What to do in the present situation

“The worse seems to be over,” was how insiders described the market last week. If you will remember, this was exactly the subject that I struggled with in my previous article.

To recall, the market went on a continuing fall since hitting record highs in July. This went on until the last week of August when, unexpectedly, the market’s fall came to a stop. This was on August 31, Friday, when the market closed in positive territory. It ended higher by about 52.83 points, or 1.03 percent, on a weekly basis at 5,196.19. The advance was small. Yet, considering how it happened, it appeared significant. For one, the market’s value turnover was just about the market’s regular weekly average. Second, volume of transactions was noticeably double that of the previous week’s. Third, compared with the market’s close the week before at 5,143.35, the market’s bottom may have been hit.

Under normal conditions, these changes may not be as significant as they would appear. For instance, the market’s value turnover was just about the weekly average for the period but it was enough to stop the market’s downward trend. The market was largely engaged in small cap trading. As is usually observed, small cap trading always happens at the closing stages of a bull market. But at current circumstances, the market is far from being dead. It’s just adrift on temporarily unfavorable, but slowly improving, economic and business developments. Active small cap trading at these stages of the market could be positive. It is an indication of a market condition that continues to bear the core essence of an active market—a market still full of speculative character.

Bottom-line spin

According to market insiders, the worse of the Chinese ghost month would fall on September 1. It was a weekend. As such, it might extend to influence the outcome of the market’s trading results the following week. If this was to happen, the market’s gain and significance at the end of trading on August 31 may go to waste. However, as what happened, the market advanced further last week, registering a gain of 5.13 points, or 0.1 percent, on a weekly basis at 5,201.32.

Since the advance was very small, and despite the comforting observation of insiders that the worse of the market was already over, I was still unsure and uncomfortable, making me lose sight of what exactly to do in this situation. This brings me to a group of students I met.

Last Friday, I was made to make a short talk on stock investments and trading to a group of Ateneo University students who were to launch a stock trading contest in school. Among other things, they wanted to know what they should do to win their game.

Come to think of it, in the sheer confusion of what has been happening in the market, I was starting to concentrate more on forecasting future market prices rather than determining what do to if the market goes against my investment and trading positions—forgetting the market adage that “making money in the stock market does not necessarily mean knowing future market prices!”

Like I told the contestants, I feel that one must first have an investment philosophy in order to become a real winner. Concentrating only in timing and forecasting future market prices—as in momentum and technical investing—may initially lead one to win some stock plays but it is not the way that would lead you to the accumulation of wealth or financial freedom. It is my conviction that such mindset may just, at best, lead one to what I call trading for a living; a way of having a means of livelihood that may not necessarily lead you to financial freedom.

An investment philosophy is described as “a set of guiding principles that inform and shape an individual’s investment decision-making process.” In simple language, it is a method of investing. The most important is called value and growth investing. The former is about investing in stocks on account of the earnings performance of the company’s business. The stock’s value is considered to be more than what it is trading at the board. That is why value stocks are on the list of stocks that are hitting below their 52-week lows.

Fundamentally, “they have a price earnings ratio (market price over earnings per share) that is found in the bottom 10 percent of all companies in the industry or even in the whole market.”

Their “price to earnings growth ratio (PEG) should be less than 1.” At this ratio, the company of the stock is definitely undervalued. The share price, accordingly, must be at tangible book value (“all assets with physical form like machinery, buildings and land including current assets such as inventory”) or even less. The most noted professional investor in value investing is Warren Buffett, otherwise known as the “Oracle of Omaha.” As a matter of trivia, he is said to have obtained this investment style from his college professor, Benjamin Graham. (His book is a “must read.”)

Growth stocks are mainly identified by the strong rate of growth of their company’s earnings. These are otherwise known as the “glamour stocks” in Peter Lynch’s enduring book, “One Up on Wall Street.” To be categorized as such, the company’s earnings should be growing at 10 percent or more in the past five years. This is brought lower from 5 to 7 percent for much larger, but whose earnings continue to grow or stay stable at such earnings growth rates.

In addition, the companies of this type of stocks must “have strong return on equity (ROE) performance over the industry in the past five years.” The companies of these stocks must have also a strong Ebitda. Their pre-tax profit margins should be the result of higher profits in relation to every increase in sales. The prospect of having a stronger Ebitda further stems from the ability of management to control cost.

These, in addition to other considerations relative to strong operating performance, form what are called growth stocks. Sometimes, however, “a stock could be considered to be both a value and growth stock considering that they are the edge of either definition.”

(The writer is a licensed stockbroker of Eagle Equities, Inc. You may reach the Market Rider at [email protected], [email protected] or at www.kapitaltek.com.)