A Brief Review of Value Investing Strategy in the Stock Market
By Hsingchien J Cheng, DMD
There are two basic types of stock market investing strategies: momentum strategy and value strategy. Momentum investing is often short term focused and uses sophisticated technical charts, trend lines, graphs, and computer simulation models to project short-term stock price movements in days (or even minutes) to capture quick profits. Value investing is focusing on a long-term time span with at least a six-month duration in studying trend charts and financial statements. For a non-professional investor, who is unable to monitor the daily volatile stock fluctuation movements, it would be prudent to become a long-term value oriented market player. There are a few golden rules worth to note, which can sound simple, but difficult to master: (1) recognize the market is efficient, (2) recognize the market is irrational, and (3) buy low and sell high.
(1) All public traded companies have to file required financial statements to the SEC (Stock Exchange Commission). Basic financial statements, such as Balance Sheets, Income Statements, Cash Flow Statements, and Owner's Equity Statements, are all public records readily available online. Since these data are monitored and scrutinized extensively by numerous analysts and investors on the Wall Street, the stock price is considered a consensus opinion of collective wisdom. Current use of technology and the internet enables information to be disseminated online to all at the lightning speed. This greatly improved the efficiency of the stock market pricing process.
(2) Market psychology is an equally important factor affecting the stock price. The sentiment can be due to non-economic events such as political, environmental, or other sensational headline news. Due to the inherent human nature fear of total loss, the stock price can easily and frequently drop at a fast and steep rate. This sometimes can create an oversold buying opportunity in the initial steep drop upon breakout of bad news. A prudent investor will ask if the incident would be fatal to put the company out of business, or as an entry point for investing. Some well-known CNN headlines cases are best exemplified by the Toyota Prius break problem, BP oil spill in the Gulf, and the Walmart bribery scandal in Mexico. Although those well-respected brands in their industries went through major setbacks in recent memory, their stock values were all eventually forgiven by investors and were able to fully recover within a year.
(3) One has to buy low and sell high in order to make a profit. There are many theories in the art of investing how to identify a "cheap" stock. One example is the Dow Dog Theory by investing in the second worst Dow Jones stock of the previous year. It takes some courage and insight to find a diamond in the rough. All market sectors are known to have their up and down cycles in approximately seven years. After considering the market fundamentals on why a particular sector or stock is temporary out of favor in the market, one can be confident and patient the fallen angel will have its up days in the future. My basic approach is to seek out the best managed company in the depressed sector that can survive the downturn cycles and benefit the most when recovery arrives later.
A qualitative approach to value investing in the stock market is discussed here. For anyone who is interested in investing as a DIY (Do- It- Yourself) project, there are numerous amounts of information available online or in publications. Education cannot guarantee getting rich in the stock market, but it will reduce the risk of ignorance. An educated investor, who is familiar with different concepts and strategies in both the short-term and long-term investing, will enjoy stock market investing as a fun and profitable hobby.