There’s more than one way to skin a cat.
Like the rather gruesome phrase (probably coined by a psychopath), there is no one specific investment style you must follow to achieve investment success. There are countless examples of investors who’ve succeeded using entirely different and sometimes diametrically opposing investment styles.
Warren Buffett is the third richest man in the world today with a net worth of US$66.4 billion thanks to value investing for over 60 years, while Paul Tudor Jones is regarded as one the best traders of all time and has made a personal fortune of US$4.6 billion based on technical analysis and swing trading.
Zealous proponents of value investing will jump in at the chance to point out that Buffett is worth 14 times Jones (and, therefore, value investing is “superior”) but they make the mistake of missing the point entirely: Jones would have most likely been a much poorer value investor and Buffett a much poorer swing trader. It’s simply about choosing something you’re naturally better at, which these two billionaires have obviously done.
Thus, it’s pointless to ask which investment strategy is the best because there is no holy grail of investing; any particular strategy can give you great returns — if you do it right.
The more useful question to ask yourself is:
“Which strategy will work best for me – knowing my unique talents, individual financial needs, investment goals, time horizon, and risk appetite?” (Along with other many myriad factors.)
For example, if you’re in your twenties starting out with a small sum of money and have a good knack for stock analysis, you might want to invest for in deep value or value-growth stocks to grow your capital base more aggressively. But if you’re in your fifties with a sizable nest egg, your focus would more likely be on capital preservation and passive income – making dividend investing more suitable for you. Generalizations, I know, but you get my drift.
Even so, unlike a marriage where you’re stuck with a bad choice that snores in bed like a 747 taking off, you are free to wed as many different investment styles as you wish – as long as it ultimately fulfills your goals and needs. For instance, you could have 50% of your portfolio invested in defensive dividend-paying companies, 30% in index funds, 15% in growth companies, and the rest in more speculative stocks because, what the heck, you fancy a wee punt once in a while just to get the heart going.
So with that, let’s dive into the five core stock investment styles and the one(s) that suit you best:
1. Index investing
Instead of trying to beat the market, index investing aims to generate the same returns as the market index through investing in low-cost index funds and ETFs. So if the stock market goes up 5% in a year, you can expect to make similar returns (less management fees and transaction costs). This is based on the premise that stock markets always rise in the long term.
Over the last 10 years, the SPDR® S&P 500 ETF has returned a compounded annual growth rate of 7.14% (as at 30 September 2016). In Singapore, the SPDR® Straits Times Index ETF has returned a compounded annual growth rate of 4.18% over the same 10-year period.
The advantage of this strategy is you don’t have to spend time and effort trying to pick individual stocks (that may or may not make money); you simply buy the whole market instead. In fact, Warren Buffett thinks that most investors will make superior long-term returns by investing in low-cost index funds.
Defeated U.S. presidential candidate Hillary Clinton also invests in one mutual fund – the Vanguard 500 Index Fund which tracks the S&P 500 index.
2. Income investing
Income investing (or dividend investing) aims to invest in companies that pay a steady stream of dividends. Companies that pay steady dividends are usually larger, more established companies (e.g. telcos, utilities, etc.) that generate large, steady amounts of profit and free cash flow. Because the growth rates of larger companies have slowed down, they’re able to return a higher portion of their retained earnings as dividends to shareholders.
Singapore REITs also pay a high dividend due to tax exemptions when they pay at least 90% of distributable income out as dividends to unitholders. As at October 2016, the average yield for Singapore REITs is around 7%.
The key to dividend investing is not to focus on high yields alone. There’s no point receiving a 10% yield this year only to have the company cut its dividend the next. What’s more important is to pick and invest in good-quality companies and REITs that are able to sustain and grow their dividend payouts year after year.
Local investment blogger AK is a well-known income investor in Singapore. His dividend income from the first half of 2016? $58,545.01 (about $9,757 a month). But that’s only from his non-REIT investments. His REIT investments earned him $397,294.28 in dividends in the first six months of 2016. Legend.
3. Deep value investing
Instead of chasing future growth, deep value investors look for undervalued stocks with a large margin of safety between value and price. So rather than predict how well a company might (or might not) perform in the next year few years, deep value investors are more concerned about protecting their downside and getting a good price out of their investment today – and the upside naturally will take care of itself.
Deep value stocks are usually net-net stocks trading below liquidation value or companies whose share prices have been significantly beaten down due to bad news or results. The key is to avoid the value traps (a company that looks cheap on paper but will never turn around and revalue upwards) and invest in companies where the bad situation is only temporary and has the potential to turn around.
Benjamin Graham, Warren Buffett’s mentor, is widely known as the father of value investing. In his 30 years as an investor, Graham boasted an annualized return of 17% and total returns of 750%.
One fund manager we know personally, Tay Jun Hao, also focuses exclusively on deep value strategies and has made 22.6% in annualized return investing in deep value and net-net stocks.
Deep value investing was also the original investment style Warren Buffett used early in his investment journey while he was learning under Benjamin Graham. Between 1957 to 1969, Warren Buffett enjoyed the best returns in his career and generated a compounded annual growth rate of 29.5% applying the deep value method taught by Benjamin Graham.
“The highest rates of return I’ve ever achieved were in the 1950’s. I killed the Dow. You ought to see the numbers. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” – Warren Buffett
4. Growth investing
Growth investors seek to maximize their capital gains and focus on investing in growth companies whose earnings or sales are expected to grow at above-average market or industry returns. Growth companies are usually smaller companies that have a lot more potential to expand in the years to come. Certain industries by their nature (e.g. technology) also allow companies to grow and scale very quickly.
As the largest social media network on the planet, Facebook has seen its revenues grow 2.7 times from $48 million in 2011 to $128 million today. In the process, its share price has risen 273%.
In ten years, Netflix has seen its sales grow from $997 million to $8.1 billion and its number of subscribers multiply from 6.3 million to over 86 million. Consequently, its share price has grown 3,006% in the same period!
Due to their explosive growth, growth companies tend to be more expensive in terms of valuation – P/E ratios can sometimes run into the hundreds or more (Netflix is currently trading at over 300 times trailing earnings). Growth companies also tend to be riskier and more volatile. Investing for growth inherently involves making a projection into the future — and growth stories don’t always pan out the way investors want to.
Phillip Fisher is known as one the greatest growth investors of all time. He authored Common Stocks and Uncommon Profits which became the first investment book ever to make the New York Times bestseller list. In his book, Fisher outlined his 15-point strategy for identifying great long-term growth stocks. The book also influenced Warren Buffett heavily and has said that it “ranks behind only The Intelligent Investor and the 1940 edition of Security Analysis in the all-time-best list for the serious investor.”
5. Value-growth investing
Value investing is usually most commonly associated with arguably the world’s best investor — Warren Buffett. However, we hesitate to call Warren Buffett a value investor nowadays.
Like we mentioned before, Buffett used to employ Graham’s deep value and net-net stock strategies early in his career. However, over the years, Buffett has changed his investment style from bargain hunting to investing in great businesses in order to grow Berkshire’s multibillion-dollar portfolio.
His contemporary approach to investing is best encapsulated by this quote:
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett
While Buffett still uses aspects of Graham’s approach for valuation, he focuses more on the quality of a firm’s business. His evolution over the years means that Buffett is now both a value and growth investor and uses an investment style we like to call value-growth investing. Another quote by him sums it up:
“Growth and value investing are joined at the hip” – Warren Buffett
Like Buffett, value-growth investors look for companies with wide economic moats, reasonable-to-good growth, stellar financial performance, and excellent management. A glimpse at Buffett’s portfolio will give you an idea of the type of companies we’re talking about: Coca-Cola, Kraft Heinz, American Express, Apple, Visa, Walmart, etc.
High-quality companies like these are rare — and the opportunities to pick them up at fair or undervalued prices, even rarer. However, when you purchase them, they will become a cornerstone of your portfolio for a long time to come.
The fifth perspective
So there you have it, the 5 most common investment styles you can use to grow your wealth. This list is by no means exhaustive; there are many other specific variants like cyclical investing, special situation investing, momentum investing, etc. But as a retail investor with a full-time job, responsibilities, and screaming kids (with snot running down their noses) at the back of your car, it’s probably easier to focus on the more straightforward methods of growing a stock portfolio.
Also, even though I mentioned Paul Tudor Jones as a contrast to Buffett at the beginning, I didn’t include technical analysis trading as an investment style, as technically (no pun intended) trading and investing are entirely different frameworks — although technical analysis can still form a part of the investor’s approach.
If you’re interested to learn more about the different investment styles, feel free to check out our links below:
- Investment Quadrant (value-growth investing)
- Dividend Machines (dividend investing)
- Deep Value Detector (deep value investing)
And we look forward to helping you make better, more profitable investment decisions!