As I said before these are my choices for investing my money. I am not an adviser so this is not a recommendation but rather a story of how I do my investing. If any of this interests you please do your due diligence to determine your own choices for allocating your money.
The market moves on emotion in shorter terms and it is the over greed and over fear that the intelligent investor, that Benjamin Graham writes about, can take advantage of. One of the first things I look to do is use this information to reduce my risks while giving myself a good opportunity for gain.
Managing Investing Risk
First and foremost I want to reduce my risk while giving myself the opportunity to gain good returns. Howard Marks from Oaktree Capital gave a quote “a 6 foot man drowned crossing a river that average a depth of 5 feet”. This is because there are times when things move from the average such as there are 10 foot depths along with shallow ones. In the case of the market, it may go up on average around 9 or 10% over time but there are times when it goes up two or three fold and times when it drops by 50%. By protecting the downside I believe I can outperform the averages over time.
There are two different types of risk I am trying to manage: market risk and business risk.
To reduce risk I look at the following eight situations:
- For the market risk: market valuation
- For the business risk: financial health, earnings and cash flow, valuation ratios, discounted cash flow, dividends, qualitative and Technical.
Note: dividends are almost always a requirement for me and ones with growth and or great growth potential. There are a few franchise stocks that do not pay dividends at this time I would still buy if they went down to a great value but probably only four I like in the whole market.
Market Valuation: The market goes up and down and not always at the same pace as the economy. as you can see in the chart below the stock market in blue and the economy in green take different paths. Since the value of businesses goes with the increase in business then an efficient market would have stocks appreciating similar to the economy.
From 1996 to 2000 the market tripled, after that it dropped by 50%, then over the next six years went up 150% and then dropped 50% and after that over the last 6 years to 2015 the market has tripled. All this while the economy generally has grown below 10% over history. In the last six years where stock prices have tripled the economy is only growing below 4%. There is a disconnect and this is where a contrarian investor takes advantage of the emotions of the market buying when people are panic selling and selling or re-balancing when people are buying and pushing prices above real value.
Market Risk Analysis detail
Business Risk: is tied to the business of the individual stocks one invests in. If the company has good business growth and strong earning generally the stock will rise. All businesses go through tough times such as recessions and market down turns as seen in the market risk chart. I feel picking stocks with healthy balance sheets helps prevent against business failure during these tough times.
This is where I have to do as much homework as I can on a business and then determine if the business is a good investment and if the stock price is fair or better for me to pull the trigger.
This involves checking:
- The balance sheet for debt and equity/tangible book value.
- Earnings power of the assets.
- Value ratios such as Price comparisons to earnings, sales, growth and tangible book value
- Placing a value per share for the company and setting price targets using earning, earnings growth and tangible book value to determine my ideal price for a stock.
- Dividend evaluation if there is a dividend.
- Qualitative evaluation of the story behind the business and latest news.
- Technical, yes I still check the charts but the fundamentals are a higher priority in making an investment decision.
Do you have an investment strategy? Please share or pose questions in the comments.
StockStory is not a financial advice site and content should not be considered for investment recommendations.
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