Investment Strategies

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Investment Strategies

Setting Goals and Making Plans

Once you realize how much information is available in The Value Line Investment Survey, the next step is figuring out how you can use it.

Before you begin to invest in stocks, you need to decide what you want to accomplish.

The first and most important step is to define your financial goals and determine when you will need the money to meet these goals.

Then you can plan an investment strategy.

Once you have determined your financial goals, then you can begin to create an investment plan for meeting them.

Investment Strategy

An investment strategy is a plan for selecting financial vehicles that can help you meet your goals. It involves identifying both the appropriate types of investments and the most suitable individual investments within each type.

Developing and sticking to an investment strategy provides much sounder long-term results than buying stocks or other investments at random, even if individually they may be smart choices with strong performance potential.

Investment Styles

For the purposes of this explanation, there are three basic styles of investing: conservative, moderate, and aggressive. In brief, a conservative investor wants to protect principal and earn income; a moderate investor is willing to take a certain amount of risk to achieve some stock price appreciation as well as current income; and an aggressive investor is primarily concerned with high overall returns even though it means taking more risk.

Whichever type of investor you are, you can use the information Value Line provides as a tool for finding the investments best suited to your goals and your style.

Diversification

Smart investors build diversified portfolios.

You create a diversified stock portfolio by buying a variety of stocks in a range of different industries. For most individual investors, a practical approach is to own at least 10 stocks in approximately equal dollar amounts in several diverse industries.

Diversification is important because portfolios with several different investments usually produce a more consistent and stable total return than portfolios with just one investment. If you own just one stock and it drops dramatically in value, the value of your investment portfolio also drops sharply. But if you own 10 stocks in different industries, the likelihood is that even if some of them decline in price, others will increase, or, at the very least, remain stable. Decades of investment analysis demonstrates the validity of the diversification approach.

Although your portfolio might not gain as much as if all your money were invested in one stock whose price escalated quickly, it is unlikely to lose as much either. It is important to remember that it is difficult to predict which individual stock will be a winner.

Remember, too, that you ought to think of a diversified stock portfolio as one component of an overall diversified investment strategy which could include bonds, cash, real estate, etc.

Risk

All investments involve risk of one kind or another.

The general rule of investing is that risk is linked to total return, or what you get back in terms of price appreciation and dividends on your investment. The greater the risk you take, the greater your return should be. The less risk you take, the less return you should expect.

You can manage the risk of losing money when you invest in stocks by creating a diversified portfolio of a variety of stocks in a range of different industries. That allows you to balance potential losses in one stock against potential gains in another, since certain stocks and certain industries tend to perform well when others lag and vice versa.

You assess risk as part of making investment choices. If you are primarily concerned with preserving your principal, you should build your portfolio around stocks that Value Line ranks 1 or 2 for Safety. The return based on price appreciation that you can expect on those stocks may be lower than the return you could expect from stocks with lower Safety ranks. On the other hand, you can be fairly confident that those stocks will be more price-stable than the market in general during a period of falling prices, even though there is no guarantee that, in a market slide, these stocks won't also decline in value.

Stock Valuation

You might hear a stock described as overvalued or undervalued. That's generally a comment on how much investors are currently paying for the stock in relation to the valuations of other stocks.

An overvalued stock is often one whose P/E ratio is high relative to the rate at which a company's earnings are likely to grow. In some cases, the future performance of these stocks may not be able to sustain the high expectations implicit in the price investors are paying. However, overvalued stocks often get positive press coverage, which builds enthusiasm for the stock and elevates the price even more, at least for a time. Then, in a downturn, the price typically falls until the stock's P/E is more in line with the median P/E of the approximately 1,700 stocks in the Value Line universe.

In contrast, an undervalued stock is selling at a P/E that is modest relative to other stocks in the Value Line universe. Investors who seek out these stocks can reap the benefit of strong future performance, assuming that enough investor attention shifts to their merits and demand for the stock increases, so that the price rises.

Book Value

Book value is the amount that would be left for common shareholders if all the tangible and intangible assets of a company could be liquidated and all the long and short-term debt, taxes, and preferred shareholders were paid. Tangible assets include the physical plant, inventories and money the company is owed, while intangible assets are the value of patents or brand names (often known as "goodwill").

Value Line calculates the book value per share for every company, and also indicates in a footnote how much of a company's book value is based on intangibles. Conservative investors may want to deduct these amounts when they are analyzing the financial strength of a company.

Dividends

Dividends are the part of its annual profits that a company pays to its stockholders as income. That percentage is called the stock's payout ratio. Well-established companies are more likely to pay higher dividends than smaller or growth-oriented companies that often prefer to use their profits to fund additional expansion.

A per share dividend as a percentage of a stock's current price is the "yield" to the investor. Investors seeking income will typically look for stocks with above average dividend yields.

One consequence of earning dividends is that they are taxable, whereas price appreciation of a stock is not taxed until the stock is sold.