Dynalect’s Investment Strategy Guide

Buy and Hold

The buy and hold strategy is one of the most well-known trading strategies in the world, and involves purchasing a stock with the intention to hold it for a long period of time regardless of short term fluctuations in its price. The most famous disciple of the buy and hold strategy, Warren Buffett, swears that holding stocks long term is the best way to turn a profit in investing. In his own words, “our favorite stock holding period is forever.”

Buffett’s assertions regarding the efficacy of buy and hold are challenged by many investors who view more short term strategies as a much better way to be successful in the stock market. This debate essentially characterizes the difference between passive and active traders, with most buy and hold investors falling on the side of pacificity. A lot of recent research suggests that passive investing does indeed carry better returns in the long term, which is beginning to create big problems for the active investor community.

Dividend Investing

Most stocks in the United States pay a dividend, which is essentially a way for the company to share some of the profits it makes with its shareholders. Dividend investors are more concerned with the size of a company’s dividend rather than any fluctuations in the actual price of the stock. Dividends can either be measured in nominal cash values, such as $1/share, or as the “dividend yield,” which measures the size of the dividend relative to the price of the stock. For example, Ford Motor Company (NYSE: F) has a current annual dividend yield of 4.8%, which means at the current share price of roughly $11.50, Ford will pay investors about 55 cents per share at the end of the year.

Although dividend investors are not necessarily interested in making money from fluctuations in the actual share price of a stock, they must be careful about selecting stocks that will not suffer significant depreciations in value over the duration of their investment. For example, if a stock pays a 10% dividend, but depreciates in value by 15% over the course of the year, the investor will end up in a much worse position than where he/she started.

Top Down vs. Bottom Up

Top Down and Bottom Up investing describe two different ways of determining which stocks are worth buying for an investor. Top down investors try to identify industries or sectors that are in a good position to experience significant future growth as a whole, and then try to build a diverse portfolio of companies operating within the identified industry in order to benefit from the predicted growth. Dynalect certainly qualifies as a top down investor; we seek to identify emerging cultural trends that are poised to experience explosive growth over the medium and long term, and then we look for ways to monetize within those trends by building a diverse portfolio of relevant companies.

On the other hand, bottom up investors work more with individual companies. The philosophy behind bottom up investing says that a well-run company with a record of impressive growth will continue to be a good investment opportunity regardless of what sector the company operates in. Bottom up investors seek to identify and invest in worthwhile companies directly instead of considering the context of larger sector-wide trends.

Fundamental vs. Technical Analysis

Fundamental analysis involves identifying and evaluating the fundamental drivers of economic growth and success within a company of interest and investing based on the assumption that companies with strong fundamentals will create value that will lead to higher stock prices in the future. Many “proper” investors will argue that any kind of investing that is not based on fundamental drivers isn’t actually “real investing.” Performing fundamental analysis requires investors to dive into the financial details of a company by looking at their income statement, balance sheet, and cash flow statements. Fundamental investors will want to get an understanding of how the company makes money, whether or not the company is in good financial health, and whether or not the company is in a good position to make money moving forward. To further your understanding of how to carry our fundamental analysis, the Dynalect Team recommends the Investopedia Tutorial on fundamental investing.

Technical analysis involves “trading the charts,” which means that investors trade based on chart patterns and statistical information, often without even looking at fundamental drivers to determine the potential of the company to make money in the medium and long term. Technical traders are typically focused on placing short term bets and actively managing a portfolio. If a bet doesn’t pan out as expected, technical traders are quick to cut their losses and reinvest the resources in another short term opportunity. There are many different quantitative measures that technical traders use to make their trades, such as the ADX, bollinger bands, Japanese candlesticks, and the MACD. To learn more about the ins and outs of technical trading, the Dynalect Team recommends reading this brief article on Investopedia.

Core and Satellite

Core and Satellite investing involves choosing a “core” set of companies to invest in, which are generally large-cap and low-risk stocks. The remaining resources are spread out across smaller, higher risk “satellite” securities. This strategy allows the investor to gain exposure to high risk – high reward securities, without jeopardizing the value of their core capital. The core and satellite strategy is an excellent way to mitigate risk, especially if the core stock selection include a diverse selection of large cap blue chip companies.

Company Size

This simple strategy involves just looking at the size of a company, generally measured in market capitalization or annual revenue figures, to determine which companies to invest in. It general larger companies are going to be less-risky investments that smaller companies. For example, Apple (NASDAQ: AAPL) is a much more stable investment option than a company like Heat Biologics (NASDAQ: HTBX), which could potentially prove to be a very lucrative, or a very disastrous investment decision. Established investors rarely invest in companies on the sole basis of their market capitalization, but it is a worthwhile piece of information to consider in cooperation with other investment strategies.  

CANSLIM

The CANSLIM investing strategy was developed by William O’Neil in his book How to Make Money in Stocks. William O’Neil is also the co-founder of the site Investor’s Business Daily, and a well-known equities investor. CANSLIM is an acronym that characterizes a comprehensive formula used to identify whether or not a company might be a good investment in the short and medium term.

C — Current Earnings

The CANSLIM strategy dictates that the first thing investors should look for when examining a company is the quality of their earnings relative to the past. For example, in order for a company to be considered as a good investment, it needs to have shown a higher EPS figure in a given quarter compared to the same quarter the year before. How much higher you might ask? There is no concrete rule, but the Dynalect Team recommends companies that have posted growth of at least 25% to ensure that the company is on a solid growth track.

A — Annual Earnings

This is very similar to the point above, but on an annual instead of quarterly time scale. When examining annual earnings, it is important to make sure the company has experienced significant annual growth over the past 4-5 years. Failure to do so could signify that the company experienced a short term burst of good fortune, but will be unable to maintain long term growth moving forward.

N — New

The “new” requirement pretty much speaks for itself. Before you consider a company as a good investment, you should look for something new in the company. This could be a new management team, a new product launch, an expansion into new markets, etc. In order for a company to attract sufficient investment to drive its stock price higher, it often needs to be up to something new to stir up some attention.

S — Small Cap

According to the CANSLIM model, smaller companies are more likely to experience significant growth in the market for a variety of reasons. The first is simply because their stock price is easier to influence. For the price of a stock like Google (NASDAQ: GOOGL) to fluctuate, it requires a relatively enormous amount of volume in terms of trading activity. On the other hand, for a company that only has a few million shares outstanding, individual traders are much more equipped with the resources to affect significant change. Smaller cap companies also have more room to experience enormous growth, which can send their stock to the bulls.

L — Leader or Laggard?

It’s extremely important to determine whether or not a company of interest is a leader or laggard within their particular industry. Laggards almost never do well on the stock market relative to other leaders in the sector. A good way to measure whether or not company is a leader is to measure the relative price strength of the stock, which describes how the stock has performed relative to its peers within a given industry. For the sake of the CANSLIM model, a good investment opportunity should have a relative price strength of at least 70 on a scale from 1 to 99, which means it has historically outperformed 70% of the stocks in was compared to within its industry.

M — Market Direction

It’s important to keep your eye on the general market when you’re investing. When the market is consistently hitting all time highs and people can’t seem to go wrong, it might be a good time to cash in some of your earnings and wait until the market cools down a bit. On the other hand, a great time to invest can be right in the aftermath of a major market correction. Always remember to buy low and sell high; investing is about timing the market, so make sure you’re paying attention!