A deep dive into multiple investment strategies
August 10, 2022
Many renowned investors have time & again reiterated the importance of having an investment strategy that works for you. This is because a proven investment strategy can help you generate the maximum return possible while also considering your tentative investment horizon, Investment objectives, risk tolerance & capital allocation. And when you keep investing & reinvesting on a consistent basis while generating quality returns, you stand an incredible chance of building massive wealth from the stock market.
Investment strategies in general tend to be rather goal-oriented and can help investors in making decisions that actually lead them to their goals. They are a wonderful way of keeping track of progress as they demand that you stick to your risk appetite. This prevents you from undertaking unwanted risks. They also ensure that you are able to take quick decisions whenever required as they pretty much are blueprint plans that have successfully worked before. This can be especially useful when it comes to the stock market.
It won’t be wrong to suggest that if the right investment strategy is chosen by an investor, then there is only a negligible chance that he can fail. The right investment strategy can massively boost your chances of financial success.
What is an investment strategy?
An investment strategy is a set of principles and practices that shape how you choose, buy & sell stocks in your portfolio. It gives you a much-needed sense of direction & guidance during various market scenarios.
When it comes to investing strategies, there is no such thing as one size fits all. The reality is that one size actually fits no one. Your stock investment strategy should be chosen specifically for you. It should be chosen after keeping in mind your tentative investment horizon, Investment objectives, risk tolerance & capital allocation towards your equity portfolio. So, something that you need to do before choosing an investment strategy for yourself is to ask yourself what are you looking for when investing in stocks. What is the kind of return that you are seeking? How long can you realistically stay invested? Are there any near-term monetary obligations that may require you to exit your positions before time? Do you have the time to maintain an active portfolio? What is the capital that you are willing to invest and for how long? So on & so forth. Once you have the answers to these questions, you can move on to select the right investment strategy for your portfolio.
What are common investment strategies?
Broadly speaking, investment strategies can be based on multiple things such as whether they are passive or active, what the stock selection criteria are, what the investment tenure is etc. Certain strategies are Index based while others are momentum based. Many investment strategies focus on a particular segment of stocks either on the basis of market capitalization or on the basis of Industry or sector. Read on further to understand some of them better.
Active investment strategies aim to actively beat the market by investing in stocks that carry the possibility of generating a quality return in the near future. Oftentimes, growth stocks belonging to growing companies are chosen. Although such stocks have a higher price-to-equity ratio than their peers and seem to be slightly volatile in nature, it is generally understood that as these companies have a consistent trend of strong revenue and delivering on projections, the faster earnings growth comes with higher business valuations and more market noises.
Growth companies usually display a significantly higher growth rate because they tend to possess some kind of competitive advantage over other companies in the same industry. The competitive advantage gives growth companies a unique selling proposition ie USP. This helps them sell and grow better than other companies within the same industry.
Active strategy approaches can be generally divided into two groups: fundamental and quantitative. The fundamental approach stresses the use of human judgment in arriving at an investment decision, whereas the quantitative approach stresses the use of rules-based, quantitative models to arrive at a decision. Both approaches have their own pros and cons. MILARS is a strategy that is based on six guiding principles & utilises both approaches in order to eliminate the cons while benefitting from the pros.
Passive investment strategies are based on an understanding that ‘more time in the market’ will offer a higher overall return than ‘timing the market’. Passive investors often keep their portfolios relatively stable over the long term regardless of short-term market fluctuations. This certainly does not mean that they buy & forget their investments. Periodic tracking & timely rebalancing in the case of deterioration of stocks is a must.
Passive investors use fundamental analysis to identify stocks that according to their analysis are of quality and are trading at attractive valuations. These stocks are chosen and held for a long-term horizon with the intention to build multifold wealth. There’s no jumping ship to something else because of a small trigger e.g. 10% increase or a news opinion.
As passive strategies often aim at spotting Multibaggers, it is essential that they are equipped to find such potential market leaders at the right time. Consider the case of Blue Dart Ltd. It is South Asia's leading express and integrated transportation and distribution company with a massive infrastructure/network across India giving it a competitive advantage over existing domestic players and new entrants. The company's strong customer base across various industries such as e-commerce, BFSI, pharmaceuticals, consumer electronics, and others, as well as other factors such as GDP growth, the Indian government's ambition to reach a USD 5 trillion economy, infrastructure development, and consumption growth among others, have kept the momentum in volume growth.
Stock Chart of Blue Dart Ltd (April 2020 - Present)
As we can see from the chart above, the stock has rallied from Rs ₹2065 to a whopping ₹8962 in just a little more than 2 years. This is a Return on Investment (ROI) of 333.99 %!
Such returns are not uncommon in the stock market. But there is no arguing that you definitely need a proven strategy that can capture these Emerging Market Leaders or Multibaggers.
Let’s have a look at another example ie Tata Elxsi Ltd. It is amongst the world’s leading providers of design and technology services for product engineering and solutions across industries including the Broadcast, Communications and Automotive sectors. The company is net debt-free with a cash surplus of Rs. 7 billion. Tata Elxsi has also entered into different verticals and now has a diversified business model. Its growth potential can be clearly seen in the rally of its stock.
Stock Chart of Tata Elxsi Ltd (April 2021 - Present)
Tata Elxsi has rallied from Rs. 696 on April 1, 2020, to an unprecedented high of Rs. 9535 as of today. This is a massive ROI of 1,269.97 %!
Momentum-based strategies combine fundamental and technical analysis in order to catch momentous price movements while avoiding idle times. The benefits of this type of trading are a more efficient use of capital and higher returns. Such strategies follow the age-old rule of trend is your friend & aim at riding the prevailing trends in the market. Capital is usually fully occupied to avoid opportunity cost & a stop loss is set to avoid letting your losses run free.
Investors that desire to trade on the basis of momentum often adopt the swing trading strategy & rightfully so. It is also recommended that such investors invest in stocks on the move in order to make quick gains in trending stocks while actively cutting losses via the usage of the stop loss tool.
Strategies based on Market Caps
If you are creating a stock portfolio designed to help you pursue your long-term financial goals, then understanding the relationship between company size, return potential, and risk is crucial. This is where the market capitalization of a company comes in. Market cap refers to the total value of all the company's shares or stock.
The stocks in the equity market are divided into Large caps, Midcaps & Small cap stocks based on their size. Large-cap firms are often dominant players within established industries and their brand names may be familiar to the national consumer audience. As a result, investments in large-cap stocks may be considered more conservative than investments in small-cap or mid-cap stocks. But this does not mean that you can only obtain mediocre returns that hardly beat inflation from large-cap stocks. As previously mentioned, the right investment strategy works to maximise your returns while taking your risk appetite into account.
Lets look at a blue chip stock that rallied quite a bit - ICICI Ltd. It is a well-known leading private sector bank in India that offers a wide range of banking products and financial services to corporate and retail customers through a variety of delivery channels and through its group companies. ICICI Bank has a network of 5,267 branches and 14,655 ATMs as of December 31, 2020.
Stock Chart of ICICI Ltd (April 2020 - Present)
ICICI Ltd has rallied up from the Rs 290-295 odd levels in April 2020 to Rs. 835 as of today. This is a Return on investment of 187.93%. Quite impressive for a Bluechip if you ask us!
This shows that investors who prefer more stable businesses while still aiming for the ‘Stock market returns’ can choose to add Large caps or Blue chip stocks to their portfolios.
On the other hand, Small-cap companies are young companies that serve niche markets or emerging industries. Small caps are considered the most aggressive and risky but at the same time, small-cap stocks may offer significant growth potential to long-term investors who can tolerate volatile stock price swings in the short term. The upside growth potential that is witnessed in small-cap companies is practically unmatched by larger companies.
Case in point - Raj Ratan Global Wires Ltd.
It is an India-based company engaged in the manufacturing of Tyre Bead Wire and High Carbon Steel Wire. The company has a 45-50% market share in the domestic market and a 20% market share in Thailand. In India, only a few large players are engaged in manufacturing tyre bead wire. This has paved a growth opportunity for Rajratan, which can be witnessed in its consistent financial performance as well as in the rally of its stock price.
Stock Chart of Raj Ratan Global Wire Ltd (April 2021 - Present)
As we can see from the chart above, the stock has rallied from just Rs 40-45 odd levels to a whopping Rs. 978 in just a little more than 2 years. This is a phenomenal Return on Investment (ROI) of 2073.33 %!
It is not surprising that Small caps are quite popular & actively preferred by investors all over the world due to their immense growth potential. These budding jewels, if caught at the right time, can literally make all your financial dreams come true!
Whichever way you choose to go active, passive or momentum, we encourage you to try & stay consistent. Don’t make changes that are driven by your emotions along the way. Stick to your investment strategy instead.
As the infamous saying goes - “The best time to start investing was yesterday”. Once you start investing, contribute regularly to grow your stock portfolio & secure your financial future. We at StockAxis are ever ready to assist you in choosing the right investment strategy that can best equip you to achieve your goals. Feel free to get in touch with us & we shall be glad to help. Happy Investing!