Value Investing and Our Medium-Term Stock Strategy

March 27, 2013

in Investing

By Eileen Tan and Ui Wei Teck (guest contributors)

The strategy of the Value Investor lies in the capability to uncover great businesses before it gets widespread attention. You can then buy low, sell high and not react to news. You have to spend time analyzing a company’s financial position in detail and compare it with other companies in a similar industry, in order to benefit from under-valued or strong growth stocks.

Buying only when there’s a margin of safety

What if the strong fundamental stock you have identified is trading at a high price with no or not much discount to its fair value?

For us, we would not buy the stock when there is no attractive discount. There will always be news that will drive the stock price up or down. So be patient to buy only when there is a huge discount to the anticipated value of the stock. This gives us the margin of safety in investment. We may miss some opportunities to make money in stocks that consistently trend upwards without much correction, but we can still make money from stocks that give us a higher chance of making profit with more room for error.

We have learnt the hard way that that it is impossible for all our stocks to perform the way we want them to, and we have to be patient to invest only when there is at least a 30% discount from our anticipated value.

We focus on about 10 to 20 shortlisted stocks to determine our buy/sell decisions and we monitor the charts daily or at least weekly. We focus on a smaller number of stocks, ideally holding about 10 quality stocks at any one time, so as not to diversify our holdings too thinly. We will stay invested until one of the scenarios below happens for our medium-term equity investment portfolio:

  • the stock price reaches its anticipated value or
  • the stock market is getting overvalued or
  • the stock market has reversed into a major downtrend

In our case, besides analyzing and selecting under-valued stocks using a business-like mindset, we are also sensitive not to become “stock collectors”. So we look for strong stocks where the anticipated value is higher than the stock price as part of our medium-term investments (those we hold on to for more than a year).

Buying good fundamental stocks for the Medium-Term (> 1 year)

We are interested to be Shareholders of a financially sound company with good business fundamentals. We do detailed Fundamental Analysis, which involves studying the company strategy, business and financial performance. Such stocks are shortlisted and purchased at the appropriate time.

Ideally, these stocks are purchased when a major market trend has just turned upwards from the downward trend. We observe this by looking at the Stock Index Chart when the 50-days Simple Moving Average crosses above the 200-days Simple Moving Average.

Besides looking at the overall market trend, we also monitor the shortlisted stock chart using Simple Moving Average (SMA). SMA is one of the Technical Analysis Indicators, which uses historical data to track the average stock price over a period of time, helping you to derive the price trends and possible future performance to determine buy/sell signals.

The 20-days SMA represents a monthly trend; the 50-days SMA represents a quarterly trend; the 100-days SMA represents a half-yearly trend; and the 200-days SMA represents a yearly trend.

For our medium-term stock investment, we determine the buy point when the stock price crosses above its 50-days SMA. It is representative as most companies report their results quarterly. If we are confident about the company’s future performance, we may also buy when the stock is near a prior support level or when the stock price crosses above the 20-days SMA by looking at its past trend.

130327 Figure 1

As for when to sell, we will adopt the opposite. For the major market trend, we will watch out when the 50-days SMA crosses below the 200-days SMA in the Stock Index Chart which indicates the reversal of the market trend. When there is an overall downtrend with major players exiting the market, we should not hang on any more and will consider exiting the stock market completely too.

130327 Figure 2

Similarly, when the stock price crosses below its 50-days SMA, it is a sell signal for the particular stock. We may also look at the 20-days SMA or Resistance level in the past to determine the selling decision. Such an indicator is not 100% accurate but it is one of the higher accuracy technical indicators which we adopt as a Value Investor. At times, we may also look at other technical indicators to re-validate our decision.

If you are not sure what stock to invest in, you can buy the entire Singapore stock market via a vehicle such as the STI ETF (Straits Times Index Exchange Traded Fund). It consists of the top 30 companies in Singapore with a periodic review of which companies are to be included or excluded in this index fund. You can buy and sell the STI ETF like a stock at any time with transaction fees.

In addition, you (or your children!) can start investing in the STI ETF with an option to consistently buy at a minimum of $200/month. By investing regularly with a fixed amount, you are purchasing more shares when the price is lower, and fewer shares when the price is higher. Over time, your average purchase cost will be reduced using this cost averaging strategy. By starting early with a smaller amount, you (or your children) can benefit from the power of compounding returns over a longer investment period.

 

By Eileen Tan and Ui Wei Teck, authors of Enjoying Mid-Life Without Crisis.

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