Whenever somebody talks about ‘Growth Stocks’, he or she also talks about ‘ Value Stocks’ in the same breath as both these types of stocks are considered two primary types of investment worthy stocks. In my last post, I talked about ‘Growth Stocks’. It’s but natural that this post is about Value Stocks and the philosophy behind picking a value stock i.e. Value Investing.
My whole blog is primarily about value investing because this is perhaps the most robust and least risky way of investing in stock marekt. Legendary investment guru Benjamin Graham and his equally legendary disciple Warren Buffett have made ‘Value Investing’ very popular amongst investors. Practising value investing requires some amount of effort and patience from an investor. Which is why though value investing is a much talked about term, it’s not really widely practiced despite its obvious advantages.
The concept of value investing revolves around investing in stocks that are trading at a price levels lower than their ‘intrinsic value’ or their real worth. The fundamental thing to remember in value investing is that when you are buying a stock of a company, you are essentially investing in the business of the company. You should buy a stock only if you believe that the business behind the stock will be able to give you good returns on your investment. Before investing in its stock, you should assess the business fundamentals, earning stability and growth, financial structure, dividend record and the management quality of the company. A value investors pays special attention to the principle of margin of safety before investing in a stock. A company can be running a great business, but if its stock is priced at a higher level than its intrinsic value, it’s not worth investing in it. Similarly, a company might be in under distress and may have lost the confidence of investors for a temporary period; but it could be a great buy if the intrinsic value of the stock is much higher compared to the current stock price after taking into account the risk factors.
For a full understanding of how you should go about selecting a value stock, you can read the series of posts on ‘How to Select a Stock for Investing’ on my blog as given below:
How to Select a Stock - Part I- Understanding a Business
How to Select a Stock - Part II- Success Levers
How to Select a Stock- Part III- Earning Record
How to Select a Stock- Part IV- Financial Stability
How to select a stock- Part V- Retained Earnings and Dividend Income
How to Select a Stock- Part VI- Management Quality
How to select a stock- Part VII- Finding the right price of a stock
A value investor doesn’t pay attention to trends in the stock market. There are various reasons why a stock price moves in the stock market in the short term. However, in the long run, it is the fundamentals of the company that drive the stock price. If you have done your analysis thoroughly following the value investing philosophy and you are a long-term investor, the chances of your investment going awry are almost zero.
Friday, April 10, 2009
Sunday, April 5, 2009
How to find a Growth Stock- what makes a stock a Growth Stock
A growth stock, by definition, is a stock that has a growth rate much superior to average growth rate of the stock market. Ideally, the earning growth demonstrated by a growth stock should be growing at far higher rate than an average stock in the stock market. When people talk about growth stocks, they invariably talk about value stocks in the same breath. The key difference is that much of the valuation of a growth stock depends on its future performance and the valuation of a value stock depends primarily on its past performance.
You should be very clear about two things. First, what growth a growth stock is, and second, whether what people are claiming as a growth stock is really a growth stock.
Let’s try to first understand what a real growth stock is. A real growth stock is a stock that has been showing an above average growth rate in its earning and sales over the last 4-5 years consistently without compromising on its business fundamentals and financial future. If a company has been funding its growth through unsafe loans, which will cripple its earning capacity in near future, it can’t be called a growth stock. You should also pay attention to growth in per share earning on diluted basis ( earning per share after taking into account preferential shares, warrants, stock options, etc). The earnings overall might have grown, but have earnings per share grown? If not, then, the stock can’t be called a growth stock. After all, you will pay premium for the expected growth of earning per share in future. If the company management has not grown per share earning in the past, you can’t just trust it to do so in future.
A growth stock should never be considered for its growth alone. Consistent growth in earnings could be a reason why you want to evaluate it for investment purpose. However, make sure that you analyze the stock thoroughly the way you will analyze any other stock. You can be a little liberal in assessing a growth stock in a few parameters like Price to Earning Ratio or Dividend Payment. However, there should not be any let up in the assessment of the financial stability and management quality.
In a growth stock, the earning growth should more than make up for the liberal PE ratio or lower dividend payment. While evaluating a growth stock, be especially careful to take into account a few other factors like:
· Net Current Asset Value in order to determine the financial viability of the firm in question
· Current Asset Value in order to determine short-term financial viability of the firm
· Debt to equity ratio
· Quality of the Current Assets.
· Performance and the credibility of the management
· Change of management in recent years and its impact
How should you find whether a so-called growth stock is really a growth stock or not? If you browse through recommendations of many investment analysts in the current environment, you will find that many of them claim that they are following growth-investing philosophy while recommending stocks. Most of them have favorite stocks that have shown promise in recent years. These stocks would have grown their sales and earnings at exponential rates in the last 2-3 years. Based on this sudden spurt in their performance in the recent past, analysts start recommending these stocks as growth stocks. As is expected, many lay investors blindly jump in to investing in these so called ‘growth stocks’ without even understanding the businesses behind these stocks. These stocks are not growth stocks; instead they are fashion stocks. Every once in a while stock markets come up with their favorite fashion stocks which are bought and sold blindly without any consideration to their underlying business value. A little peek into the history should keep us sane as most often these misinformed investment result in disastrous returns and heartbreaks. Before investing in any stock, you need to analyze it thoroughly to be confident of its value as explained in this post earlier.
You should be very clear about two things. First, what growth a growth stock is, and second, whether what people are claiming as a growth stock is really a growth stock.
Let’s try to first understand what a real growth stock is. A real growth stock is a stock that has been showing an above average growth rate in its earning and sales over the last 4-5 years consistently without compromising on its business fundamentals and financial future. If a company has been funding its growth through unsafe loans, which will cripple its earning capacity in near future, it can’t be called a growth stock. You should also pay attention to growth in per share earning on diluted basis ( earning per share after taking into account preferential shares, warrants, stock options, etc). The earnings overall might have grown, but have earnings per share grown? If not, then, the stock can’t be called a growth stock. After all, you will pay premium for the expected growth of earning per share in future. If the company management has not grown per share earning in the past, you can’t just trust it to do so in future.
A growth stock should never be considered for its growth alone. Consistent growth in earnings could be a reason why you want to evaluate it for investment purpose. However, make sure that you analyze the stock thoroughly the way you will analyze any other stock. You can be a little liberal in assessing a growth stock in a few parameters like Price to Earning Ratio or Dividend Payment. However, there should not be any let up in the assessment of the financial stability and management quality.
In a growth stock, the earning growth should more than make up for the liberal PE ratio or lower dividend payment. While evaluating a growth stock, be especially careful to take into account a few other factors like:
· Net Current Asset Value in order to determine the financial viability of the firm in question
· Current Asset Value in order to determine short-term financial viability of the firm
· Debt to equity ratio
· Quality of the Current Assets.
· Performance and the credibility of the management
· Change of management in recent years and its impact
How should you find whether a so-called growth stock is really a growth stock or not? If you browse through recommendations of many investment analysts in the current environment, you will find that many of them claim that they are following growth-investing philosophy while recommending stocks. Most of them have favorite stocks that have shown promise in recent years. These stocks would have grown their sales and earnings at exponential rates in the last 2-3 years. Based on this sudden spurt in their performance in the recent past, analysts start recommending these stocks as growth stocks. As is expected, many lay investors blindly jump in to investing in these so called ‘growth stocks’ without even understanding the businesses behind these stocks. These stocks are not growth stocks; instead they are fashion stocks. Every once in a while stock markets come up with their favorite fashion stocks which are bought and sold blindly without any consideration to their underlying business value. A little peek into the history should keep us sane as most often these misinformed investment result in disastrous returns and heartbreaks. Before investing in any stock, you need to analyze it thoroughly to be confident of its value as explained in this post earlier.
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