HOW TO PICK A WIN­NING STOCK

In­vest­ing in stocks can be quite a daunt­ing task. How do you know if the one you picked is go­ing to per­form? fin­week asked some ex­perts from PSG As­set Man­age­ment how to make stock-pick­ing less frus­trat­ing.

Finweek English Edition - - FRONT PAGE - By Lameez Omar­jee ed­i­to­rial@fin­week.co.za

in the­ory, in­vest­ing in the stock mar­ket should be easy: buy low and sell high. Do­ing this with­out the ben­e­fit of hind­sight, how­ever, is much eas­ier said than done.

In­vest­ment de­ci­sions are made in real time, and this process can of­ten be dif­fi­cult and in­tim­i­dat­ing for in­vestors. To gen­er­ate aboveav­er­age re­turns in the long term, in­vestors need to think in­de­pen­dently of the mar­ket and not be un­duly in­flu­enced by short-term events, says Greg Hop­kins, chief in­vest­ment of­fi­cer at PSG As­set Man­age­ment.

The ob­jec­tive to buy low and sell high is dif­fi­cult to do in prac­tice when the mar­ket is con­fig­ured to make you do the op­po­site, he ex­plains. Th­ese fac­tors can cre­ate panic set­ting in or cause ir­ra­tional be­hav­iour, ac­cord­ing to Hop­kins:

1. Neg­a­tive news head­lines

Th­ese cre­ate fear and un­cer­tainty around cur­rent events. Re­cent ex­am­ples in­clude de­clin­ing com­mod­ity prices, China’s slow­ing econ­omy and a sell-off in emerg­ing-mar­ket cur­ren­cies.

2. Short-term fo­cus

Look­ing at funds that per­form poorly on a weekly or daily ba­sis creates a nat­u­ral re­ac­tion by the in­vestor to “avoid the pain” and sell.

3. Loss aver­sion

If there is a port­fo­lio with 10 funds, seven of which per­form well, in­vestors will re­main fix­ated on the three funds that un­der­per­form. To coun­ter­act this, Hop­kins rec­om­mends you as the in­vestor take a long-term ap­proach be­fore you make in­vest­ment de­ci­sions; are pru­dent about the way as­sets are de­ployed; and have an ob­ses­sive fo­cus on re­search­ing any se­cu­rity you plan to buy and en­sure you understand the odds.

Hop­kins ex­plains a sim­ple phi­los­o­phy to get the odds in your favour:

De­ter­mine the “eco­nomic moat” or com­pet­i­tive ad­van­tage of the busi­ness you’re in­vest­ing in. A busi­ness with a com­pet­i­tive ad­van­tage over its ri­vals should gen­er­ate higher mar­gins. Con­sider the man­age­ment of the busi­ness, their track record, past per­for­mance and the lev­els of trans­parency, es­pe­cially re­gard­ing eth­i­cal is­sues. Con­sider the mar­gin of safety: make sure there’s a buf­fer be­tween the price paid for a se­cu­rity and the value gen­er­ated. In­vest in high-value busi­nesses that are sell­ing at be­low-av­er­age prices. While it is usu­ally dif­fi­cult to swim against the stream, it is of­ten in tough times that great in­vest­ment op­por­tu­ni­ties present it­self, Hop­kins says. In 2012/13, when Europe was strug­gling, fur­ni­ture re­tailer Stein­hoff, for ex­am­ple, made a num­ber of ac­qui­si­tions in Europe, a de­ci­sion that was ques­tioned by its South African in­vestors. Stein­hoff’s strat­egy was to ex­ploit the fear and un­cer­tainty in the mar­ket and to buy aboveav­er­age com­pa­nies in Europe at be­low-av­er­age prices, be­cause they were un­der-ap­pre­ci­ated by the mar­ket, ex­plains Hop­kins.

Th­ese events have led to the re­think­ing of the idea of “qual­ity”, says Hop­kins. Some high­qual­ity stocks, with long his­to­ries and good man­age­ment, have also turned around and made losses. Some com­pa­nies that could not keep up with their in­dus­tries as they be­came com­pet­i­tive in­clude Tesco, IBM and Al­stom.

Al­though the bias is to­ward high-qual­ity and fast-grow­ing busi­nesses, the price should also be con­sid­ered, says Shaun le Roux, fund man­ager at PSG. Of­ten, in­vestors opt to pay for stocks that are ex­pen­sive for the prom­ise of “hyped growth”. Look­ing at the div­i­dend yield will in­di­cate if the stock is ex­pen­sive. A stock trad­ing at 25 times greater than earn­ings with a low div­i­dend yield of 2% im­plies the stock is ex­pen­sive, he ex­plains.

A stock that trades at a value 10 times greater than earn­ings and has a div­i­dend yield of at least 5% presents an “in­ter­est­ing op­por­tu­nity”, says Le Roux. How­ever, th­ese stocks of­ten fall out of favour with in­vestors be­cause they seem dull and bor­ing, are fac­ing cycli­cal head­winds and aren’t grow­ing earn­ings and div­i­dends as fast as “good story” stocks. Cur­rent ex­am­ples in­clude Im­pe­rial, FirstRand, Old Mu­tual and Mi­crosoft.

There are high-qual­ity stocks that present a good op­por­tu­nity, if their growth po­ten­tial is sus­tain­able. Some of th­ese in­clude Capitec, Dis­cov­ery and Ja­panese multi­na­tional telecom­mu­ni­ca­tions and in­ter­net firm Soft­Bank, ac­cord­ing to Le Roux.

To gen­er­ate above-av­er­age re­turns in the long term, in­vestors need to think in­de­pen­dently of the mar­ket and not be un­duly in­flu­enced by short-term events.

Greg Hop­kins Chief in­vest­ment of­fi­cer at

PSG As­set Man­age­ment

Shaun le Roux Fund man­ager at PSG As­set Man­age­ment

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