulous focus, discipline and diligent work; so
anyone who thinks that using a Quotrek while holding down a job at a fast food
outlet might want to reconsider.
Arguments against trading
Obviously, trading
requires much time to become good at it. Yes, we have heard of many superstar
traders; but we often forget that these traders have the equipment and the time
of day – perhaps, the whole day -- to trade consistently. It may sound
discouraging; but considering the time and effort that most successful traders
put to engage in trading; the prospects for beginners to attain the same
benefits with less effort and fewer resources is quite low. With the amount of
money involved in the stretch of a day to a year investment time-period, a
person with limited time will potentially gain greater success in a personal business venture
on a long-term basis than diving headlong into a Vegas-like environment.
Summary
For now, you may be
capable of naming and defining accurately every acronym of approaches we have
discussed, such as CANSLIM and GARP. Likewise, you have understood some
underlying investing principles minus those odd acronyms. You know the gist of
such methods as fundamental, quantitative, and technical analysis used in
choosing stocks. Most probably, you will eventually devise your own peculiar
style of investing. And as you increase you knowhow and expertise in this
exciting adventure, you will build your personal investing philosophy that will
fit your own special needs and objectives perfectly.