Education • 6 min read
Are you ready to start investing but want to learn more about investment strategies first? Find out about the basics behind quality investing, an investment strategy based on the quality of an asset, not so much on price or growth prospects.
There are so many different ways to select the assets you want to invest in based on your personal financial situation, on your investment goals and, last but not least, how comfortable you feel about investment risk.
You want to buy low and sell high, right? Unfortunately, it’s not as simple as that. An age-old motto in investing is that it pays off to buy a stock that is significantly below its “fair” value (real market value) at a low price and wait for its price to increase once the market realises that the asset is undervalued. What does this mean?
An undervalued stock means that this stock is trading in the market for a value that is lower than its true value, which is determined by fundamental analysis. The reasons behind this could be negative press about a company, poor finances, negative industry events affecting a company and more.
This strategy is called value investing and it is reputed to be one of the tried-and-tested strategies of Warren Buffet, who is considered one of the world’s most successful investors of all time. Value investing is based on detailed analysis of the fundamentals of a company, buying its stock at a low price and then holding it as a long-term investment.
However, this strategy could obviously backfire, especially if you’re just starting out and don’t have the experience of Warren Buffet. Why? Your undervalued stock could potentially turn out to be a value trap, which is why you need to analyse the performance of the company you are planning to invest in very carefully.
Some stocks may appear to be value investments with an attractive dividend yield. A company might appear to be heading for a turnaround from the events that led to its low price and valuation - but only at first glance, ultimately rendering such an investment a “value trap”.
On the inside, the company’s margins, profits and reserves may be negatively affected, which could indicate dividend payments won’t be distributed to shareholders. A company may also be highly dependent on special effects caused by economic developments affecting its industry and only post high profits once in a blue moon, causing the share price to go up and then to fall again. Let’s look at some of those effects.
One-off effects in an income sheet are another factor that may distort perception. For example, if a company sells a piece of land for a high amount, this may lead to a high profit this one time, as may postponements of major orders or special write-downs. Plus, remember what Benjamin Graham, the “father of value investing”, said about safety and earnings:
”An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.”
Seasoned investors draw on long-time experience and know that value traps can’t always be identified easily. Investors who are also new to investing may find identifying value traps even more difficult. In a nutshell: we cannot stress enough that doing your research is paramount - getting a hold of a company’s earnings report is just the first step. Make sure to also read our article on getting information about stocks.
Now that you know the foundations, let’s move on to quality investing.
Founded on value investing, the name of this investment strategy already says it: the focus of an investment decision should be on the quality of an asset rather than the asset’s growth or price.
Traditionally applied in the evaluation of bonds and real estate, quality investing determines the quality of an investment based on a specific set of criteria and groups stock into quality and low-quality stocks. Let’s look at this criteria in closer detail.
Go ahead and start your research by assessing the financial strength of a company based on their balance sheet in their earnings report. Key performance indicators, such as price/earnings ratio, cash flow considerations, debt/equity ratio and other ratios indicate how effective a company is at achieving its business objectives and illustrate its progress on the way there. They are also indicators for the valuation of a share.
A look at management and investor relations is also a good idea: low staff fluctuation in the board and extensive communication with stakeholders are usually positive signs.
Competitive advantages put a company ahead in more than one sense and it is even better if the company can maintain them in the long term - what Warren Buffet refers to as “economic moat”. Competitive advantages, among others, may include factors such as a strong brand, low production costs, registered trademarks and network effects. Only a few companies worldwide meet all these criteria.
Looking at a market environment, a strong brand and registered trademarks founded on a strong business model may contribute to a company’s pricing power for staying ahead of its competitors. We all know these brands: they are the ones that their users are in love with and would never leave. If your users think that you are the only company that provides their product, even better.
Low production costs support high quantities of products and enable a company to offer volume discounts and low prices to a large number of customers, making it difficult for competitors to enter the fray. Finally, network effects will draw additional users and customers to a product or service and add value to the product and the brand this way.
Don’t forget this is a learning process - and remember Benjamin Graham, the father of value investing? It was also he who was the first to observe that the highest losses are not a result of buying quality stock at a price that is too high but buying low quality stock at seemingly low prices. Who could argue with that?
Are you ready to start? Bitpanda makes it easy for you. Download the Bitpanda mobile app for iOS or Android on your smartphone to sign up. Verify your Bitpanda account in just a few minutes with one of our trusted verification providers, choose the payment option you prefer, and deposit your starting balance. You can now start investing in various assets, such Bitpanda Stocks*, crypto, and precious metals 24/7. You can create your Bitpanda account here.
This article does not constitute investment advice, nor is it an offer or invitation to purchase any digital assets. This article is for general purposes of information only and no representation or warranty, either expressed or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of this article or opinions contained herein.
*Bitpanda Stocks enables investing in fractional stocks. Fractional stocks in Europe are always enabled via a contract which replicates the underlying stock or ETF (financial instruments pursuant to section 1 item 7 lit. d WAG 2018). Investing in stocks and ETFs carries risks. For more details see the prospectus at bitpanda.com.
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