eToro
By eToro
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Seven Strategies to Beat the Market

Deciding where and how to invest is not easy and never has been. There are numerous attitudes and strategies that rely on different parameters and various philosophies, from buying stock cheap to purchasing growth stocks, to investing according to global events.

So where should you start?

How can you absorb everything that’s happening in the market, from a change in a specific stock to a change in the global economy, from trends in commodities to trends in currencies?

What should you focus on?

There are many approaches that work in different timeframes and capitalize on different trends, but we’ve chosen seven strategies that could prove useful in relation to recent events, and enable you to get a sense of how investors are thinking and how they put their money to work.

investment strategies

1. High Beta

Beta is an indicator used by investors to measure the relative volatility of a stock compared to the broader market. The common practice is to use the S&P500 as a reference to the broader market and divide the average fluctuation of the stock relative to the S&P500, if the stock is traded in the USA.

For example, a stock with a 1.3 beta moves on average x1.3 for every S&P500 move. If the S&P500 gains 10%, the stock with a 1.3 beta gains 10 x 1.3 = 13%. On the other hand, if the S&P500 drops by 10%, the stock drops by 13%. This means that the stock is a high risk high reward. If the general market drops, the stock plunges more; if the general market is rising, the stock could potentially outperform. If you’re wondering how to calculate beta, there’s no need to worry – there are plenty of sites that calculate beta for you; Yahoo Finance is one of them.

OK, now that we’ve got the idea, how exactly are you supposed to invest using beta? If you think the broader market is heading higher, then a high beta stock could yield more than average. Because rate hikes in the US are probably being postponed, investors are betting on further gains for the S&P500. This would favor high beta stocks. Among them are stocks such as Ralph Lauren, the clothing company; Baidu, the Chinese search giant; and First Solar, the solar panel manufacturer. Each is a high risk high reward.

Action Items: 

  1. Google high beta stocks and produce a list.
  2. Open the stock’s page on yahoo finance .The beta will be among the figures presented.
  3. Check the stock’s beta to validate its above 1
  4. Determine the market’s direction. Since a high beta stock moves more than the broad market it’s important to determine the market direction first.
  5. If the market is bearish select the highest beta stock and short it, because it will fall in price more than the rest. If the market is bullish select the highest beta stock and buy it.
  6. Remember if the broad market trend changes you need to shift your positions accordingly from long to short and vice versa.

High Beta Stocks: Ralph Lauren, Baidu and First Solar.

Summary for Ralph Lauren

2. Cyclical vs Defensive

In general, although each stock is an entity in its own right, there are stocks that are considered cyclical and defensive. Stocks that are considered cyclical outperform when the economy is growing.

Cyclical – outperform when the economy is growing When the economy grows, consumers spend more, therefore stocks in the automotive sector, clothing and restaurants tend to benefit. On the other hand, defensive stocks are those in sectors that outperform even when the economy is weak.

Defensive – outperform even when the economy is weak An example of such a sector is pharmaceuticals – after all, medication is not growth-dependent because people don’t stop needing medical treatment when the economy is poor. Another example is consumer staples – consumers continue to buy soap, for instance, even when the economy slows.

Now down to strategy. Before applying this approach, we have to figure out where growth is heading. In this case, we’ll focus on the US. GDP indicates growth but PMI indicators tend to move faster – after all, a new reading is published each month, and unlike GDP, which could grow for various reasons, the PMI measures the sentiment, and thus can be used as a good predictor.

Below we can see the Chicago PMI index, and we can see a plunge in sentiment between January and March, and a recovery of sentiment in April. In the corresponding period, as you might expect, cyclical stocks suffered losses.

Chicago PMI
Source: www.tradingeconomics.com

However, as April’s reading bounced back, it could suggest that it’s time for the cyclicals to outperform once more.

As we explained, the automotive sector tends to be highly cyclical, so it could gain from the changing trends. Which automotive stocks might gain? Ford Motors and Harley-Davidson, the motorcycle manufacturer.

Cyclical Stocks: Ford Motors, Harley Davidson.

Defensive Stocks: Pfizer, Procter and Gamble

Action Items: 

  1. Google cyclical and defensive stocks and make two lists.
  2. Check the Chicago PMI index. If it’s on a rising trend this is a good time for cyclicals. If the PMI seems to be getting weaker, it’s better to own defensive stocks.
  3. Make sure to always check the PMI as the change in sentiment should also means you need to switch from cyclicals to defensive and vice versa.

3. Oil Recovery

The third strategy that investors are looking at is betting on an oil recovery. After oil tumbled from above $100 to below $50 – a drop of more than 50% – investors are beginning to see oil as a bargain. Essentially, what investors look at is the fact that oil production in the US fell, and oil has fallen too far, too fast.

oil chart

Oil has fallen too far, too fast!

This has forced many oil giants to trade at a discount. Although one could also try to buy futures, the oil stock of a well-funded company could be less risky. One of the reasons is that oil companies can cut costs and pay dividends while oil is a bet on it rising higher or lower.

Among the best positioned and more financially stable are the two oil giants, Chevron and Exxon Mobile, both of which pay a high dividend and yet are positioned to gain if oil recovers. Take into account However, there are two things potential investors should take into account.

  1. First is that the journey towards higher oil stocks, although potentially lucrative, could be very jittery amid overall nervousness in the sector.
  2. And secondly, most analysts expect that once oil does recover to the level of between $70 and $80 a barrel, the rally is expected to end, so you’ll have to be quick to exit once the target is reached.

Action Items: 

  1. Google the biggest Oil companies in the world, make a list
  2. Focus on companies with stable earnings and a valuation of more than 30bln to make sure the company is safe and sound.
  3. Make sure the company is not operating in Russia, as this could mean more risk than you are willing to take.
  4. Divide your holdings between a few Oil stocks.
  5. Hold the stocks as long as Oil is higher than $50 and lower than $70

Oil Stocks: Chevron and Exxon Mobile.

4. High Growth Stocks

Unlike the previous strategies, the high growth approach is based on going from down to up. That is, rather than predict the growth of the economy and apply it to your stock choices, you examine the growth of the company itself to determine which stock is worth buying.

The idea behind this strategy is to identify which stock is cheap relative to its growth, rather than relative to its current earnings.

For investors, this takes shape in something called the PEG ratio (price/earnings to growth ratio). PEG is calculated by taking the P/E ratio, which is the stock’s price divided by its earnings, and then dividing it by the average earnings growth rate of the company.

PEG ratio < 1 – discount relative to its growth

If the PEG ratio is under one, the stock is trading at a discount relative to its growth. And before you begin to scratch your head, you don’t need to worry because a PEG ratio for each stock can be found on most financial news sites, such as Yahoo Finance.

Which stocks are not priced in for their rate of growth?

Surprisingly, it’s not those of small stocks. In fact, the world’s most valuable company, Apple, was trading with a PEG ratio of less than one not so long ago. At the moment, it’s giants such as Ford and Avis, the car rental company, that have a PEG ratio lower than 1. So when you think of a growth stock, you may find high growth in the large companies as well as the small.

Action Items:

  1. Google stocks with PEG under 1,make a list
  2. Open the stock’s page on yahoo finance and click Key statistics, the PEG ratio will be among the figures presented.
  3. Check the stocks’ PEG ratio and validate that it is below 1 but higher than 0.
  4. Check the market capitalization through Yahoo finance(appears on the stock’s page).
  5. Filter out companies with a market capitalization of less than $10Bln as they are risky.
  6. Go to the income statement on the stock’s yahoo page and make sure the revenue is steadly rising in the past few years.
  7. The lists of stocks you are left with are likely to be high quality high growth stocks and are worth buying if that’s your chosen strategy.

Stocks with a positive PEG but under 1: Deutsche Bank AG, Ford Motors.

Bottom right column, Yahoo! Finance (Ford Motors Co. (F))

Ford stats Yahoo!

5. Dividend Yield

Today, investors are used to buying and selling at the click of a button, with most relying on the price fluctuation of the stock. But until the 1970s, it was very common to buy stocks for their dividend.

Dividend – company distributes cash to stock holders

A dividend is basically when a company, usually with a strong cash flow, decides to distribute some of its earnings in cash to stock holders. If you decide to hold the stock just for its dividend, you can ignore the stock fluctuations and enjoy a steady payment of dividends.

Of course, there’s the risk of the company lowering its dividend or the stock falling sharply, but if sufficiently capitalized, this strategy can prove lucrative. However, there is another element that makes stocks with a good dividend yield worth holding. The fact that an investor can expect a cash payment in every quarter, or at least at year end, tends to limit the stock’s downside – after all, the lower the stock, the better the yield from the dividend.

For example, if share a trades at $100 and the dividend is $5, the yield is 5% a year. But if the stock now trades at $50, the dividend yield is now 10%, making it more attractive to buy. For a stock to be a good dividend payer, the company must have a good, firm cash flow, a steady or rising dividend over the years, and preferably be a large company in size.

Although this strategy of basing investments on dividends goes way back, it is still widely used.

Which stocks are good dividend yielders?

AT&T, the telecommunications giant, currently has a dividend yield of 5.60% – Lockheed Martin, the security and aerospace company, has a yield of 3.21% – McDonald’s, the world’s largest hamburger chain, has a yield of 3.54%.

Action Items: 

  1. Google large cap stocks with high dividend yields. Large cap is the slang for large companies and will allow you to filter out smaller and more risky companies. Make a list.
  2. Go to Cash flow on the stock’s yahoo page and make sure the cash flow is positive and at least steady. As long as its cash flow is not negative nor on a decline your fine. Filter out those that don’t fit.
  3. On the yahoo stock page you can see the dividend yield, a yield higher than 3% is good.
  4. Chose the stocks with the highest dividend yield left in the list after all the filters.

Stocks with a high dividend yield: AT&T, Lockheed Martin, and McDonald’s.

AT&T Yields

6. Credit Growth

This strategy belongs to the group of top-down strategies, taking into account what happens on a macro scale and using it to pick stock.

The idea of credit growth is simple – it focuses on financials, and the idea is to invest in banks or other financial institutions that are in a region where credit is growing. After all, banks really gain from providing loans to individuals and businesses. As credit in the market is expanding, banks gain more, and therefore their stock tends to gain, too.

What causes credit in the economy to expand? Low rates and, to an even larger extent, quantitative easing (QE), which is effectively when a central bank prints money to stimulate credit.

About QE

Back in 2008 and until 2014, the US Federal Reserve was engaged in a massive program of quantitative easing; in March 2009, the Fed’s QE was beginning to take effect and banking stocks surged. JP Morgan surged by 168% until the last year, and Citi gained an eye-popping 224% in the same period. All on the back of massive credit growth.

City vs. JPM
Source: Google Finance

Quantitative easing has now ended in the US, only to begin on a massive scale on the other side of the planet, in the Eurozone (and in Japan, too).

So what do investors do? They follow the money!

Now that credit is expected to grow in Europe, investors are eyeing banks such as the

  • Spanish Santander
  • Deutsche Bank – the largest German bank in terms of assets
  • Barclays, the UK banking giant, which is highly integrated into the Eurozone banking system

Of course, many European banks are facing headwinds from the prolonged weakness in the region, and from regulatory fines, but this was also the case for US banks in 2009, which is why many investors might shrug off the temporary weakness and flow their money into credit growth and European banks.

Action Items:

  1. Google most capitalized banks in Europe, make a list.
  2. On the stock’s Yahoo page check for banks with a P/E higher than 13 and higher than 7, and filter those out.
  3. Hold as long as the EURUSD is under 1.3, since above that level the Eurozone economy and credit growth could begin to slow again.

Banking Stocks in the Eurozone set to grow: Deutsche Bank, Banco Santander and Barclays.

7. Ride the Dragon

This final strategy is based on following China. China is not only the world’s second largest economy but it also has an acute impact on commodities and on various other countries’ economies, such as Australia, New Zealand and Japan. Because China is so big and so dynamic in its growth, if it grows faster or slower, it has the power to determine trends throughout the region, especially in the aforementioned economies.

If we can figure out where China’s economy is heading, we can use that to decide how to invest in China-oriented trades.

So where is China’s economy going?

Although there is a reasonable slack in the economy, many expect more stimulus to come from the government, whether it’s through spending or through more rate cuts by the Chinese central bank, the PBoC. On the back of the expected stimulus, stocks in Shanghai and Hong Kong have surged, with indices outperforming most of their peers in the rest of the world.

What should we make of this?

Well, some China-oriented stocks, which are not in Hong Kong or China, might be undervalued, despite their exposure to the Chinese dragon – the ASX 200, for instance, which comprises the 200 largest companies in Australia, from mines to real estate to banks.

With China being the largest trading partner of Australia, and the main driver of growth, one would expect a surge in the ASX 200 as well, but the Australian index has lagged and massively underperformed in comparison to China’s rally. This might mean that if we were to follow the dragon and its effect on Australia, then the ASX 200 is set to rally and catch up with indices in Shanghai and Hong Kong.

Moreover, with the Reserve Bank of Australia recently slashing interest rates to a record low, the case for the ASX 200 is even stronger, making it the perfect way to ride the dragon to profit.

Action Items: 

  1. Focus on stocks in the Australian stock market or the ASX200 index as a whole.
  2. Stocks must be from the mining sector unless you are buying the ASX200 index to reduce your risk
  3. If you buy stocks not the ASX200 filter out companies with a market capitalization below $20Bln to reduce risk.
  4. Filter out stocks with a P/E higher than 13 and lower than 7 , as a P/E lower than 7 could signal problems in the company.
  5. Google China Manufacturing PMI, as long as it’s above 50 the trend should hold.

Stocks and Indices Oriented to China: ASX200, Rio Tinto, BHP Billiton.

Our Favorites

Each of these seven strategies has the potential to provide good results and allow you to beat the market but, as always, they also carry risk.

Before selecting an investment strategy, you must decide how much you are willing to risk.

For example, buying an index is safer than buying a single stock, and buying an oil company, when oil is still going through a shaky recovery, is not for the faint-hearted. Therefore, you need to decide what you are willing to risk and how comfortable you are with uncertainty. Although all seven might be profitable, our two favorites are:

1. The high dividend strategy, which points to some undervalued stocks that have suffered from negative sentiment, such as AT&T.

ATT dividend yield strategy

2. Follow the dragon and the ASX 200 index, because the index is undervalued and the macroeconomics environment is gradually becoming more favorable.

Ride the dragon

Moreover, as we’ve explained, an index tends to be safer than stocks, so if it is set to outperform, it would be a good choice. As seen in the two charts below, the trend has already begun for the ASX 200, while the high yielding stock of AT&T has yet to begin its momentum.

Out of the seven strategies, will those two be the ones that outperform?

Time will tell! With all seven strategies under your belt, you have a good indication of what investors are looking at and how you can leverage that knowledge for your own personal portfolio.

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