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Stock-picking strategies

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GARP investing
 

The hybrid characteristics 
Like growth investors, GARP investors are concerned with the growth prospects of a company: they like to see positive earnings numbers for the past few years, coupled with positive earnings projections for upcoming years. But unlike their growth-investing cousins, GARP investors are sceptical of extremely high-growth estimations. 
GARPers pay attention to the return on equity (ROE) figure, P/E ratio and price-to-book ratio (P/B ratio). 
 

GARP at work 
Because a GARP strategy employs principles from both value and growth investing, the returns that GARPers see during certain market phases are often different than the returns strictly value or growth investors would see at those times. For instance, in a raging bull market the returns from a growth strategy are often unbeatable. However, when the market does turn, a GARPer is less likely to suffer than the growth investor.
Therefore, the GARP strategy not only fuses growth and value stock-picking criteria, but also experiences a combination of their types of returns: a value investor will do better in bearish conditions; a growth investor will do exceptionally well in a raging bull market; and a GARPer will be rewarded with more consistent and predictable returns. 
GARP might sound like the perfect strategy, but combining growth and value investing isn’t as easy as it sounds. If you don’t master both strategies, you could find yourself buying mediocre rather than good GARP stocks. But as many great investors such as Peter Lynch (pioneer of GARP investing) himself have proven, the returns are definitely worth the time it takes to learn the GARP techniques.
 

CAN SLIM
CAN SLIM is a philosophy of screening, purchasing and selling  stocks. Developed by William O’Neil, the co-founder of Investor’s Business Daily, it is described in his highly recommended book ‘How to Make Money in Stocks’. 


The name may suggest some boring government agency, but this acronym actually stands for a very successful investment strategy. What makes CAN SLIM different is its attention to tangibles such as earnings, as well as intangibles like a company’s overall strength 
and ideas. 


The best thing about this strategy is that there’s evidence that it works: there are countless examples of companies that, over the last half of the 20th century, met CAN SLIM criteria before increasing enormously in price. In this section we explore each of the seven components of the CAN SLIM system. 
 

C = Current earnings 
O’Neil emphasizes the importance of choosing stocks whose earnings per share (EPS) in the most recent quarter have grown on a yearly basis. For example, a company’s EPS figures reported in this year’s April-June quarter should have grown relative to the EPS figures for that same three-month period one year ago. 

Earnings must be examined carefully 
The system strongly asserts that investors should know how to recognize low-quality earnings figures - that is, figures that are not accurate representations of company performance. Because companies may attempt to manipulate earnings, the CAN SLIM system maintains that investors must dig deep and look past the superficial numbers companies often put forth as earnings figures.O’Neil says that, once you confirm that a company’s earnings are of fairly good quality, it’s a good idea to check others in the same industry. Solid earnings growth in the industry confirms the industry is thriving and the company is ready to break out. 
 

A = Annual earnings 
CAN SLIM also acknowledge the importance of annual earnings growth. The system indicates that a company should have shown good annual growth (annual EPS) in each of the last five years. 
It’s important that the CAN SLIM investor, like the value investor, adopt the mindset that investing is the act of buying a piece of a business, becoming an owner of it.
 

A quick re-cap
The first two parts of the CAN SLIM system is fairly logical steps employing quantitative analysis. By identifying a company that has demonstrated strong earnings both quarterly and annually, you have a good basis for a solid stock-pick. However, the beauty of the system is that it applies five more criteria to stocks before they are selected.
 

N = New 
O’Neil’s third criterion for a good company is that it has recently undergone a change, which is often necessary for a company to become successful. It may be a new management team, a new product, a new market or a new high in stock price. 
 

S = Supply and demand 
The ‘S’ in CAN SLIM stands for supply and demand. The analysis of supply and demand in the CAN SLIM method maintains that, all other things being equal, it is easier for a smaller firm, with a smaller number of shares outstanding, to show outstanding gains. The reasoning behind this is that a large cap company requires much more demand than a smaller cap company to demonstrate the same gains.
 

L = Leader or laggard 
In this part of CAN SLIM analysis, distinguishing between market leaders and market laggards is of key importance. In each industry, there are always those that lead, providing great gains to shareholders, and those that lag behind, providing returns that are mediocre at best. The idea is to separate the
 contenders from the pretenders.Do not let your emotions pick stocks. A company may seem to have the same product and business model as others in its industry, but do not invest in that company simply because it appears cheap or evokes your sympathy. 
 

I = Institutional sponsorship 
CAN SLIM recognize the importance of companies having some institutional sponsorship. However, be wary if a very large portion of the company’s stock is owned by institutions. CAN SLIM acknowledge that a company can be institutionally over-owned and, when this happens, it is too late to buy into the company.
If a stock has too much institutional ownership, any kind of bad news could spark a spiralling sell-off. O’Neil also explores all the factors that should be considered when determining whether a company’s institutional ownership is of high quality.
 

M = Market direction 
The final CAN SLIM criterion is market direction. When picking stocks, it is important to recognize what kind of a market you are in, whether it is a bear or 
a bull. 
Although O’Neil is not a market timer, he argues that if investors don’t understand market direction, they may end up investing against the trend and thus compromise gains or even lose significantly. 
 

Sri Lankan appetite
Most market participants in Sri Lanka select stocks based on a certain set of criteria. They would ground their decisions on well-established principles. Nevertheless, certain individuals who lacked long-term oversight adopted erratic trading patterns in the recent past.


Their decisions were based on rumours. They chased the mirage of unusual short-term profits. It is interesting to note that even certain institutional investors endorsed such erratic trading patterns. Such entities were prompt in referring to this trading pattern as speculation.


We cannot undermine the importance of speculation in increasing liquidity. Yet, it is important to revisit the definition of speculation.
According to Keynes, speculation is the activity of forecasting the psychology of the market. Differently stated speculation could be explained as  the practice of engaging in risky financial transactions in an attempt to profit from fluctuations in the market value of a stock (price movements), rather than attempting to profit from the underlying financial attributes of a stock (commonly known as fundamental analysis).  Nevertheless, when we observe trading patterns it is reasonable to question if investors were truly speculating or if it could be perceived as gambling. 


The distinction lies in quality and the risk involvement. While gambling is based on ignorance and wild guesses speculation involves educated decision-making.It implies an almost scientific prediction based on probability and risk assessment. Gambling with stocks exposes your portfolio towards much more risk than healthy speculation.


Gambling could even hamper performance of the market and would be impossible to expect sustainable levels of liquidity through gambling. Both retail and institutional investors failed to consider the aforesaid risk involvement.Further on, the efficient price discovery mechanism was disrupted. Companies that had poor financials were trading at exorbitant prices. Rumours pushed the demand for
 these stocks.Investors, on the other hand, paid a heavy price for their irresponsible investing. Most of them were burdened with financial losses.


The securities regulator cannot recommend a fine blend of profitable investment strategies as it does not fall within its purview and also because markets are unpredictable.. Investors are given the liberty of selecting the most suitable strategy.Nevertheless, as the authority entrusted with the profound duty of maintaining efficient markets the regulator could urge market participants to apply rational methods of selecting stocks instead of erratic 
irrational investing.  
(Source: Investopedia)

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