Wednesday, December 26, 2012

Why Investors Look at Stocks Differently

I’ve been meaning to write this article for a while now because I think it’s the sort of subject little discussed in mainstream journalism. Essentially, most investment journalism focuses on buying or selling this stock or other with a forthright opinion expressed either way. I understand why this formula works (not least because readers want this), but there is usually very little discourse over how or where the stock should fit in your portfolio. In addition, there is never any discussion of the investment approach of the author, how it might affect a decision over a stock or even the positioning of that stock within a portfolio.

In terms of portfolio construction, I have discussed the matter in an article linked here. In this piece I want to focus on how different investors might view stocks differently.

Same Stock, Different View

It's important for investors to understand that there is no absolute truth to investing. The key thing is to find a strategy or tactic that works for you and then implement it in a way that works for you. Then try to make sure that it works across market cycles and conditions. For the record, with me, this has always meant a diversified stock picking, growth at reasonable price (GARP) based approach. I tend to buy quality stocks that I think are 15-20% undervalued and in a position in the economy that I think has upside potential.

I’m not saying it is a perfect strategy, but I am saying it works for me. I’m also pointing out that sometimes I might look at a stock from this perspective and reject it because it doesn’t fit the model (Cue howls of derision and contempt in the comments section when a writer dares to mention that he doesn’t fancy a stock for his portfolio). The point is, it might not work for me but other investors who follow, say, a value or special situations based approach, might love the stock.

You have to do what works for you.

Some Examples

I want to give some brief examples of what I mean here.

I’ve written about Cisco Systems (NASDAQ: CSCO) and Intel (NASDAQ: INTC) quite a bit and I think neither stock fits the bill for a GARP based investor. I last covered Cisco here and Intel here. They share similar characteristics. Both are seeing growth slowing but present good long term value. Intel offers a very high dividend, and Cisco is turning itself into a value play by returning cash to shareholders. What both are not is companies that have much upside surprise (in my opinion) over the next six to twelve months. The semiconductor industry continues to downgrade expectations and the telcos remain reluctant to spend. Growth orientated investors like me don’t tend to buy such things, but that doesn’t mean that value players won’t make money from them!

Another example is Autodesk (NASDAQ: ADSK), which I covered in an article linked here. This is a company facing very difficult market conditions and a lot of near term risk combined with the execution risk inherent in its shift towards software as a service based sales.  Again this is not the sort of stock that a GARP based investor would buy, but why should that matter to a special situations investor?  The latter tend to buy a lot of these sorts of stocks and hit a few huge home runs with them while missing with a lot of stocks elsewhere. Just because it doesn’t suit my portfolio profile, it doesn’t mean that it might not fit yours.

The last two examples are of stocks that I like but appreciate won’t fit other styles of investing are Allergan (NYSE: AGN) and Wabtec (NYSE: WAB). I hold both and wrote about them here and here. Now, I can understand why value investors won’t fancy Allergan on nearly 27x current earnings or Wabtec on 17x earnings.  However, both have relatively secure mid and long term growth prospects. Allergan has the opportunity to get Botox indications expanded, and its eye care division is well placed for stable growth amidst favorable demographic changes.

As for Wabtec , it has near term catalysts from positive train control (PTC) revenues and shale gas rail, while longer term there are geographical opportunities for expansion, and rail is seen as an energy efficient and cost effective way to transport goods.

Both stocks convert earnings into cash flow well, and despite the high rating, a GARP investor will be attracted to them while a value investor will simply balk at the evaluation.

The Bottom Line

In conclusion, there is no right or wrong way to invest. The only wrong way is to not stay true to your principles, and the only right way is to try to keep those principles flexible. In the end, the aim is to generate favorable risk adjusted returns over the long term.

Sometimes writers don’t articulate why they favor certain stocks over others. They are afforded that regrettable luxury* because many of them don’t own anything they write about, so getting it wrong or right doesn’t really matter. For private investors, this luxury doesn’t exist, so the next time you read a stock write-up try to consider how the stock fits into your style of investing or your portfolio.

*For the record I do try to self impose a discipline of monthly write-ups and I do invest in stocks I write about

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