Equity Portfolios: Investment Styles
The key technique in building portfolios which can outperform the market is known as fundamental analysis. Fundamental analysis focuses on finding companies with the best business prospects.
The stock market’s short-term price movements often do not accurately reflect what is going on in the economy or in any one company. In the longer term, these ‘fundamental’ drivers of share value will assert themselves. So fundamental analysis looks at a share’s market price in light of the company’s underlying business proposition and financial situation. The aim is to find shares which are currently undervalued by the market - that is, shares whose current share does not reflect their profit potential.
There are two ways of looking at company fundamentals:
1. Business profile - the history and current goals of the company
This is qualitative analysis and it involves making a judgement about a company - its products, its organisation, its external public image and internal culture, and how well it is placed to profit from broader socio-economic trends.
2. Financial profile - the management of company finances as revealed in their reported accounts.
Some of this is purely ‘quantitative’, picking out figures for things such as operating costs, borrowing levels, sales and earnings growth. But these need to be compared with past form and with the financials of similar companies to give a picture of overall financial health.
And future profitability, which is what share-selection is basically trying to uncover, will always require financial forecasts which can only be based on value judgement. Comparisons of fundamental valuations with market price valuations are also open to a variety of interpretations.
Within fundamental analysis there are a range of different investment styles, which can create portfolios which may behave very differently across the short term. However, most styles fall into either the growth investing camp or the value investing camp. Let's find out what they are.
