When it comes to share investing there are plenty of theories about what might produce the best returns.
There is no single right answer to investing. People’s needs differ. People’s attitudes to risk vary. Market moods swing, making it difficult to be sure which type of investment will do well. All these uncertainties do not stop investment experts having their preferred approaches which they advocate.
There are arguments about whether smaller companies will normally, on average, beat larger companies, on the grounds that they have more scope to grow and may often be more innovative and price competitive. Some of the longer-term figures show quoted smaller companies in aggregate outperforming quoted larger companies over various time periods. It is generally accepted that small companies are riskier than large companies, with any one of them running the risk of commercial failure from bad decisions of one or a few people, from intense competitive pressures from companies much larger than themselves or from market moods deciding to mark them down owing to perceived risk. In falling share markets small company share prices can be especially damaged. If one or two sellers emerge for a given company there may not be any or many wishing to buy those shares, leading to sharp falls.
There are arguments about whether growth companies do better than various types of more defensive company such as utilities or large food companies with good market share. Growth companies often have high share prices and low dividends. Nonetheless if they achieve fast growth in profits, dividends and or retained earnings they might outperform. Markets like growth and shares are primarily about taking risks to enjoy a rising dividend income and or a rising capital value of the company. So-called defensive shares such as utilities can outperform when investors worry about a possible economic downturn, or when threats emerge to growth sectors. These companies have relatively stable revenues because people still need water or electricity during a downturn, when they do cannot afford to buy a new car or need new furniture.
Some investors favour an income-based strategy. You can run an equity portfolio where you only buy and hold companies that pay an above average dividend. This may give you companies in sectors that are out of favour with strong underlying earnings. It may also give you shares in companies in trouble, where the share price has gone down to begin to discount the forthcoming bad news. That bad news may include a dividend cut. Income investors need to think not just about how the most recent dividend compares to the market average pay out, but whether that dividend is sustainable in future. Income investing can also put you into cyclical companies that experience profits downturns when the economy struggles, but recover swiftly when things pick up. At various stages of the market cycle these shares might be on higher dividend yields.
Some managers say they are “value” investors. They look for well based companies with decent prospects that are currently out of favour in the market and therefore on cheap valuations. If the investor is right about the underlying soundness of the company in due course the shares may well attract a higher valuation.
Some investors are “momentum” investors. They buy shares that are going up, on the basis that positive trends often continue for a decent period of time, allowing them to make money as the trend continues. Other investors are contrarians. They deliberately buy shares that have fallen a lot on the grounds that market trends overdo share prices on both the upside and the downside. They take the view that these extreme valuations offer opportunity, but they need to judge when a trend has gone far enough and is likely to reverse.
All these different ways of choosing a portfolio have some merits. Indeed, more than one of them at any given time can work. It goes to remind us how complex the market is, and how many different buyers and sellers there are with varied views of what is best. My main take away from this is the need to have a portfolio with a range of different investments, as you are not going to get all your investments right. The winning strategies or styles vary over time.
The above article was previously published by Charles Stanley on 30th July 2019