Not many of us align our investment choices with our unique situation and this affects our stock market success. The purpose of this article is to shed light the different ways or methods of investing in the stock market.
There are broadly 3 investor types that the stock market caters for and they are:
- Value investors
- Growth investors and
- Hybrid investors.
The value investor takes significant interest in dividend payments, so they invest most or sometimes all of their investable money in dividend paying stocks. In addition to this, these investors try to acquire dividend paying stock at a discount whenever they are undervalued by the market and also take a long term view to investing.
This is not necessarily a bad thing, as they benefit in two ways – the potential increase in the stock price (capital appreciation) with time and the dividend they receive a few times (usually twice) in the year. Together, they are referred to as the “total return” on each share that they own. For investors that need a source of income (like retirees for instance) this is a very good investment solution as far as the stock market is concerned.
Does this mean that only retirees should invest in these kinds of stock? The answer is a resounding no! Anybody can invest in dividend paying stock. If you don’t need the cash flow that dividends provide at the moment for instance, you can reinvest the dividend when it is paid out – this is where compounding comes into play.
I know people who only invest in companies that pay “hefty” dividends and the reason is quite obvious – they may need money for upkeep and other needs that they may have as they are no longer working (retirees no offence).
Growth investors on the other hand hope that the earnings of the company they are investing in grows at a faster rate than its peers in the industry or even faster than the overall stock market. So if a company is young with a high growth potential (e.g. the industry they are in has increasing demand for its goods/ services), it stands to reason that the shares of that company in the future will be in high demand, which will lead to the stock’s price rising – growth investors swoop in to buy these stocks before this happens.
The advantage of stocks that don’t pay dividend is, their earnings are put back to work (as is expected) so that the growth investor, benefits from the growth in stock price. What does this mean for the investor?
A growth investor is more tolerant to risk than a value investor, they are therefore willing to invest in the stocks of growing companies (not what a value investor will do). Since it is expected to grow faster than its peers, the stock is sold off in a relatively short time for a profit because, unlike value investors, growth investors don’t look at long investment horizons. But remember, higher returns, higher risk!
The hybrid investor sits in the middle and applies various characteristics of both value and growth investing. These investors buy stocks of companies which have solid growth potential and are also undervalued by the stock market. Such investors are also referred to as GARP (Growth at a Reasonable Price) investors. I am one of these guys and I look for stocks that are at neither extremes.
Remember the low dividend paying stock’s I mentioned earlier, some of them can actually be growth stocks because the companies may still be young and in growing sectors. They can grow to be superstar firms, with high stock prices that pay huge dividends – these are the kind of stocks I like!
So where do you fit in? Are you investing the way that you should or are you following someone else’s plan? Remember, you should have a reason for investing in the stock market as well as a strategy. This means aligning yourself in the most appropriate way that will optimise your stock portfolio. So ask yourself, why are you investing and what should my style be? Just a thought.