Top Equity Investment Strategies for Your Portfolio
KEY POINTS
Key equity investment strategies include active or passive investing, valuation, and market capitalization.
Strategies can be combined to build a diversified portfolio aimed at achieving your short-term and long-term goals.
There are many types of investment strategies and styles associated with investing in equities. It is important to understand the unique traits of each one and how such may impact your investment plan.
A single security can be connected to multiple strategies. For example, a technology stock may be associated with large cap stocks while also being a growth stock.
Sound confusing?
We have broken down the strategies into the following 3 groups.
Active vs. Passive
You and your investment advisor should always be actively involved in managing your investment portfolio. Such may include an allocation to exchange traded funds, mutual funds, or index funds. Such securities can either be actively managed or passively managed.
The S&P 500 has a beta (statistical risk measurement of volatility) equal to one. Therefore, beta is often equated to what an investor could passively earn by simple investing in an index fund. Whereas alpha refers to the returns generated by the investment manager that are in excess of the market.
Alpha – Active Investing
Investment managers that employ an active investment style try to earn a rate of return in excess of the market. Such excess return is referred to as alpha. Such investment vehicles often charge higher fees than a passive investment vehicle due to the added value provided by the manager.
Numerous studies have shown that few active managers can consistently beat their respective benchmark for 3 consecutive years. Therefore, you and your investment advisor must do the necessary due diligence before allocating to an active manager.
Beta – Passive Investing
Passive investing can provide excellent diversification and may be less risky and less expense than an allocation to an active investment strategy.
Value vs. Growth
At one end of the spectrum, value stocks are priced at a discount with long-term growth potential. At the other end of the spectrum, growth stocks are more expensive, but offer potentially superior growth rates.
Value
Value investing focuses on investing in undervalued stocks that have the potential for long-term appreciation. Such companies will trade at a discount relative to their intrinsic value. Investors may use several financial ratios to assess the value proposition of a particular stock including, but not limited to the price-to-earnings ratio and the price-to-book ratio.
An example of value investing would be purchasing a stock after a severe negative market shock. The stock price may be depressed, but you consider the long-term investment fundamentals intact.
Value investing has a high degree of overlap with contrarian investing. Contrarian investing involves buying stocks that are currently out of favor with the market, based on the conviction that they will rebound.
Growth
Growth stocks typically have higher price-to-earnings ratios than value stocks (i.e., more expensive) as investors forecast the company will produce above average earnings growth. Such growth may be primarily top-line revenue as profitability and cash flows growth may trail by several quarters or years.
Technology stocks are often classified as growth stocks as their top-line revenue can generate above average growth rates due to the market uptake of their disruptive technologies.
Growth investing may overlap with momentum investing. Momentum investing focuses on stocks that are trending upwards with the expectation that such trend will continue.
Market Capitalization
Market capitalization measures the size of a company based on its number of shares issued (publicly traded and restricted) multiplied by its share price. The value can change daily based on changes in the share price.
There are three primary categories for classification:
Small-Cap
Market value less than $2 billion
Mid-Cap
Market value between $2 billion to $10 billion
Large-Cap
Market value greater than $10 billion
You may also see small cap and large cap further broken down into micro-cap and mega-cap respectively.
There are other strategies that overlap with the above. For example, blue-chip investing involves investing in well-established companies with large market capitalizations. Such typically overlaps with large-cap equities.
Morningstar is a popular American financial services research firm that incorporates market capitalization into their analysis. Their classification methodology is slightly different than above and is summarized as follows:
Large-cap stocks represent the top 70%, mid-cap the next 20%, and small-cap the remaining 10% of the stock universe.
Style Box
Morningstar created the mutual fund style box that can be utilized for mutual funds or individual stocks. Such provides a clear and concise picture that illustrates a security’s attributes with respect to valuation and market capitalization as referenced above.
The following sample chart shows the valuation along the horizontal axis and the market capitalization along the vertical axis.
|
Large |
|||
|
Mid |
|||
|
Small |
|||
|
Value |
Blend |
Growth |
|
Investment Strategies
The above investment strategies are commonly used to describe an investment manager’s high-level approach to constructing a portfolio. There are several sub-strategies that can be deployed to achieve specific objectives. For example,
Income Generation
Passive income can be generated from investments in dividend paying stocks, bonds, or real estate investment trusts. Such can be used to fund many things including retirement or a reinvestment strategy.
Sector Investing
Concentration on a specific sector or industry to capitalize on the projected growth opportunities.
Socially Responsible Investing
Incorporates environmental, social, and governance factors into the investment allocation process.
Index Investing
Involves investing in a broad market index (e.g., S&P 500 Index) to achieve market returns. Exchange traded funds can be a relatively inexpensive way to incorporate an index strategy.
Cyclical Investing
Focuses on investing in companies that are sensitive to economic cycles (expansion, peak, contraction, recovery) and perform well during periods of economic growth.
Defensive Investing
Concentrates on companies from industries that are less likely to be affected by economic downturns.
Event Driven Investing
Involves capitalizing on corporate events including mergers, acquisitions, and spin-offs.
Long/Short
Involves buying stocks you anticipate increasing in value, and borrowing to sell stocks short you anticipate decreasing in value. Such dynamics can also be achieved using derivatives (e.g., options, futures).
BOTTOM LINE
There are many different investment strategies that you and your investment advisor can implement to achieve your short-term and long-term goals. You must actively manage your portfolio and do not be afraid to modify your mix of strategies to maximize your returns in an ever-changing market.
