Investing in the Stock Market -- Lesson 4
January 21st 2008 10:18
Styles of investing
The most basic principle of investing is to buy low and sell high. Some people, judging by the prices they pay, need remembering this principle. In fact, if you buy high, there is only a speculative possibility that you will make a gain.
The next basic principle of investing is that there are no free lunches. If someone is offering you something, he must be getting something else for it, be it in the form of money or risk.
There are different styles of investing. I will approach two: investing on trends and contrarian investing.
Most people invest on a trend they spot. Say Rio Tinto Limited has been going up for the last three days, and they buy. Conversely, if it’s going down, they sell. The problem with this style is that you have to detect the trends in order to take advantage of them. That, though, is not always linear.
The other problem is that, you must, in addition to spotting a trend upwards, identify its highest point in order to sell and make a gain. This might be hard to achieve.
The other investment style is the contrarian. The contrarian is someone who buys when prices of chosen companies fall. The contrarian sees value in some business and is happy to buy them at low prices, typically when they fall. This investment style, though, is only suitable for single minded people.
Fundamental and Technical Analysis
When you want to know in what company to invest, what you do? There are two approaches: fundamental analysis and technical analysis.
Fundamental analysis is based in finding out the characteristics of a business proposition, its product, its management, its goodwill, its financial characteristics. Fundamental analysis may also take into account the economy as the context where business operate.
Technical analysis or Chartism is based on deciphering trend lines in the share price history of a company and then projecting them into the future to determine future share prices. Technical analysis makes many assumptions such as that information in the stock market is reflected efficiently and rationally in the share prices, something which may not verify.
Value Investing
Value investing is based in finding the intrinsic value of a company and then buying it for a price much below such value. Value investing concerns therefore with determining a company’s value, which is distinct from its price. This difference constitutes a margin of safety.
Ben Graham started value investing during the great depression of 1928. These days it was possible to find companies trading for below their working capital (cash plus receivables and inventory) and Graham would buy them. He would then hold them for some time expecting its price to match its value.
To calculate a company’s intrinsic value, its cash flows are projected ten or more years ahead and then discounted to their present value. The details of this calculation are beyond the scope of this article.
In terms of value investing, when you buy a company for a price above its value expecting it to go even higher, you are speculating, not investing.
Ben Graham most prominent book is The Intelligent Investor, which had four editions, is published by Harper Business and whose ISBN is 0060155477.
Growth Investing
Growth investing is based in finding and buying a business which has a competitive advantage which will allow it to grow considerably in the foreseeable future. The growth investor is prepared to pay a fair price for an excellent business.
The current exponent of growth investing is Warren Buffett. Buffett started by working with Graham and being a value investor. He then realised that some business, not mater what, would just always under perform. This set him to discover business with a competitive advantage and to invest in them.
End
The most basic principle of investing is to buy low and sell high. Some people, judging by the prices they pay, need remembering this principle. In fact, if you buy high, there is only a speculative possibility that you will make a gain.
The next basic principle of investing is that there are no free lunches. If someone is offering you something, he must be getting something else for it, be it in the form of money or risk.
There are different styles of investing. I will approach two: investing on trends and contrarian investing.
Most people invest on a trend they spot. Say Rio Tinto Limited has been going up for the last three days, and they buy. Conversely, if it’s going down, they sell. The problem with this style is that you have to detect the trends in order to take advantage of them. That, though, is not always linear.
The other problem is that, you must, in addition to spotting a trend upwards, identify its highest point in order to sell and make a gain. This might be hard to achieve.
The other investment style is the contrarian. The contrarian is someone who buys when prices of chosen companies fall. The contrarian sees value in some business and is happy to buy them at low prices, typically when they fall. This investment style, though, is only suitable for single minded people.
Fundamental and Technical Analysis
When you want to know in what company to invest, what you do? There are two approaches: fundamental analysis and technical analysis.
Fundamental analysis is based in finding out the characteristics of a business proposition, its product, its management, its goodwill, its financial characteristics. Fundamental analysis may also take into account the economy as the context where business operate.
Technical analysis or Chartism is based on deciphering trend lines in the share price history of a company and then projecting them into the future to determine future share prices. Technical analysis makes many assumptions such as that information in the stock market is reflected efficiently and rationally in the share prices, something which may not verify.
Value Investing
Value investing is based in finding the intrinsic value of a company and then buying it for a price much below such value. Value investing concerns therefore with determining a company’s value, which is distinct from its price. This difference constitutes a margin of safety.
Ben Graham started value investing during the great depression of 1928. These days it was possible to find companies trading for below their working capital (cash plus receivables and inventory) and Graham would buy them. He would then hold them for some time expecting its price to match its value.
To calculate a company’s intrinsic value, its cash flows are projected ten or more years ahead and then discounted to their present value. The details of this calculation are beyond the scope of this article.
In terms of value investing, when you buy a company for a price above its value expecting it to go even higher, you are speculating, not investing.
Ben Graham most prominent book is The Intelligent Investor, which had four editions, is published by Harper Business and whose ISBN is 0060155477.
Growth Investing
Growth investing is based in finding and buying a business which has a competitive advantage which will allow it to grow considerably in the foreseeable future. The growth investor is prepared to pay a fair price for an excellent business.
The current exponent of growth investing is Warren Buffett. Buffett started by working with Graham and being a value investor. He then realised that some business, not mater what, would just always under perform. This set him to discover business with a competitive advantage and to invest in them.
End
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