Fundamental Investing Strategies

There is no foolproof stock picking strategy. Fundamental investing strategies are simply applications of theories and sometimes two seemingly opposite strategies can be successful.

It is important, whichever strategy you choose, that it fits your personality, the time you have available and your risk tolerance.

Let’s take a look at some different types of fundamental investing strategies:

 Value investing

One of the key requirements of value investing is knowing the intrinsic value of a stock. The main objective of value investing is to buy a quality business for a reasonable or discounted price. this means buying a stock close to or preferably at less than its intrinsic value. Value investors are usually long term investors and generally ignore day to day price fluctuations.

There are a number of ways an investor can approach intrinsic value and we have provided the following research topics which we suggest you explore further:

  • Discounted cash flows
  • Understanding time value of money
  • Strong fundamental ratios, including growing earnings, growing dividends, strong cash flow
  • Margin of safety

Once you have gained an understanding of these topics you may want to consider putting them together into a value investing strategy. For example you may want to consider buying stocks that have a:

  • Share price no more than two thirds of intrinsic value
  • PE ratios within the lowest 10% of market
  • PEG less than one
  • Stock price equal to or less than tangible book value
  • Debt to Equity ratio of less than 1
  • Current asset ratio against current liability of greater than 2 to 1
  • Dividend yield close to or above market average
  • Earnings growth at least 7% per annum compounded over a reasonable period

Note that this is not a recomendation for a strategy but simply an example.  We strongly encourage you to do your own research on this and other investment strategies.

 Qualitative measures

Some investors use qualitative measures on their own to develop their investment strategy, however, they can also be combined with other strategies quite effectively.

The types of qualitative questions you may want to ask when you reserach a particular company are:

Management

 

  • Who are they, where have they been before, why are they doing what they are doing?
  • What are they doing and are they doing it well?
  • When did they start doing it?
  • Is management invested in the business? (particularly important with smaller companies)

Corporate Governance

 

  • Does the company have independent directors?
  • Does the company have an independent chairperson?
  • What is the quality of reported information?

Company

  • What does the company do?
  • What is it's business model
  • How does it make money?
  • Where does it make money?
  • Who are it's customers?
  • Does it have a strategy for future growth?
  • Is there anything special about the company?

Industry & Competition

 

  • Is the industry cyclical?
  • Where in the cycle are we now?
  • Does the company have an competitive advantage or a ‘moat’?
  • Is the company well known, do they have a 'brand' advantage?
  • Does the company have a special patent or product or certain way of doing business?

Just a hint here, keep things simple!

Perhaps develop a checklist so that you can be consistent, no matter which company you are researching.

 Growth investing

Growth investing focuses on companies with future growth prospects with less emphasis on current price value. In fact, growth investors can buy companies that are trading at high PE ratio, in the belief that their worth will grow over time.

Some guidelines or criteria for a possible growth investing strategy might be:

  • Strong historical earnings growth
  • Strong forward earnings growth
  • Stable & relative costs when compared to revenues
  • Stable or increased return on investment

We strongly encourage you to do your own further research on this strategy and all the other fundamental investing topics.

 Growth at a reasonable price (GARP)

The GARP approach is a combination of both value and growth investing. GARP investors look for companies that have:

  • A share price slightly less than their intrinsic value
  • Solid sustainable growth potential with a focus on realistic growth rates between 10 – 20%
  • Positive earnings for a number of years
  • Positive earning forecasts for future years
  • High and increasing ROE
  • Preferably a low PE and low price to book ratio or other similar criteria

We strongly encourage you to do your own further research on this strategy and all the other fundamental investing topics.

 Income investing

A focus on income is a fairly straightforward investment strategy which aims to pick companies that provide a steady stream of income.

Some factors to take into account are:

  • Dividend yield - what is it?  Is it high for the wrong reasons?
  • Past dividend payout policy – is it consistently high?
  • Growth and Earnings Growth prospects
  • Other Qualitative measures

A Brisbane member has presented a paper focused on income investing, titled 
 How I would invest $1Million in my SMSF.

The ASX has some great hints and tips on income investing.

Warning

All fundamental investors need to be aware that even the best companies from a fundamental point of view can be impacted by a Black Swan event that may offer buying opportunities or alternatively signal a fundamental revaluing of the company.