There are over 2000 stocks on the ASX; so you need a way to filter the market to a manageable list of stocks.
With the two common types of investing being Growth and Value investing you need to first determine which type of investing you prefer.
Growth vs. value investing
Growth investing is a style of investment strategy. Those who follow this style, known as growth investors, invest in companies that exhibit signs of above-average growth, even if the share price appears expensive in terms of metrics such as price-to-earnings or price-to-to-book ratios.
Value investing is another style of investment strategy, which involves buying securities whose shares appear underpriced by some form(s) of fundamental analysis.
As example, such securities may be stock in public companies that trade at discounts to book value or tangible book value, have high dividend yields, have low price-to-earnings multiple or have low price-to-book ratios.
It's hard work
I focus on growth investing because I want my capital working as hard as possible. A value investor can buy a 'good value' stock and see it stay the same or similar value for weeks, months or even years.
I will focus on looking for 'growth' stocks as this is my core area of investment and where I want my capital allocated.
Market searches can be done a number of ways but the two common ways are fundamental analysis and technical analysis.
Time to analyse
Fundamental analysis uses balance sheets, profit and loss and cash flow reports to look at the financial health of a company.
Technical analysis uses the stock price and does not take into account the financial aspects of the company.
I personally use both methods in my investing. Although they are used for different tasks they both have their time and place.
Find the right stocks
When filtering the market I want to find stocks with earnings growth that is above average rates and also has a solid balance sheet. We want high growth stocks that are not taking too much risk to grow too fast. These ultra high growth stocks are normally companies that grow via acquisition or take on high levels of debt. There is nothing wrong with this growth strategy as long as it does not put the whole company at risk.
An example of a company with a growth strategy that ultimately put the company under terminal financial stress was Babcock and Brown.
Babcock and Brown listed on the ASX in Oct 2004 at $5.00 a share and then ran through to $34.00 in June 2007. As they say the rest is history... BNB delisted in 2009 with the company having no assets at all.
Growth scan filters
With various tools available for scanning the market including free and paid alternatives; you can decide what suits you best. I won't go into detail of each - although I use IRESS for my own scanning.
My growth scan filters stocks that have:
- Market Capitalisation > $150M
- Gearing < 50%
- ROA (return on Assets) > 8%
- Revenue Growth % > 10%
- EPS (Earning Per Share) > 0
- Profit > Previous Profit
- Volume Week Rolling > 100,000
At any one time this will return a list of approximately 100 shares, which makes the list of 2049 shares on the ASX much more manageable.
Try before you buy
Now just because a stock turns up in this scan does not mean you go out and buy it. All it does is focus our attention and resources on where we want to invest.
We still need to do more analysis to determine:
- Is the stock up trending? This is where I use technical analysis to time the entry.
- Do we like the sector the stock is in and how does it fit in with the rest of the portfolio?
- Is the stock likely to have continued earnings growth at the same rate it has been?
- Has the recent news from the company been positive?
The main criterion from the above analysis is we only want to own stocks that are up-trending. The underlying price of the stock is what we buy and sell and decides if we make or loss on the investment.
Seek capital growth
If the underlying fundamentals of the stock are good, it means nothing if we are losing money on the actual share price. As a growth investor I seek capital growth.
In the next article I will detail how I use technical analysis to filter the stock list even further to stocks that are up trending. From there we can start to find stocks that we would actually add to our portfolio.
James Ramsay is an advisor at Bell Potter Securities who works with you to build a portfolio using a range of investments that are suitable to you. You can contact him on 08 9326 7664 or firstname.lastname@example.org.
Important Disclaimer-This may affect your legal rights: This article has been prepared without consideration of the personal financial situation, particular needs or investment objectives of any specific person and therefore constitutes general investment advice only. A licensed financial services adviser should be consulted to determine the suitability of any investment to the reader's relevant personal circumstances before taking any action with regard to the comments or recommendations contained in this article.