I visited the grade 9 class again to continue the stock market investing lessons. The teacher is always apologetic that I have to put up with the kids, and she doesn’t seem to believe that I’m enjoying teaching them. The hardest part, I told her, was trying to boil down the wisdom that I’ve gained over seven years of work into three one-hour lessons. I may be flattering myself a little bit, but that’s what it feels like. To the kids, it may just feel like drinking from a fire hose.
This week, we looked more closely at how to choose stocks to invest in, and how to trade them (in the simulation software). There definitely wasn’t enough time, and that’s my excuse if it seems a little incoherent here. I told the story of the first time I bought and sold stocks, based on stories in the news. The benefit is that it works well over the short term (a couple months), but over the longer term, they tend to revert to the mean. Besides that, investing in what’s in the news leaves the outcome to luck. So I presented three strategies that can be used with a stock screener.
I presented two stock screeners. There are others, and any will do. Stockhouse.com (under Market Info in the menu) used to be really easy to use, but they’ve expanded it. It’s a little less clear, now, but it produces good results. Morningstar.ca has a good screener, but I don’t recall if it will do US and Cdn stocks at once. If you’re looking for new companies to consider investing in, where do you start? That depends on your style.
Value. Are you the type of person who likes to buy things on sale? Stocks go on sale. The relative cost of a stock can be measured by P/E, the price to earnings ratio. This compares the earnings (per share) of the company to the price (per share) that people are willing to pay. A higher P/E is a company that people are paying a higher price for in the market (relative to the profitability of the company), and a lower P/E is similar to a sale. This is a really good strategy for the long-term investor who believes their companies will come back into favour. Filter on P/E (lowest to highest).
Growth. Are you the type of person who likes to be on the cutting edge? Some stocks are expensive precisely because their future prospects are so bright. If next year’s earnings will be double this year’s, and then double again the following year, the price today might appear high. Earnings that are growing steadily year-by-year should increase the value of the company (proportionately) over time. Filter on Earnings growth (highest to lowest).
Income. Do you depend on your portfolio for income? Companies, especially larger, more stable companies, may choose to use their profits to pay a dividend instead of retaining the earnings for reinvestment. Many companies will pay out 50-60% of their profits, although former income trusts may pay closer to 100% of profits (which leaves little room for error). For these companies, it’s good to look at payout ratios and debt levels to be relatively confident in the ability of the company to maintain dividends.
There’s no reason an investor couldn’t mix these strategies. Growth and income are sort of mutually exclusive, since profits can either be used to pay dividends, or reinvest in growing the company. Value and Income combine nicely, since the yield increases (as a percentage) when the share price falls. Value and Growth can combine (somewhat) to form Growth at a Reasonable Price.
My personal strategy is a value + income strategy. What strategy do you favour? Do you have difficulty sticking to a single strategy? Do you use a journal to reflect on why trading decisions are successful or not?