1 Forgotten Investing Tip for Improved Performance
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Being a successful investor requires many attributes and thousands of books have been written on the subject. Investors often read about how George Soros or Warren Buffett or the latest hedge fund manager engineered their great returns. While it makes for interesting reading, it can often lead to contradictory approaches. Novice investors may be torn between an asset class or individual stock that is both praised and hated by their most respected peers. So what is an investor to do?
Determine Your Holding Period
One of the best things an investor can do to immediately help performance is to do a deep-dive on their real holding period. Are you a trader with a holding period of hours, days, or weeks? Maybe your strength lies in navigating the cyclical bull and bears that often persist between six months and three years? Or are you an investor that invests based solely upon secular market cycles that can last upwards of a decade or more? Once you identify your approach- consider that your mission statement. Don’t flip between approaches. All stock and allocation decisions should abide by your mission statement. This will keep you focused on your goals and allow you to block out side distractions.
If you identified yourself as a trader you should be focused more on market momentum, event catalysts such as ECB and FED meetings, earnings announcements, etc. A trader focusing on Apple (NASDAQ: AAPL) should be concerned with whether or not the horrendous 2Q12 earnings was due to delayed purchases in anticipation of the iPhone 5 release or maybe whether the stock’s percentage in the NASDAQ is approaching a critical rebalancing point. The stock’s weighting in the NASDAQ 100 is just shy of 20%, a similar level that created a 2011 rebalancing in the Index. At that time, Apple’s weighting was reduced by 8% and a similar outcome could put short-term selling pressure on the stock as ETF’s and portfolio managers match the new Index weight.
If an investor identifies themself as secularly focused, then whether results hit or miss in a quarter should have little bearing on their investment decision. A series of weak results certainly could alter their long-term thesis, but one quarter is irrelevant. Here, an investor needs to make sure they disregard short-term factors, such as a product delay that sends shares down 3%, and focus on the big picture. Along with their outlook for long-term growth and competitive positioning, investors should be focused heavily on valuation- as this is the key determinant to market-beating returns over long holding periods. There are plenty of competitively entrenched companies that currently have excessively cheap stocks- Microsoft, Apple, Google, and Intel to name a few.
But valuation takes on more than just price-to-earnings multiples. Ultimately, it boils down to whether or not a company can earn a consistent return that exceeds their weighted average cost of capital and an investor’s cost to achieve such results. Investors that think Facebook (NASDAQ: FB) and its 900 million monthly users will be the go-to social media site for many generations should jump aboard the stock now. Forget the 100x P/E ratio- if the company can remain entrenched for that long, it is almost certain that they can master the advertising situation and earn returns well in excess of their cost of capital. Remember, you are buying for the secular trend and not whether the stock will be higher or lower in a month. Contrarily, if adults decide the concept is stale or younger individuals want to be different then their facebooking parents, then a 6x price-to-book valuation would likely prove to be unjustified.
Playing the cycles
Cyclical investing generally creates more turnover (i.e. fees), but not the excessive levels that trading generates. It allows investors to get the majority of cyclical bull markets, but gives them the flexibility to reduce exposure when bear markets can destroy a portfolio. Investors under this camp may take advantage of mean reverting opportunities such as the disconnect between gold mining stocks and the spot price of gold. Here, bellwether Barrick Gold (NYSE: ABX) is a logical choice with industry leading mine diversity and strong reliance on politically safe North America.
Maybe you fancy the idea that communication equipment capital expenditures will soon revert to more normalized levels after having been in a steady decline for more than a decade (when measured as a percentage of total investment). I think this industry makes plenty of sense as an upgrade cycle in more than overdue coupled with strong pricing power and historic low valuations. Those fancying lower volatility and steady dividends would look toward Cisco Systems (NASDAQ: CSCO), which just increased its divided by 75% and now has a forward implied yield of 2.8%. Its valuation is incredibly cheap from a cash flow perspective as evidenced by the EV/Free cash flow ratio.
If you like the space, why not combine it with the leading cloud-based player- F5 Networks (NASDAQ: FFIV) F5 who has almost 50% of the application delivery controller market, which helps company’s manage growing network traffic, application complexity, and security concerns. The stock has made a good move, but with returns on invested capital going from 9% in 2008 to 23% in 2011, it fits the bill for those not handcuffed by basic P/E valuation. The company looks poised to produce strong, elevated returns on invested capital.
Determining your correct investing style can help keep you focused during these see-saw markets. ECB this, QEx, analyst upgrades, and P/E multiples all mean different things based on what style of investor you are. When seriously considering the case for a stock or an asset class, make sure it fits your mission statement and investing style.
market8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Facebook, and F5 Networks. Motley Fool newsletter services recommend Apple, F5 Networks, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.