A Comprehensive Guide of 5 Best Stock Investing Strategies

I often mentioned on this site of stock strategies based on performance and dividends. Because it is the investment method that I have personally chosen, that I know it works, and that it is relatively simple to implement. That said this method is not the only one that can earn long-term returns above the average.

However, solid, profitable and time-tested stock strategies are not as many as we think: In my opinion, there are only five of them robust enough and sufficiently tested by serious academic research to be worthy of interest. Without further delay, here is a guide to the 5 best strategies for investing in the stock market.

What you will learn in this article:

• A very simple strategy that makes it possible to beat 90% of the players in the stock markets
• More complex strategies with annual returns of 25 to 30% per year
• The difference between an active strategy and a passive strategy
• The Pros, Cons and detailed performance of each strategy

The best passive strategies for investing in the stock market

Passive strategies consist of simply investing in stock market indices (such as S&P500, Dow Jones), they are said to be “passive” because they do not seek to do better than the indices, only to replicate them as more accurate as possible. These strategies have the advantage of being very little time-consuming, and you will not need a great knowledge of the stock markets to be effective.

Passive stock strategy No.1:  Invest in a stock index

If I told you about an extremely simple strategy to achieve a better performance than 90% of the professional fund managers, which could be put in place in a few minutes, and at a low cost would you be interested?

This revolutionary strategy is… just buying a stock market index.

Below is a graph showing the number of equity funds that have done less well than their benchmark stock index over periods of 1 year, 3 years, 5 years and 10 years.

It is interesting to note that if funds manage to achieve higher performance over short periods of time, but over a 10-year period, 90% of funds are beaten by the Global equity index (which is simply an index of all the global shares that you can buy very simply via a tracker), and 95% of the funds are beaten by the U. S equity index.

To do better than 90% of professional players in the markets, all you have to do is buy the global equity index or the US equity index. The MSCI World and the S&P 500 are two good vehicles to implement this strategy.

The stock market can sometimes seem complex, and your banker may have already tried to sell you incomprehensible financial products, but as you can see, in fact simplicity beats the complexity 90% of the time.

Benefits of the Strategy:

• Easy to implement
• Little time-consuming
• Long-term returns historically around 10% per year for the US stock index
• Time spent managing your portfolio and yield achieved unbeatable

Disadvantages of the strategy:

• Periods of market crashes, sometimes it’s difficult to live psychologically (2008)
• Ability to achieve better yields or identical returns, but with less volatility means less advanced strategies

Passive stock strategy No.2: Create a global stock portfolio

Creating a global stock portfolio is a passive strategy of using a number of low-correlation stock indices to reduce risk.

Fully stock indices (such as the MSCI World) are those that have the best long-term performance. That said, as any investor who has lived the year 2008 may know it, it comes sometimes (often) at the price of high volatility. Using a basket of low-correlated indices can help reduce risk while preserving high yields.

If you are interested in this kind of strategy I invite you to read the article “earning 9% per year with the permanent portfolio“. The article explains in detail how to use gold, bonds and stocks to reduce your risk through diversification while having a significant return.

Benefits of the Strategy:

• Easy to implement, thanks to the use of trackers/ETFs
• Strong reduction in volatility and risk due to the use of multiple class of assets
• Portfolio management little time-consuming

Disadvantages of the strategy:

• Long-term returns often lower than “all-stock” indices
• Bond markets (usually used as the number 1 option to diversify) currently highly overvalued

The best active strategies for investing in the stock market

“Active” stock strategies are intended to use a judicious selection of securities to achieve better returns than their benchmark stock index.

Attention however: the majority of the investment funds use this type of strategy, and that is why the majority of the funds achieve more than mediocre performance: it turns out that the stock indices are in fact very difficult to Beat. However, three active management strategies are known to have sustained higher-than-average yields.

Active stock market strategy No.1: “Value” strategy

What is a value-based strategy?

We often talk about ‘Value Investing’ to refer to this style of investment in reference to the eponymous book of legendary investor Benjamin Graham (mentor to Warren Buffet) who popularized this method and applied it himself with great success. Value Investing is about chasing companies with a high discount, which allows them to be bought below their actual Book Value.

This strategy assumes that stock markets are not always logical and that during periods of panic selling, prices can become irrationally low compared to the real value of businesses. Benjamin Graham profited precisely from these periods to buy massively, he called it “buy with a margin of safety” because the purchase with discount allows to reduce the risks and to realize potentially big profits when the market returns to the Reason and precisely revalues the company temporarily undervalued. It’s a bit the same principle as buying an apartment below the market price in real estate.

What results can be obtained?

The investor who has had the greatest success with this method is known to all those who have already read a ranking of the world’s greatest fortunes: Warren Buffet. Between 1976 and 2007, Buffet got annual returns of 30% per year using a combination of this method and his unique know-how, making him one of the best investors of all time.

In the facts few “value” managers have managed to achieve such long-term performance levels, but academic research agrees that investing in solid stocks that temporarily undervalued is a strategy that has enabled to obtain long-term returns higher than the stock market indices.

How to apply the strategy?

Investors applying this strategy are primarily based on specific financial ratios to determine whether a company is trading at the right price or its actual value. The commonly used ratios are usually the price to earnings, the price to sales, or the price to book, however the valuation of the real value of a company can have part of subjectivity, and that is why the performance of Warren Buffet have rarely been matched.

Nevertheless, the concept of buying with a discount makes sense and works, even if one is not called Warren Buffet: buy Cheap at good quality is a concept that works both on the stock market and in real estate.

Benefits of the Strategy:

• Higher long-term returns
• There is little concern about market fluctuations
• Buying with a discount automatically prevents bubbles and overvalued areas
• Strategy validated by many university studies
• Low turnover (little purchase/resale), therefore low cost and low tax

Disadvantages of the strategy:

• “Cheap” does not necessarily mean “opportunity” (we find ourselves analyzing a whole bunch of low priced companies: most of them are low-priced for very good reasons (problems of management, profits, sector, long-term vision), so always do some in-depth analysis,  otherwise you’ll just find yourself with bad companies in a portfolio.
• The discount is not a guarantee of immediate profits (there may be a very long period of time before the market recognizes that it was “wrong” about the price. You can buy with a discount today but the price may not move well for 2 or 3 years, then you must not be stressed and keep your portfolio diversified).
• Accurately evaluating whether a company is undervalued or overvalued is sometimes difficult (the market takes into account the expectations of stakeholders in quoted prices and the ratios used are changing according to sectors and economic cycles)

Active stock market strategy No.2:  “Growth” strategy

What is a Growth strategy?

The so-called “growth” strategies are the opposite of “value” strategies. Here we do not take into account the value of a company and we do not try to buy on discount. On the contrary, we are looking to invest in the hottest companies of the moment, those who are expecting rapid and massive growth in their profits.

The valuations of these companies can be really astronomical but this does not matter to a growth investor, only two essential factors count: the growth of stock price, and the growth of profits. Some “major” growth stocks in recent years are Amazon, Google, or Apple for example, and the profits made by those who invested in them are actually MASSIVE.

That being said, the problem of this kind of strategy and since there is only few Google and Amazon, it’s very difficult to identify them before their massive increases. So many of your stocks won’t go anywhere and your profits will come from a minority of stocks carrying a big advance. This is not an obvious psychological strategy and you absolutely need a method to manage the risks and cut your losses on securities that’ll go nowhere.

What results can be obtained?

To illustrate how investors are actually positioned on Amazon, here is a graph illustrating the value of this stock since its IPO in green, and the maximum losses between the highest and lowest in red:

As you can see: to win the maximum returns of 38,911% in the long run, you would have seen your shares lose 60%, 70% or even 90% of their value on multiple occasions. I only know extremely few investors who are capable of bearing this kind of loss without selling, panicking, or losing their conviction on the company.

To avoid going through this kind of problem, it takes a complete method that mixes market timing, technical analysis and fundamental analysis. And this is exactly what William O’Neil developed, the inventor of the CANSLIM method and father of most modern growth strategies.

William O’Neil is probably the most representative investor of this style of investment, even if he is not the only one to use it, and he has made many disciples since the release of his book. The annual returns of his method would be around 25% per year between 1977 and 2013, depending on the sources I could find, which comes to compete with Buffet’s long-term returns and his value style. However, these returns would be at the cost of a much higher volatility and therefore a higher risk.

How to apply the strategy?

If you are interested in this strategy, the best solution for you is to read William O’Neil’s book, but if I were to give you the outline of a standard growth strategy, it would be to: look for companies with profits in the midst of explosion, look for companies whose prices are rising and are growing faster than those in the market, look for stocks in the booming industries of the moment, make sure we are in a highly bullish stock market, and manage your risk by placing an automatic sales order 5 to 10% below the buying price if the stock suddenly turns upside down and does not go in the direction expected.

Benefits of the Strategy:

• • Yields higher than long-term stock market indices
  • Fast Profits (stock goes up as soon as you buy or is resold quickly with a slight loss)

• Opportunities to earn 100%, 200%, 500% on certain positions

Disadvantages of the strategy:

• Complex to implement
• Time Consuming (you have to constantly look for the best companies and monitor their positions)
• Difficult to hold psychologically
• Unstable yields over time (high volatility)

Active stock market strategy No.3: “Performance” strategy

What is performance strategy?

We come to the last strategy (which is also the one I speak most often): the performance strategy. Contrary to the two previous strategies, the price is only the second important thing here. We are not trying to get rich with explosive growth or catching up on an undervalued company, but simply with the dividend paid by the company.

This has a major advantage: dividend payments are regular and always positive, even if the value of stock fluctuates. We are therefore concentrating here on solid companies which distribute dividends in constant increase to take advantage of the effect of compound interests through the reinvestment of these dividends.

What results can be obtained?

It also happens that companies that have distributed growing dividends for many years are naturally outperforming the market, as you will see in the following graph:

This makes sense because a growing dividend stock over a long period can only be paid for through a stable growth of the company over time. Like undervalued companies or explosive growth companies, the dividend companies therefore offer a natural advantage in order to achieve higher long-term returns.

If you want a more concrete example of what can be done with this strategy, I invite you to read the article “Becoming an annuitant in 10 years with the stock market“.

How to apply the strategy?

You can start making your selection from the list of American”dividend aristocrats“. To do the right thing, however, as in the case of the value strategy, it is necessary to undertake a more in-depth analysis of the company in order to determine whether the growth of the dividend is sustainable over time, if the company is financially healthy , if your price-entry is too high, and if the probability of cutting the dividend in the future is low or high.

Benefits of the Strategy:

• Higher long-term returns
• High probability of success
• Relative simplicity of implementation
• Low turnover and low fees
• Little time-consuming once the strategy is put in place
• Regular cash flow

Disadvantages of the strategy:

• Long-term total returns less impressive than growth and value strategies
• Requires time and patience before you see the results

Conclusion

I hope that this quick overview of the main strategies to make long-term money in the stock market will have been helpful. I think it is important to point out that the yields of the “value” and “Growth” strategies are not necessarily constant from one year to the next, i.e. it is very possible that one style has very superior performance to another during Periods that can be extended over several years.

In fact, the “value” and “growth” styles generally work in opposition: at the end of the years 1990, investing in the hottest values of the moment was the ideal way to earn a lot of money. But during the explosion of the Internet bubble, the style “value” outperformed.

Similarly, in a period of crazy growth in stock markets, dividend payers will tend to rise lower than growth stocks, while in a more lateral market, these stocks will have higher performance. So there will always be years a style will have exceptional performance and another disappointing performance. This is exactly what makes these strategies more difficult to apply than passive strategies. The important thing is to be able to choose a style and stick to it if you want to benefit from higher returns over the long term.