An investment style is somewhat underestimated nowadays, yet gaining a basic understanding of the major investment styles is one of the fastest ways to make sense out of the thousands of investments available in the market today, and the mere knowledge of these styles may change the way you look at trading.
The main investment styles may be broken down into three fields, namely;
1) active vs. passive management,
2) growth vs. value investing, and
3) Small cap vs. large cap companies.
Active or Passive Management
In determining investment style, an investor should first consider the degree to which they believe that financial experts can create greater than normal returns. Investors who want to have professional money managers carefully select their holdings, will be interested in active management. Actively managed funds typically have a full time staff of financial researchers and portfolio managers who are constantly seeking to gain larger returns for investors. Since investors must pay for the expertise of this staff, actively managed funds typically charge higher expenses than passively managed funds.
Some investors doubt the abilities of active managers, as not all would be on the same level of experience. Many passive funds earn better returns for their investors than do similar actively managed funds. Passively managed funds have a built-in advantage – since they do not require researchers, fund expenses are often very low.
Growth or Value Investing
The next question investors must consider is whether they prefer to invest in fast-growing firms or under-priced industry leaders. To do this, analysts look at a set of financial metrics and use judgment to determine which label fits best.
The growth style of investing looks for firms that have high earnings growth rates, high return on equity, high profit margins and low dividend yields. The idea is that if a firm has all of these characteristics, it is often an innovator in its field and making lots of money. It is thus growing very quickly, and reinvesting most or all of its earnings to fuel continued growth in the future.
Furthermore, the value style of investing is focused on buying a strong firm at a good price.
Thus, analysts look for a low price to earnings ratio, low price to sales ratio, and generally a higher dividend yield. The main ratios for the value style show how this style is very concerned about the price at which investors buy in.
Small Cap or Large Cap Companies
The final question for investors relates to their preference for investing in either small or large companies. The measurement of a company's size is called its market capitalization or cap for short. Market capitalization is the number of shares of stock a company has outstanding, multiplied by the share price.
Some investors feel that small cap companies should be able to deliver better returns because they have greater opportunities for growth and are more agile. However; the potential for greater returns in small caps comes with greater risk. Among other things, smaller firms have fewer resources and often have less diversified business lines.
Share prices can vary much more widely, causing large gains or large losses. Thus, investors must be comfortable with taking on this additional level of risk if they want to tap into a potential for greater returns.
Clearly defining the investment style that fits you will help you select investments that you will feel comfortable holding for the long term, and that are of interest to you; thereby motivating you to keep on researching your investment for the long haul.
This article was issued by Steve Diacono, for Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.