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But let's get some things straight from the start.
First of all, there are no guarantees in the stock market. The strategies are not magic formulae to help you make an investment fortune. And secondly, there is no such thing as the "correct" way to invest, although there are plenty of "incorrect" ones. What brings real success to stock market investment is not so much the actual method of investing as the investor's application, knowledge and profound belief in a preferred and sound process.
These Foolish strategies will offer guidelines to investing, not hard and fast rules. Over time, the greatest investors have all taken on board investing methods from other people, but gradually adapted the techniques to suit their own personality and comfort.
All the Foolish strategies vary in terms of their approach, in the method of share selection, time horizon and the tolerance to risk. Mismatching your investment aims with the wrong strategy is the quickest route to stock market disaster.
You
So, before we look at the various approaches to stock market investment, you need to look in the mirror.
Ask yourself these questions:
• Am I aiming to beat the stock market?
• Can I devote a significant amount of my spare time to investing?
• Can I stomach one of my shares losing 50% of its value?
• Do I want to learn about accounting and valuation?
The first question is the most important. What sort of investment performance are you after? If you're happy being exposed to the long-term returns from equities, but without necessarily beating the stock market, then the Foolish strategies are not for you. A simple trouble-free low-cost index tracker should be your alternative.
But if you are keen to try and beat the stock market, then you'll need to have plenty of spare time to do so. Golfer Gary Player once remarked "the harder I practice, the luckier I get". The quotation is tailor-made for investment. The more you read, research and learn, the better an investor you will become. Following any of the strategies requires dedication and patience. If you're not inclined to put the required time and effort into the strategy, then you'll lose money. If this is the case, then a simple trouble-free low-cost index tracker should be your alternative.
When you pick individual shares, you'll sometimes endure a volatile ride. Expect your handpicked portfolio of shares to diverge significantly over the short term from the underlying stock market performance. In a nutshell, if you're terrified of one of your companies losing half its value for no reason, then stock picking strategies aren't for you. If this is the case, then a simple trouble-free low-cost index tracker should be your alternative.
And finally, accounting and valuation. Basically, do you wish to get your head around some of the complicated numbers at the back of an annual report and a few simple valuation measurements? A lack of inclination to become familiar with either will restrict the strategies to choose from. And a lack of inclination to become familiar with both means that a simple trouble-free low-cost index tracker should be your alternative.
So, if you've answered yes to the previous four questions, then we can continue.
The Strategies
The strategies fall into two camps. Most beginners would recognise the fact that when it comes to selecting a company to invest in, some subjectivity is needed. Considerations over the company's products, rivals and future will eventually have a bearing on the long-term share price performance. Opinions will obviously differ between investors. This subjectivity, to a certain extent, forms the basis of all but one of our Foolish strategies.
The odd-man-out is the mechanical strategy.
Mechanical Strategies
Here, no pondering is needed over a company's products and its competitiveness within its industry. Nor is there any poring over accounts. In fact, proponents of mechanical strategies would probably tell you that the less you know about the companies, the better. All that's needed is a grasp of basic investment valuation ratios and statistics in general, plus reams of historic stock market data to forge your filters.
The theory is simple. After analysing years of statistical data, "mechanics" believe that repeatedly reinvesting in the companies that exhibit the winning characteristics of years gone by will lead to continuing outperformance.
A simple example. Say you'd discovered that, on average, companies that possessed a dividend yield of over 4% and a price-to-sales ratio of less than 0.5 had beaten the overall stock market in nine of the past ten years. The mechanical investor would simply expect this trend to continue and would, each year, select the companies that fitted the winning statistics.
Mechanical strategies are very clear cut in their operation. There are no ifs, buts or maybes involved. You pick your group (usually of at least five) that possess the historical winning attributes. One year later, you sell the lot and follow the same procedure, reinvesting in the companies that exhibit the predefined criteria.
Although the time needed to select each annual portfolio is minimal (about 30 minutes a year), effort is required to develop the winning selection criteria. The Motley Fool currently runs two portfolios based on mechanical strategies, and tracks the performance of several others. Interested? Then click here.
The Qualiport
The Qualiport's motto is "to buy great companies at cheap prices and hold for the long term". The portfolio is loosely based around the philosophy of Warren Buffett, the famed US investor, who has accumulated $30b over his lifetime solely through stock market investment.
The type of company this Foolish real money portfolio searches for is one with a proven and superior financial record, whose business and products lead to a relatively predictable future and whose share price is attractive. The trouble with such enticing companies is that they are few and far between, and the ones that do exist are rarely attractively valued. This usually leads investors who follow this route to hold a small handful of companies, and then make relatively few, but large, investment decisions as and when valuations become attractive.
Identifying companies that have a superior financial history requires a good understanding of accounting. Being able to grasp the importance of margins, cash earnings and returns on shareholders' equity is all-important for those looking towards taking up the Qualiport selection process. The other key concept is valuation. Understanding this is another must before following the Qualiport's philosophy. If the distinguished record of Mr Buffett inspires, then click here for details.
The Rule Shaker
The Motley Fool's other long-term real money portfolio, inspired by the founders of Foolishness, Tom and David Gardner, is the Rule Shaker. Whereas the Qualiport reviews history for suitably predictable companies, in the hope that their record will continue, the Rule Shaker primarily looks to the future. What counts here are companies that will, or continue to, "shake" the world with their product, and make and break the industry rules on the way. The portfolio revolves around, but is not exclusively made up of, companies of a "hi-tech" nature.
The emphasis is squarely placed upon your interpretation of how the company's leading technological product will fare in the future. Will it dominate the industry? How will it stand up to the competition? Will it ever become superseded? If you're going to go down this route, you've must have a very sound understanding of your company's offering and the industry itself.
There's less emphasis on the numbers. Only cursory glances at the accounts, usually to ensure the company isn't about to go bust, are required. In general, no accounting certificates are needed here. And better still, there's absolutely no place for valuation. It's totally ignored. So, if technical revolutions are of more interest to you than boring figures, then click here.
Value
Value investing is at the other end of the investing spectrum. While the Qualiport and Rule Shaker try to choose inherently strong businesses and look to hold their investments for the long term, value players seek the complete opposite. Short-term investments in relatively poor businesses is the name of the game.
A contrarian nature is required. Don't expect too many like-minded investors to be joining you on your quest. Value investors will be looking in unloved sectors, hunting for unloved companies. The theory goes that depressed valuations will be eventually recognised in some way and so the "value" will be outed. Using this method, you will come across some justifiable stock market dogs, all of which look cheap, but will hurt your wallet if purchased. Being very selective by setting low valuation ceilings is a key principle in this game, to offset the potential damage a genuinely bad company can produce.
Value philosophers, of course, live and breathe valuation criteria. Any prospective value investor will need to know most of the important valuation ratios. A fair amount of accounting knowledge is generally required, but not much. Usually, very low valuation ceilings will minimise the downside of any accounting question marks. Obviously, the less stringent your valuation, the more companies come into view. And so this leads to a higher chance of picking a real howler and the greater need to peruse the accounts. If you fancy going against the crowd, click here.
Sector Specialists
The above four strategies each has a single method of selecting a wide variety of companies. Becoming a sector specialist turns that concept on its head. Here, investors stick to one familiar industry, but use the variety of Foolish long-term or short-term approaches to select the stocks. Concentrating on one particular sector should lead to specialist knowledge and understanding that should, in turn, lead to outperformance.
Just about any sector will do. Although, perhaps the best to choose are either those with the most recognisable long-term prospects (e.g. software), those with a multitude of companies to choose from (e.g. construction), or those where you have a professional edge in a complex area (e.g. a doctor and the biotech industry). A good example of one sector to avoid is tobacco, with just three very large members operating in a mature and simple industry. Click here for a review of past Sector Dissectors, and here for the latest article.
Golden Rules
Before you adopt one of these Foolish strategies, absorb these golden rules.
• Mechanical discussion board
• Qualiport discussion board
• Rule Shaker Principles discussion board
• Value discussion board
• Investing Strategies discussion board