“Secret Recipe” for Successful Stock Trading?
Throughout the course of multiple studies one common trend has become glaringly apparent when searching for an indication for the potential for future performance of stocks….. hold your breath…. Valuation. Simply put, over the course of time in an investment, cheaper stocks are tending to deliver better returns to the investor than the expensive ones. Seems so simple, right?! Well, there is more. Fidelity conducted a new study in an effort to harness that potential, enhance it, and lower the volatility and maybe even increase the returns!
This new study completed by Fidelity showed that “adding a quality metric to a traditional value-based approach to stock picking may have the potential to help improve long-term results, both in terms of risk and return.” They studied the numbers for the past 25 years and found that even though growth stocks are desired and sought after by investors, low expectations of value stocks mean that when they actually produce better than expected outcomes, they then have the potential to outperform. By finding quality investments in companies with superior business models and a track record of generating profits that are higher than a company’s cost of capital, they were able to net higher returns with lower volatility. Fidelity explained this finding:
Why does quality help? For one thing, quality can contribute to the long-term compounding of capital: Because high-quality companies by definition tend to produce more return on their investments, they have more money to reinvest in their business. This can lead to a virtuous cycle of growth and profitability. In addition, many companies with high-quality metrics have strong underlying competitive advantages that persist over time, including brand recognition and intellectual capital. These competitive moats can translate into less volatile earnings margins and revenue growth.
While the system seems so simple, what can be challenging for investors is finding a low volatility stock that is also considered “quality”. The study found that when a portfolio is equally weighted with quality and value factors, it delivered better risk-adjusted returns and absolute performance than the market as a whole. Fidelity says that “one of the advantages of this strategy is that it tends to outperform over most intermediate and long-term time periods.”
What does all this really mean to you? If you aren’t trying to time the market, and can devote the time to research the two factors which could mean a good buy, then that lower priced stock “gem” that you find could bring you substantial returns with less heartache.