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Separate the wheat from the chaff
Market Outlook

Separate the wheat from the chaff

It’s time to get out a clean sheet of paper, focus on the fundamentals and concentrate your portfolio.
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6 SEPT, 2022

By Don O'Neal

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First, it’s important to recognise that things have changed. What used to work for stock picking won’t work in the same way, possibly for years. Holding the best companies with the best growth stories seemed to be a good approach over the past 10 years.

But I believe the last decade was too easy. Whenever retail investors get hyped up and day traders abound via trading apps such as Robinhood, that is a sign.

Going forward it will likely be harder to generate good returns, and the factors that drive returns most likely will change. For example, you can no longer buy and hold the fastest growers without regard to profits. I see this as a welcome return to fundamentals.

You may hear the current decline described as a correction of high multiple growth stocks. While this is generally true, it is incomplete. The stocks that have fallen the most all had fundamentals that disappointed versus expectations. Stocks with continued good fundamentals have held up better.

A lot of stocks have plummeted, but that doesn’t mean they are all bad investments. Consider this example: In the 2000 bear market, both Amazon and Pets.com declined more than 80%. Pets.com went on to become a poster child for irrational exuberance as its stock went to zero. Meanwhile Amazon went on to become …. Amazon.

Bear markets can inflict pain indiscriminately

Source: FactSet. Full chart shows monthly returns from 1/31/00–6/30/22. Smaller chart shows daily returns from 1/3/00–12/31/00.

For me, it’s time to get out a clean sheet of paper, focus on the fundamentals and concentrate your portfolio. Ruthlessly throw out the pretenders and hold only the highest conviction investments. Separate the wheat from the chaff.

This could be growth companies in the semiconductor, cloud services or search areas, for example. But it could also lead to more value-oriented companies like defense contractors, insurers or energy companies.

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