Cutting to the chase, it’s practically impossible to time the stock market. If you’re hoping to hear the Finimize “buy” bell ringing, then you’re in for a disappointment.
However, if you’re thinking about buying while so many people are screaming “sell,” you might be onto something.
Investing is about being ahead of the pack, even if it means going against the grain.
High-quality stocks have lagged behind the overall market this year as investors have shifted their focus to other areas.
The chart below shows that the iShares MSCI USA Quality Factor ETF (ticker: QUAL; expense ratio: 0.15%) has underperformed the S&P 500 index of large US stocks by four percentage points this year.
This is not a huge shortfall, but it is an underperformance nonetheless. Some stocks considered to be high quality, such as Microsoft (MSFT), Alphabet (GOOGL), or Nike (NKE), have also seen declines.
Looking for predictable investments is about finding certainty that a company’s profits can grow into the future, and avoiding risks to those profits.
Quality stocks have the characteristics that make them well-suited to today’s scary markets: higher predictability and lower risk. By tattooing these doctrines onto their arms, quality practitioners ensure that they will always remember the importance of predictable growth and avoiding unnecessary risk.
The two most popular investment styles are growth and value. They sit on opposite ends of a spectrum in terms of valuation.
Value investors look for companies that are struggling, usually either stagnant or in decline, in the hopes that things will eventually improve.
At the other end of the spectrum, growth investors seek out high-flying stocks of companies that are growing rapidly. In between, stock prices tend to get gradually more expensive as you move from the dirt cheap to the high-flyers.
Some investors believe that both the value and growth approaches come with big risks. They claim that the problem with down-and-outs is that for many of them, nothing ever improves. And even when prospects do pick up, investors might have had to wait years to cash in, during which time they could’ve been enjoying nice returns from healthier companies.
When it comes to expensive growth stocks, companies don’t always enjoy rapid growth forever. Usually, competitors will enter the market and start to cut into their profits. So investors can get caught off guard if (or when) a rapidly growing company hits a snag and their stock value plummets. Just look at how investors who bought into “pandemic winners” like Peloton (PTON) or DocuSign (DOCU) have been left bruised.
Quality traders look for companies that are in good health, growing at a reasonable pace, and trading at fair valuations. By avoiding the risks at both ends of the spectrum, they can focus on finding the best middle-ground opportunities.
When it comes to quality investing, it’s all about avoiding the risks that come with cheap no-hopers and over-priced growth stocks.
A good place to start is by looking at a stock’s valuation. For example, using the S&P 500 index’s price-to-earnings ratio (P/E) of 16x as an average valuation for the US market, you can assign a range that cuts off the extremes. Where you draw boundaries is, frankly, arbitrary, but a decent rule of thumb might be five P/E points on either side: leaving a P/E range of 11x to 21x for quality stock fishing.
Let’s take a step back. That P/E range would eliminate some of the more expensive growth stocks like Tesla and Amazon, as well as many banks and commodity companies.
But that’s okay: quality investors are often perfectly content to say “not for me, thanks” and move on. By the way, the range would also leave out Microsoft, but not by much.
In the end, it’s up to you where you draw the line: you might think a 10x-30x P/E ratio range is better, for example, which would include Alphabet, Microsoft, and Nike.
What you’re really looking for as a quality investor is predictability. And you can get an idea of how predictable a company’s prospects are by looking at these five things:
No high or low extremes here. Stick to those that are still not overvalued or extremely undervalued. If the Stock is falling incesitnly, there might be a good reason.
Look at the last five years of sales growth from the Markets feature on your Finimize app. You want to see decent historical sales growth (say, 5% or more per year) that’s stable. You don’t want to see big gains one year followed by declines the next.
Companies can grow despite losing money due to sky-high costs and chunky outlays. You’re not necessarily looking for the most profitable firms, but you want to see that margins are getting fatter over time.
So check out the firm’s profit margins – profit divided by sales – over the past five years, and see whether they have grown and by how much. Use the Markets tab, along with annual reports or free tools like Koyfin.
If it’s easy to replicate the firm success and there are many competitors, possibly, it’s best to stay away from betting on such firms, instead, try range trading could be a good substitute for such types of CFDs on stocks.
This is self-explanatory, if what the company does results in a strong product/service offering that is hard to shake off even after major missteps (think Samsung phones blowing off, or Woltsvagen cheating on their environmental friendliness), it’s a good place to put you long CFD position.
When considering which stocks to go long on, remember that there are many factors to consider.
However, if you focus on quality companies with good prospects, you may be able to avoid the risks associated with value and growth investing. By following this approach, you may be able to find some quality stocks that will pay off in the long run. Just don’t be greedy with taking too much margin from your brokerage.
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