Getting started on picking and analysing stocks: Part 1

This is written by @fayewang, stock market analyst at Investingnote.

Choosing an analysis method & stocks based on your own time horizon

Time is always an important factor in an investor’s trading/investing strategies. Before you start planning on investing, the first step is to decide the length of your time horizon. There are various investment periods: 1) Long-term, 2) Medium-term and 3) Short-term. This article will have greater emphasis on the long-term investment and fundamental analysis.

1. Long-term investment
From my personal opinion, a long-term investment should at least last for one year. Before any further discussion, it is essential for investors to know that market is about “expectations”. I will explain it with following examples. Firms usually announce the date of financial results release before they have the actual movement, thus people form their expectation towards the result in advance. This means that usually, the market price has already incorporated those expectations before a certain event. After the initial publicity of those financial results, whether the stock of a firm has obvious price changes truly depends on whether the results meet the expectations of shareholders.

One year should be long enough for the market to absorb unanticipated information and fully reflect it in the price, and that’s also why fundamental analysis is more meaningful for long-term investors. As a fundamental investor, I normally start my analysis with the company’s financial statements, but always bearing in mind that those documents actually reveal performance of a firm in the last financial period (year or quarter). Longer time frames give the market enough time to digest all expectations and responds after certain event or news. That also explains why price is tend to be less volatile in the long run than in the short run.

Also, for long-term investors, bluechips and defensive stocks will be the optimal choice in portfolio.
According to Barron’s Dictionary of Finance and Investment Terms, bluechips mean “nationally known company, with a long record of profit growth and dividend payment.” According to the definition provided by Investopedia, defensive stock means ”a stock that provides a constant dividend and stable earnings regardless of the state of the overall stock market”, find the definition here: http://www.investopedia.com/terms/d/defens....
The principle is simple: investors should keep stocks that would not be severely affected by economic fluctuations since they gonna to buy and hold for long time.

The common misconception is that all bluechips are defensive stocks. In fact, not all blue chips are but they are more likely to be more “defensive” due to considerable profit scale and favourable government policy. Additionally, bluechips have greater chance to increase their intrinsic value as time goes by. Representative of long-term investors could be Warren Buffet, who tends to hold securities for more than 5 years or even 10 years.

2. Medium-term transaction
The medium-term here may refer to the time horizon that is more than one month but less than one year. However, the boundaries of different time frames are not absolute, so medium-term here can also refer to period that is “neither too long or too short”. The categorization and conceptualization of different time horizons are simple ways that help investors figure out how long they should hold securities or other financial instruments.

Within such a time frame, people can combine both technical and fundamental analysis to make a decision. Using fundamental analysis to analyse a stock is useful because investors would not want to invest in a company with weak financials and indications of failing. Then, technical analysis can help you decide an appropriate entry time.

During the medium-term investing horizon, cyclical stocks can be a good choice for investors. As defined by Investopedia, ‘A cyclical stock is an equity security whose price is affected by ups and downs in the overall economy’. One of the best examples is REITs and property counters, which are affected by interest rates. Thus, investors tend to avoid interest hikes and invest when the economy is relatively stable.

3. Short-term trade
The short-term time horizon is normally less than one month. Stock prices are live, changes every second, and people are trading every moment. People who want to trade certain stock can even execute the buy/sell transactions within several minutes, also known as intraday trading. For such investors, technical analysis will be more suitable because price trend is the emphasis. As Benjamin Graham said in his book, “Security Analysis”, fundamental analysis is less meaningful for traders, who make their decisions based on the price patterns/charts and news.

Traders, especially day traders, are more likely to choose stocks with high level of volatility because their target is earning quick money within a short time of period. It will be pointless if the stock maintains stable price or trends sideway. Thus trading is more risky than investing, and requires strategies plus experience. However, traders have a wider range of choices even when there is a limited amount of bluechips, because there are also many small/medium cap stocks that have the potential for trading. That is also one of the reasons why traders like to play with penny stocks, which can edge up or drop down severely within single trading day. Overall, trading is not a easy as it requires ample skill, time and emotional discipline.

4. Income and Growth Stocks

As the returns from investing in a stock can be derived from both dividend yield and capital gains yield, there are 2 common types of stock that focus on each of these yields. These types of stock are known as income and growth stocks here.

Income stocks, also known as “dividend stocks”, is the kind of stock that people buy it for steady dividend income. Normally, income stock is stock of mature corporations that has no immediate need for further expansion, thus they are able to pay higher portion of their earnings to shareholders (provided they are doing fairly well as a business). On the contrary, growth stock are categorized by companies that enjoy rapid growth. People hold growth stock because they believe the stock price will rise in the future therefore they can sell it at a much higher price.

One thing that need to be clarify is that the choice of Income or Growth stock is not based on the time horizon, but based on an investor’s own risk tolerance. Growth stocks are often with higher risk because growth companies are new and volatile, and exposure to higher possibility of bankruptcy. Hence, the returns are usually higher because investors expect to be rewarded when they take up a higher risk. For investors who are looking at steady income as an outcome from investing and are unwilling to take up too much risk, picking a good income stock will be a wiser option.

You can check bluechips with highest dividend yield in Singapore market here: http://www.sgx.com/wps/portal/sgxweb/home/...

5. The Function of a Portfolio
There are people who think that having a portfolio is not effective to diversify risk. I would like to say portfolio management is actually an efficient strategy to protect your investments and capital. These are some tips to help you get started on constructing a well-diversified portfolio.

i) Make sure your portfolio has clear time structure, which means you should have a general idea about how long you gonna to hold each stock.

ii) Match the stock type to your time horizon, probably you won’t buy and hold a penny stock for several years and you will not trade a bluechip with obvious sideway trend.

iii) Don’t put all your eggs in one basket. Putting too much stocks in your portfolio is also not advisable as it may be distracting to your investment objectives and stock-picking efficiencies. It is therefore more advisable to just focus on a few key stocks that you’ve hand-picked and have done the homework for.

To be continued in Part 2...

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