My simple defensive investment principles in the stock market
Starting the investment journey takes courage, but is simple to do as detailed my in previous post about how to start investing in the stock market. In my years of investing in the stock market, I have found my style of investing – scared-to-die approach. If you are like me, then you are a defensive investor too. Defensive investors need a set of Investment Principles to protect ourselves.
No point fighting against our nature and go for the high growth, high risk, high return investments because we will die out of a heart attack. Been there, done that. Wasn’t a pleasant experience.
Jason’s 8 Investment Principles in Stocks
I have set up 8 Investment Principles for myself and I have followed them quite religiously in my stock market investments. It’s not foolproof, but at least I can sleep soundly at night.
(1) Know the company and business
The notion of “invest in what you know” is exactly what this Investment Principle is all about. The concept is simple: would you rather put your money with someone you know or a total complete stranger?
It’s the same with investing because if you know the company, you know the range of products they have, the market they serve, and the outlook for the company. You will know if they deserve your money.
If you don’t know the company, then you don’t even know what they do to make money. So… why would you invest in them again?
(2) Dividend paying consistently
Dividend is a distribution of the profits earned in the business to the shareholders and is a passive income to investors. I am building my passive income portfolio with dividends and so this becomes an important Investment Principle.
I can rest assured that if the stock price drops from my entry price, I can still sit back and collect dividends without worry.
The dividend yield (DY = total dividends paid in a year / share price invested) I am looking for is at least 3% to qualify as a stock worth investing.
With that said, I do take caution if there is an increase in dividend yield due to the drop in share price instead of a rise in dividends paid as that may be a red flag about the company and may impact future dividends.
More on dividends and what to look out for here.
(3) Buy only when it is red
Just like shopping, we would want to get the product at the cheapest price possible, yes? It’s the same for investing, where I am only interested to buy when the prices are falling.
(4) Avoid industry concentration
When investing, it is important to determine the portfolio we want to be holding and part of that comes with diversification.
Spreading our investment into different industries will help us mitigate industry risks, such as the travel industry has been severely impacted by the COVID-19 pandemic. Imagine a portfolio that is wholly invested in airlines and casinos and hotels when the pandemic hits… It will take a long time to recover.
My loose guideline for my own portfolio in this aspect is to keep my exposure to an industry at a max of 20%.
(5) Valuation at low end compared to its peers
Valuation is a commonly gauged as a function of the share price over the earnings per share (P/E ratio). There are a lot of financial websites out there that can show you what the P/E ratio of a company is.
Before investing into a company, I’ll look at all the comparable companies and check if it is under or over valued compared to the peers.
For example if I’m looking at investing in Digi, I’ll gather Maxis, Axiata, Time Dot Com and Telekom to make a comparison.
You may refer to my post on how do I find undervalued stocks in the market which would extend on this point.
(6) Industry outlook is neutral or good
Before investing in any company, it is crucial that the outlook is at least neutral, which means to say that businesses in the industry will operate as usual.
Stay away if the industry outlook is bleak or negative, no matter how attractive the company’s share price has become.
(7) Growth in revenue / profits
Growth in business reflects a potential growth in value and translates to a growth in share price (hopefully). Easiest way to look at this is the growth in its revenue and profits on a year to year basis. Exceptions are allowed depending on the story & industry the company is in, but investment priority is given to growing companies.
(8) Never, ever, ever fall in love with any stock
The only thing that is constant is change
Heraclitus (Greek Philosopher)
At any time, a stock that we have invested for a long time may become a high risk stock. Taking the pandemic again as an example: I was an investor in an airline company for a long time, but ever since the pandemic hit I no longer have positions in the company and will not take on any positions no matter how low the price drops due to it not fulfilling Investment Principle No. 6.
The key here is to evaluate our investments frequently and keep up to date with news about the companies. I use Google Alerts to get news of companies in my portfolio sent to my mail daily.
Rule of Thumb in Buy / Sell
Just as a rough guideline, this is the rule of thumb that I follow after the company passes the 8 Investment Principles.
Buy Alert: When the share price is lower than the middle of the 52-week high and low
Sell Alert: When the share price is higher than the middle of the 52-week high and low
You can easily find what is the 52-week high and low from any financial websites or even in your trading platform. Then just simply add the two numbers and divide 2 and you will get the middle share price.
The Importance of Keeping a Watchlist
Investing is a long journey.
The more we trade, the more companies that will come to our attention. At the same time, most of these stocks may not fulfill all the 8 Investment Principles and the Rule of Thumb when we first come them.
This is why a watchlist is important.
It keeps track of all the potential stocks so that we can easily go back to them at a later date to re-evaluate the position of the stocks.
Discipline
It takes A LOT of discipline to stick to the Investment Principles and Rule of Thumb. There will be temptations.
Case in point: The glove counters have been very hot ever since the pandemic happened. However, it did not give sufficient dividends and the share price keeps soaring to new highs. So, I did not take any position at all in these companies. It is easy to say that, on hindsight, I have missed out on this wave, but it just doesn’t fulfill my scared-to-die Investment Principles and hence it is not a game I will partake.
The market is huge. There are many ways to invest, and what I missed out in gloves, I make back elsewhere. In the end, it is about what you want to do with your investment and is a choice you will have to make.
Alternatively one may opt for passive investing via ETFs, but you should take note of a few things before understanding if it is suitable for you.
