Month: February 2023

There are a lot of investment strategies to choose from depending on what you want to achieve. Once you know what type of investor you are, when you need money, and how much you can spend on investing you can start building your investment strategy.

In this article, I will cover some of the popular investment strategies that are used in the stock market. If for example, you want to mix stock investing with ETFs you are more than welcome to do so.

For more information on index funds you can read my other article – ‘Index Funds‘.

What Type Of an Investor Are You?

Before even starting to think about investment strategies that work best you have to determine what type of an investor you are. Or want to be if you are just starting out.

It matters because it really depends on how much time and effort you want to put into investing. If you can spare several hours each day then you might be doing fine with active trading. However, if you want to spend only several hours each month investing, the buy, and hold style would suit you much better.

Buy And Hold Style

The first of the investment strategies is the buy and hold strategy which means that you buy good companies at a fair price and you do not plan to sell them unless something changes in the company. This strategy is used by most famous investors like Warren Buffer, Peter Lynch, and Benjamin Graham.

Advantages

• Easy to manage – Once you pick the stocks you have to regularly check if they are still the same great companies that you bought them from before. There is no need to watch them daily.
• Fewer transaction fees – because you are not doing a lot of trading you are not paying as many transaction fees to brokers.
• Tax efficiency – you be strategic about taking stocks out and pay fewer taxes than with active trading.
• Do not have to time the market – the most important thing is picking fairly priced good companies. Since you do not plan to sell companies for a long time it does not matter as much whether you bought the company at absolute rock bottom or not.

Disadvantages

• Might miss some opportunities – because you are not trading actively and really analyze each company before buying it you might miss some profitable opportunities that active traders might have spotted.
• You might not want to sell losers – since your strategy is to buy and hold you might be reluctant to sell companies that are not doing so well. The problem with value stocks is that they might get to their previous price for a long time.

If you want to learn more about investing styles you should read my other article – ‘Understanding The Stock Market For Beginners‘.

Active Trading Style

Active trading style is commonly seen in the movies about Wallstreet. It means that you are trading daily or even hourly. This is the second of the investment strategies.

Instead of fundamental analysis you are doing technical analysis and do not care about the company’s financials whatsoever.

Advantages

• You take advantage of opportunities – by analyzing the market daily, you are likely to spot some good opportunities to trade.
• Sell losers early – when making a purchase you are likely to have a strategy at what prices you are likely to sell stocks. If it is a bad trade you just cut your losses and move on to the next stock.
• Relocate portfolio often – your portfolio is changing every day, so you are most likely to spot everything that is happening with each industry early on.

Disadvantages

• Need to spend more time – opposite to the other strategy you really have to commit some time each day to trading. This might even be your day job.
• More transaction fees – You are doing a lot of trades each day and paying transaction fees with each buy and sell making your broker richer.
• More taxes – if you are doing well you are sure to pay taxes on your investments.
• No compounding benefits – since you are holding stock only for a short time compounding is not reached by far.
• Usually underperforms in long-term – you might have a good run for some time but statistically, you are likely to lose big sooner or later. Because of this buy and hold strategy is much safer.

Growth Stock Investing Strategy

Investing in growth stocks is the third of the investment strategies. Growth stocks are appealing to a lot of investors because they are flashy in their returns when the market is doing great. In the bull market, these stocks are skyrocketing and in the bear market, they are the first to lose in value.

You can often see that the P/E ratio of these stocks will be higher than the market average. That is because people are easily hyped about new and exciting things and keep overinvesting in growth stocks.

Momentum drives the price up once the price starts rising. Once people see what they would have made if they invested one year ago and see that the prices are still rising they want to jump on the train and expect for these stocks to keep growing even more.

Companies like Amazon which are growing fast might not even be profitable yet. They are simply growing in their revenue gaining a huge market share.

Growth stocks are often associated with high volatility and thus a big risk. So, if you chose this strategy you also have to prepare yourself for what you would do if the company dropped 10%, 20%, or even 50%. Would you still hold it? Or would you buy more shares at a cheap price?

Overall these stocks are great for long-term investors because growth stocks keep rising if they manage to achieve their goals. You must have to have patience and believe in the future of the company to withstand all this fluctuation.

How to find these stocks?

• Fast-rising sales – you want to see at least 10% yearly growth in sales for 10 years.
• Fast-rising earnings – like with sales of 10% on average per year are what you want to see.
• ROE – this ratio should also be rising at least 10% on average.
• Low debt – it is best if the company does not have debt and if it does then no more than 2 years of its earnings. It is also required that debt would be lower than last year.
• Technology or Healthcare sectors – these sectors are full of growth stocks.
• Look for global trends – you have to be in the loop and read the news to spot big new trends. They help companies grow like crazy.
• Look for competitive advantages – the only way you would be able to sleep well at night if your stocks lose value is by knowing that they have something special that would help them survive everything.
• Insiders buying – this is an amazing sign that the stock is about to rise in value. That means that insiders must know something good that is about to happen.

Some examples of growth stocks are Amazon, Facebook, Apple, Biogen, Uber, and Starbucks.

Income Stock Investing Strategy

Investing income stocks is the forth of the investment strategies. This strategy is all about giving you income in a form of dividends. You want these companies to be big, established, reputable, and have a good record of paying dividends and even increasing them. Imagine that you are getting a salary quarterly only for the fact that you invested your money into the right companies. That is making your money work for you.

You also want some price growth on these companies. Though the numbers can be much lower than with growth stocks. This not only gets you dividends but also ensures that your initial investment is not lost.

Typically dividend-paying stocks are large-cap companies because they have already grown as much as they could. So, instead of investing money, further companies decide to award their investors with dividends.

Income stocks are great for retirees for income because they are a pretty safe investment till a low-interest rate environment is kept. At the moment interest rates are rising so I expect that income stock will not be doing so well as people will be switching to bonds. Generally when interest rates are high bonds are safer investment options guaranteed by the government, so there are more attractive to investors.

How to find these stocks?

• Consistent dividend paying – you want to see at least 10 years of dividend paying records with missing them. It is best that the company would be paying them for 20 or 30 years even and rising the dividend amount.
• Company stability – you want a company that does not fluctuate a lot. You can look at the Beta index that can be found on the main page of Yahoo Finance. You want it to be below 1 and even best if it is below the sector average.
• Sector stability – it is important that there would be as less happening in the sectors as possible.
• Dividend yield – This is the most important number for you as it shows how much money you will be getting
• Dividend growth rate – it is a good sign if dividends are growing regularly.
• Dividend payout ratio – companies payout dividends from their earning, and it is best that the payout ratio is around 50-70%. If it is 80% or more then it might be a bad sign the company is not leaving enough money to fund its further growth.

Some examples are Johnson&Johnson, Procter&Gamble, General Mills, Wells Fargo, Xcel Energy, and Exxon Mobil.

Value Stock Investing Strategy

Value investing is the fifth of the investing strategies. The strategy means that you are looking for stocks that are undervalued to their current price. The strategy is widely known as it is promoted by a lot of famous investors like Warren Buffer, Peter Lynch, Benjamin Graham, and many more.

This strategy revolves around finding hidden gems to invest in. So, naturally, you have to look at the fundamentals of each stock and calculate its intrinsic value, and then compare it to the current price.

You can find a lot of these stocks when the stock market is undervalued, which means after a big crash. Of course, crashes do not happen every couple of years so, you might need to look at the companies one by one to find the one that recently release some bad news, that is being sold out, but the company still has good fundamentals and still has a huge potential to get back its value and grow further.

To be successful at value investing you also have to have contrarian investment thinking. That means that you should buy when others are selling and sell when others are buying. This whole process is very subjective as it basically says you make money when you think that the company will rise and the other person thinks that it will fall even more.

This is a long-term strategy, so there is no real need to try to time the market if you did your research. If not then it is a high risk that the price might never return to even its previous value.

How to find these stocks?

• Price to Book ratio lower than the market average
• Price to Earning ratio lower than the market average
• Future growth potential – you have to evaluate previous growth and the potential that the company still has. Name what has to happen for a company to double in value and later check if that indeed happens.
• Good cash flow – The company is still generating good cash flow even when it lost some of its value.
• Competitive advantage – this is one thing that increases your chances of the company you bought rising in value. This means if times are bad for the whole industry this company will take even more market share.

It is hard to tell what companies are currently undervalued, but to understand the principle better you can take Warren Buffet for example. He invested in Coca-cola when it was the most popular drink in America, but has not yet gained a lot of market in other countries. Buffet saw this and heavily invested in the company that made him billions years later.

GARP Strategy

GARP is the sixth of the investment strategies. Growth at a reasonable price (GARP) is a strategy that combines growth and value investing strategies into one. It means that you are still looking for undervalued stocks like in the value investing strategy, but you are also looking for sustainable growth potential.

To find these companies you have to do a qualitative analysis. This means that you have to evaluate companies strategy, management, the industry that the company is in, and if there are any demographic changes that can help a company grow.

How to find these stocks?

• Earnings growth – you want to see that a company increases its earnings at an average of 10% or more for at least 10 years.
• Earning per Share (EPS) – it has to be 15-20% lower that the markets average
• P/E ratio – it has to be higher than with value stocks, but lower than with growth stocks, around 15-25.
• Price-Earning to growth ratio (PEG) –  value should be less than 1, near 0.5. This is the main ratio of this model.

Active Trading Strategy

The active trading strategy is usually associated with Wallstreet because we see investors in the movies use this strategy a lot. It means that you are trading daily or hourly.

With this strategy, you can throw everything that was mentioned before out of the window, because you would not be using fundamental analysis at all.

This strategy is all about looking at past movements of a stock to predict the future by investigating past prices and trade volume. By doing this you make a couple of assumptions. Firstly, the market price is the actual price as all information is known and secondly, those price movements are not random.

Your key tools are different chart diagrams that help you analyze the stock prices at various time frames. This strategy is most definitely not for beginners as you have to put a lot of time into it.

How to find these stocks?

• Look for trends – how strong is the trend, and how likely is it that it will continue?
• Support and resistance areas – additional lines that you draw on top of the charts.

For examples, of how to do this analysis you can read my article – ‘3 Easy Ways To Calculate Stock Price‘.

Dogs Of The Dow Strategy

Dogs of the Dow strategy is the seventh of the investment strategies. It means that you pick 10 USA Fortune 500 companies in Dow Jones Industrial Average with the highest dividend yield. This strategy is similar to the income stock investing strategy because it revolves around large-cap companies that are already established in the market.

The idea is that good stocks that are out of favor (lower price, higher dividend yields) will rise in value again. Each year you have to rebalance and select new 10 underperforming companies in the index fund and repeat the process.

You can read more about it here – dogsofthedow.com.

Dividend Aristocrats Strategy

The dividend aristocrats are the eighth of the investment strategies. It is also very popular that was even taught in my university. The idea is that you look for companies in the S&P 500 index fund that have increased dividends for the last 25 years. You buy as many companies as there are.

This strategy is strong in the bull market and extra strong and safe in falling markets because these companies could temporarily lose their value but they still keep paying you dividends.

Historically till 2009 the strategy made the same returns as S&P 500 index fund but after that, it outperformed the index. The key moment why this happened is because interest rates were really low since then.

Dividend stocks tend to do worse if interest rates rise and right now is the moment that interest rates rise. I believe that it will hurt all income stocks, Dogs of the Dow, and Dividend Aristocrats strategy users. However, once the economy recovers there will be still viable options.

If you are interested in this strategy you can check ETF that tracks Dividend Aristocrats.

Dart Strategy

The dart strategy is the ninth of the investment strategies. This strategy is as silly as its name, however, it usually outperforms amateur investors. To try this strategy yourself all you need to do is list all the companies on a dart board and throw darts. You buy the companies that were hit.

A lot of times this strategy can do better than investors, who lack knowledge of the stock market. There was a lot of analysis on whether this strategy works or not and a lot of times what people think are good buying options are really not as great as buying stocks at random.

In all seriousness, I would really not recommend you this strategy as a real strategy. Rather if you want to test it out you can test it with paper investing to compare how you are doing against some random stocks.

How To Find Your Investment Strategies?

All the strategies that were mentioned above are only examples of how people are investing in the stock market. It does not mean that you have to do the same thing.

Firstly, you should start by trading what you know. You must know some sectors, industries, or companies better than most people. Start with them. Read ‘Investment Checklist By Invest‘ for more information.

Secondly, you should select a trading style that works be for you. If you have a lot of time active trading might be what appeals to you. However, if you are a busy person value investing or growth investing might offer you some great guidelines for what to do.

Thirdly, decide on the number of stocks you want to trade or how many stocks should be in your portfolio. Usually, 20-30 should be a good starting point. If it feels daunting then maybe you want to lower this number but keep the diversification.

Fourthly, leverage tools that were mentioned above for company evaluation. Use the correct tools – fundamental and technical accordingly to your style of investing.

Finally, after you evaluate companies do not just throw that knowledge out. Keep a list of companies that you have screened and make a watch list of what companies you would like to buy and what prices these companies should be trading at for you to buy them. If later on prices drop and fundamentals do not change then it is the right moment to make a purchase.

If all of these strategies seem too complicated for you at the moment consider investing in ETFs that follow popular index funds – ‘Passive investing With Index Funds‘.

Don’t miss new articles by subscribing!

When you are just starting you might be thinking that you are supposed to purchase individual companies’ stocks to invest. For a beginner how to know what stocks to buy can be quite a puzzling question.

I can tell you now that it definitely is not the only option to buy stocks and probably not even the best option even for most investors. I will look through the popular investment options and give you my opinion about all of them.

Individual Stocks

Since you are reading this article I assume this investment type you already know. Individual stocks are one of the most popular and well know investment types out there. The only question for you remains how to know what stocks to buy.

Picking individual stocks yourself without prior knowledge is not recommended. They are risky and volatile, so you must know what you are doing. Buying just one or two company shares that you like is not an investment strategy. I would call that more of a gamble. You could have a good run but most likely you would lose money.

Either way, when talking about a diversified portfolio including some of them might be a good idea.

Advantages And Disadvantages of Individual Stocks

• More Control

Individual stocks give you more control over your investment portfolio. You can diversify it as you like including all the growth, value, small-cap, large-cap, and other types of stocks. You also can choose industries in which you want to focus, what companies to avoid, and in what companies you want to put more money.

• More Targeted

When you choose another investment option will likely be buying all sorts of companies. With individual stocks, you can pick 20-30 stocks that you like and get higher returns.

• Less Diversified

The drawback with individual stocks is that probably you will not be owning 500 stocks like buying S&P 500 index fund. Because of that, your portfolio will be less diversified, therefore, it can be riskier.

• More Personal

Picking stock yourself means that you will be more involved in the processes and do your research. As this can be a good thing beware that it will take more of your own time.

• Note On Diversification

There are a lot of opinions on how many companies you should buy to consider your overall portfolio diversified. Having 20-30 companies is the recommended average. With fewer companies, you are not diversifying your portfolio that much, and with more stocks, you might be over-diversified. Thus you limit your potential gains. Having too many stocks can also be too hard to track and manage. According to popular opinion, one stock should never take more than 5-10% of your portfolio as you get too dependent on it.

• To Diversify Look Into Different Types Of Companies

To have a diversified portfolio you should also look into different industries, different company sizes, and styles.

You should read more about them in my other article – ‘3 Types Of Stocks That You Need To Know‘.

Mutual Funds

When trying to answer the question of how to know what stocks to buy I believe that mutual funds should be mentioned in this list. Mutual funds still control a lot of money and do quite a large impact on the market due to their size.

However, in my opinion, high taxes and high entrance requirements make this investment type hard to enter.

Advantages And Disadvantages of Mutual Funds

• Risk Management

A pool of investors sharing risk and reward when investing in mutual funds. So, this is a safer option than investing in stocks by yourself.

• Diversified Holdings

Mutual funds are kept diversified, so they provide less risk overall. Different funds focus on different types of companies or they can be trying to diversify as much as possible. However, due to their size, they have to avoid small-cap and mid-cap companies. In most cases as the funds would affect these companies’ stock prices too much.

• Professional Management

Mutual funds are managed actively and passively (index funds).

Actively managed funds have the advantage that a human will select companies based on knowledge whereas index funds have preset rules on how to invest. This is quite controversial. When there is no manager there is no human emotion that can make a bad decision.

• Liquidity

Mutual funds are easy to sell at any time as they are popular and there will always be buyers.

• High entry

Most mutual funds have a minimum investment sum that you have to invest. Mutual funds usually start at 50.000 USD to entry, and index funds can have this sum of around a few thousand dollars.

• Expenses

There are a lot of expenses associated with mutual funds.

Expenses For Mutual Funds

1. Sales Charges (load ~3%) – actively managed funds asks you to pay 3% on average just for the privilege of working with them. Because of this point, I would never consider investing in an actively managed fund. Index funds usually do not have this charge.

2. Expense Ratio (1%) – On average mutual fund charges 1% for operating expenses and marketing. This alone is not that bad as you usually have some expenses with other investment types. However, usually not that high.

3. Other Charges – There can be a lot of other charges associated, so you have to read the expenses sheet carefully before investing.

4. Redemption Fee (~1%) – This fee is quite common with mutual funds. It means that you have to pay a fee if you want to sell your position before the agreed term.

You can find these expenses on the Yahoo Finance website and easily compare them.

Equity Trading Funds (ETF)

When considering how to know what stocks to buy these funds can be considered as a lighter mutual funds version. You can purchase a lot of different index funds as stocks through brokers, and online brokers. You can find practically any kind of ETF. For example, you can search for AI index funds and find at least 5 companies that use AI in their products or services.

Advantages And Disadvantages Of ETFs

1. Large Diversification – S&P 500 following funds are just one type of ETF. You can find ETFs that consist of 1000 stocks or even more. This ensures that you really own a large portion of the stock market with just one purchase.

2. Typically Tracks an Index – Most ETFs track some kind of index funds and set them as a benchmark. This works pretty well as most of the S&P 500 following indexes have the same returns or 0.1% lower, which is not that bad.

3. Low Expense Ratio – Expenses for ETF usually are minimal. Most likely you will have to pay taxes when you make a purchase or make a sale. In some cases you might receive dividends, so you would also have to pay taxes for them as income.

4. Traded On The Market Like a Stock – Trading ETFs is as easy as purchasing stocks, which can be bought through brokers or most online brokers.

5. Price Changes During The Day – ETFs have the same trading hours as stocks, so it depends on which exchange a particular ETF is sold.

6. Liquidity Like With a Stock – There is a large number of buyers and sellers, so you will not have problems cashing out whenever you need to.

7. Pay Commission To a Broker Like a Stock – As I mentioned before usually there are no additional fees when purchasing an ETF.

8. Can Buy Just 1 Share – There is no minimum sum which you have to invest like with other mutual funds. You can simply purchase 1 ETF stock.

Because of these reasons, I believe that ETFs have a distinct advantage over other investment options that can give you diversification without any hustle.

Stocks And ETFs

A lot of investors that I know or the ones that I have listened to in podcasts have a strategy of buying ETFs as a majority of their portfolio. The other part is purchasing some individual stocks on the side.

Quite a Safe Option – strategy does pretty well as long as the market is doing good, and it is for most of the years. When you purchase one or several ETFs for most of your portfolio you can try to expand your diversification. You can do that with low-cap, or mid-cap stocks to fill in the gaps your ETF portfolio does not cover.

Better Diversification – Another reason to purchase some stocks on the side is, for example, if you purchase an S&P 500 following ETF you might want to balance out the high investment portion on the technology sector and put some of your money into some safer stocks that do well when the market overall is not doing so great. So, this is a good way to look when you ask how to know what stocks to buy.

80% ETFs, 20% Stocks – When talking about proportions a suggestion that I saw is owning 80% of ETFs. For example, S&P 500, Total stock market, or International indexes following ETFs and buying some other individual shares as your other 20% portfolio.

Of course, everything is okay if you want to make your portfolio with only ETFs. This actually may be an excellent option for people who do not have much time to spare. Picking and tracking stocks yourself can take up a lot of your time.

However, if it is too boring for you to own just one or a few ETFs you might want to do the analysis and make a strategy yourself. In that case, you are more than welcome to do so. Actually, I use this strategy as I invest most of my money in ETFs and a smaller portion of my portfolio consists of a lot of different investment options.

Doing this can also make you higher returns than with just ETFs if you made the right decisions when choosing your stocks.

Conclusion On How To Know What Stocks To Buy

• Individual stocks require a lot of work, but are very versatile and can give you high returns
• Actively managed mutual funds should be left alone for institutions to invest into
• Passively managed mutual funds are a great investment option that is diversified and can give you market average returns.
• Equity trading funds (ETFs) are better than passively managed mutual funds: even fewer expenses and fewer restrictions. An excellent option for beginners and can be the only option for even experienced investors.
• Mixing ETFs with individual stocks is a viable option for most experienced investors.

Don’t miss new articles by subscribing!