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.
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