As one reads the literature of stock investing, it becomes clear that the world of investing, like the Christian world, is divided into denominations. Each denomination of investment philosophy thinks it knows how to get to heaven (that is, make money), but each has a different idea of how to do it. Sometimes the differences are radical.
Each time you buy a book on investing or check one out from the library, it pays to know which denomination it represents. Here are four basic denominations (or approaches) to investing in common stocks.
INDEXING (Motto: "Don't try to outsmart the market.")
Plan: Invest in mutual funds such as one finds in the Vanguard (vanguard.com), Fidelity, or Pimco families that are geared to various market indexes. Allocate your assets among different kinds of funds (for example, small cap/large cap, value/growth, domestic/foreign/emerging) in order to optimize risk and return.
Books to Read:
Armstrong, Frank. The Informed Investor. New York: Amacom, 2002.
Ellis, Charles D. Winning the Loser's Game: Timeless Strategies for Successful Investing. 3rd ed. New York: McGraw-Hill, 1998.
Malkiel, Burton G. The Random Walk Guide to Investing. New York: W. W. Norton, 2003.
GROWTH (Motto: "Buy a few eggs you know will hatch.")
Plan A: Momentum Investing ("The trend is your friend"); buy and sell stocks that have the most favorable outlook over the near term, usually six months to a year. Day traders represent the extreme in momentum investing.
O'Neil, William J. How to Make Money in Stocks. 2nd ed. New York: McGraw-Hill, 1995.
O'Neil, William J. 24 Essential Lessons for Investment Success. New York: McGraw-Hill, 2000.
Plan B: Sweet Anticipation ("Buy high and sell higher"); buy and hold companies that grow sales and earnings at stable rates well above average, which, in turn, produce high profit margins and above average return on equity. These companies typically have high P/E ratios and low dividend yields.
Buffett, Mary and David Clark. Buffettology. New York: Rawson Associates, 1997.
Buffett, Mary and David Clark. The New Buffettology. New York: Rawson, 2002.
Lynch, Peter. One Up on Wall Street. New York: Simon & Schuster, 1989.
VALUE (Motto: "Buy a dollar for fifty cents, over and over again.")
Plan A: Contrarian Investing ("Buy fear and sell greed")--buy stocks that are temporarily out of favor as evidenced by low P/E ratios, low price-to-book ratios, and low price-to-cash-flow ratios.
Dreman, David. Contrarian Investment Strategies: The Next Generation. New York: Simon & Schuster, 1998.
Wanger, Ralph. A Zebra in Lion Country. New York: Simon & Schuster, 1997.
Plan B: Fundamental Investing ("Plant a seedling and watch an oak grow"; "Buy a bargain and wait"). Create a margin of safety by buying and holding stocks that are selling at substantial discounts to their cash or liquidation values. Determine the spread between the price of a stock and its intrinsic value. Look for low price-to-book ratios, a continuous record of high dividend yields, and strong underlying assets or cash flow.
Graham, Benjamin. The Intelligent Investor. 4th revised ed. New York: Harper Business, 1973.
Klarman, Seth A. Margin of Safety: Risk-Averse Value Investing for the Thoughtful Investor. New York: HarperBusiness, 1991.
Vick, Timothy. Wall Street on Sale. New York: McGraw-Hill, 1999.
INCOME (Motto: "Dividends don't lie.")
Buy stable businesses that have low levels of debt, a low beta, and a long history of steadily increasing dividends.
Klugman, RoxAnn. The Dividend Growth Investment Strategy: How to Keep Your Retirement Income Doubling Every Five Years. New York: Kensington Publishing Corp., 2001.
Miller, Lowell. The Single Best Investment: Achieve Lasting Wealth with Low Risk, Steady Growth Stocks. Holbrook, MA: Adams Media Corporation, 1999.
Tigue, Joseph and Joseph Lisanti. The Dividend Rich Investor: Building Wealth with High-Quality, Dividend-Paying Stocks. New York: McGraw-Hill, 1997.
As you read about the different approaches, you will decide which makes most sense to you, which most fits your personality, and which offers the best return given the time you have to devote to investing. Good luck, and see you in church.