Stock Selection: Balancing Quality, Value and Growth
“Don’t put all your eggs in one basket”, is age-old advice. Indeed, we talk extensively about diversifying your investments geographically (US, Foreign Developed and Emerging markets) and across asset classes (Stocks and Bonds, plus perhaps commodities or real estate.) But investors don’t often consider diversifying investing styles or methods. Doing so adds yet another layer of risk management. At this year’s conference presentation I discussed three investing styles: quality, value and growth, and how each can go in and out of favor. Chasing styles can be dangerous, so I try to balance all three to create more of an all-weather stock portfolio.
- QUALITY STOCKS exhibit consistent profitability, financial flexibility, a moat or competitive advantage, and proven management.
- VALUE STOCKS are underpriced relative to their earnings power or asset value. Usually they are out of favor because of a temporary or fixable problem.
- GROWTH STOCKS are growing quickly and tend to be priced high compared to their current earning or assets.
In defining these styles, I also outlined fundamental and quantitative signals of each. Fundamental refers to the “art” of investing: assessing CEOs, surveying the competitive landscape, and talking to customers. Quantitative methods are more “science,” using financial ratios and algorithms to rank stocks the way a smart robot might invest. The human side of fundamental investing can be subject to bias or other psychological errors. Meanwhile, quantitative methods aren’t forward looking, and their advantage can shrink with more widespread use of algorithms and computing horsepower. By picking stocks that are attractive for fundamental and quantitative reasons, we can lower the risk of loss.