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Long Equity

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The goal of long equity strategies is to earn profit from either price appreciation or dividends. Both of these earnings can come from income, growth, or value shares, but you should select shares depending on which fit your portfolio’s orientation towards risk, return, and liquidity needs. The strategy for long equities changes specifically on the share type being selected. You should have a general idea what you are seeking in each investment.

If you purchase long equity, your analysis needs to reflect possibilities for capital appreciation or dividends. Using ratios and fundamental indicators will alert you to purchase each share type: Growth, Value, or Income shares. A portfolio should never consist of only one type, but feature a division of all three. The favored share type should be the majority within the three categories.

In each case, it is better to select solid firms with depressed market prices. Purchasing great firms at lower share values increases potential long term return and decreases risk of losses. Overvalued or price inflated shares are more likely to suffer price decreases. If these shares maintain good fundamentals they can reverse their depressed pricing over the long term. You will earn growth from share recovery and the long term performance afterwards. Investing contrarily to the market by purchasing shares when others are selling together can set you up for profit, but only if the firm’s fundamental abilities are not impaired. Bear markets and crashes are great for providing you with future opportunities, especially if the reasoning behind them is disconnected completely from firm fundamentals like geo-political events. They deliver great chances for you to purchase shares below intrinsic and discount values.

Selecting Growth Shares

If you desire a portfolio of equities that rapidly accumulates capital gains, select growth shares. Growth Shares are poised to grow rapidly but have moderate risk. This risk is due to their vulnerable size: They typically are small to middle capitalizations, and rarely come in large capitalizations. Mega capitalization firms are too large and typically capped out their growth potential.

Start with revenue growth and market share. Compare these to direct competitors. Growth rate should be higher than industry average or most competitors for several years in a row. They must also be highly likely to provide sustained growth in the future. Look for expanding market share and revenue growth.

There is a healthy amount of turnover ratios that can help you. High or increasing Asset Turnover helps firms earn increased profit from each asset, fueling growth and reinvestment. Accounts Receivable Turnover indicates the speed debts owed by others are received. Cash flows into the business quicker for paying debts, solving problems, and reinvestment. Inventory turnover is the speed a firm sells its inventory. Higher numbers mean quicker inventory clearance, displaying the increased sales needed for growth. Note: A firm can sell their inventory at a discount which results in raising turnover without growing their actual revenue.

Specific profitability ratios also assist with finding growth shares. Return on assets is best at a moderate level for growth firms. If too low the share isn’t growing enough profit to reinvest comfortably, but if return on assets is too high the firm is not fully investing in its future. Return on assets functions the same as margins. If the firm saves money damaging its growing brand’s reputation with poor quality products it will suffer in the long run. Operating and Retained earnings margin are useless if they damage the brand, but they should still allow for reinvestment growing revenue and capabilities.

Retained profit per share should be a multiple of dividends per share, indicating net income is going back into the company. The majority of funds need to be reinvested into the company to grow it for the future. Dividend Cover is the amount of times a firm could pay its dividend. If reinvesting almost all of its profit this should be middle single digits or above.

A growth firm needs to have enough debt to boost earnings without financing costs suppressing the firm’s ability to reinvest. Take a look at the firm’s interest cover. If this number is below two, or close to it a downturn could make life very stressful for the investment. Growth firms need some cushion for their errors.

Selecting Value Shares

If you desire an investment with moderate growth but fairly low risk and stability, look for value shares. These shares are priced below their intrinsic value due to many potential reasons. Your goal is finding firms which will provide stable future growth below their actual valuation. You can use multiple valuation models to identify the price of the share. The various possibilities for valuing an investment includes the Dividend Discount Model, Discount Cash Flow Model, Adjusted Present Value, and various others. The firm should be below or within range of intrinsic value for investment to occur.

The firm must not be below value due to permanent or unrecoverable damage. It should be able to recover during your expected holding period. Value firms are usually mature firms which can outlast most temporary problems. A price loss can be due to a few things, but not all of them at once. A loss can be due to the following failures, all of which are recoverable:

Failure to meet estimates

  • Downturns in economy or industry
  • Negative press
  • Poor reviews about non-essential products
  • Negative analyst projections
  • A credit rating downgrade

A firm’s depressed pricing should not be due to negative fundamental changes from which they cannot recover. This is a judgment call, to some degree. Not all of these things will permanently doom a firm, but many of them will if they become long term problems. Examples are:

  • Losing substantial customer base or market share
  • Default
  • Approaching bankruptcy
  • Most cases of fraudulence
  • Technological or market trends rendering the firm irrelevant
  • Negative press of crucial product lines
  • Product issues with crucial product lines
  • Analyst downgrades due to fundamental issues
  • Long term decreases in crucial fundamentals

These long term trends could include:

  • Some combinations of declining revenues,
  • Increasing expenses,
  • Increasing debt as a percentage of earnings.

In these cases, especially if multiple, you should wait to see how the firm will counter the problem before investing. Do not invest simply because market price is below intrinsic value.

Selecting Income Shares

If you desire to build liquid income you should use income shares. Picking these equities provides higher cash dividend yields. When you are shopping for these shares you need to pick solid fundamental firms with high after expense liquidity.

Long term stability is absolutely essential, and your analysis of these shares should account for that benefit. Your firms need to have stable earnings, stable expense ratios, and low reinvestment needs. This typically results in large or mega capitalization firms, but any firm selected at any capitalization needs fundamentals which indicate they will remain capable of paying dividends.

You should avoid trends of falling sales, market shares, rising costs, and rising debts. These can result in dividend cancelation or reduction. Avoiding them is absolutely essential. Lastly, if dividends are stable over the long term but the market price itself is volatile, it is better to purchase shares closer to historical lows. Purchasing shares at lower prices results in higher dividend yields, delivering more income as a percentage of money spent.

Long Equity: Transaction Orders

There are many orders which are useful specifically for long equity trades. These assist in preventing losses and executing desired trades at specific values. These three orders specifically protect you from mistakes and errors many other people forget to make in the market in relation to valuation based strategies.

The purchase limit order will automatically buy shares priced below a set point. This is extremely useful for when you are seeking purchase shares below a set value. Since you should purchase solid shares below a specific price, it is best used to automatically purchase shares falling below intrinsic or discounted values.

The sale limit order will automatically sell shares which are priced above a set point. You can lock in gains by selling shares above a set value level by using sale limit orders. The downside to these orders is missing all potential gains after the set point if price continues rising. If the price spikes to or above that point, and then fell, the gains would be secured even if you personally missed the timing for the sale.

The sell-stop order automatically sells shares at specific price below the market price. If the price falls to this price, the shares are automatically sold to prevent further loss. This avoids all future losses beyond that price, but cancels the possibility of you recuperating losses from the share if it moves upwards. This can also be used very effectively as a trailer. As the share’s price increases over time, raising the sell-stop closer to the new price will help prevent decreases that would erase previous gains.

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  • Federal Reserve Mandate versus Expectations
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  • Economically Correlated U.S Dollar Projections
  • Large Trading Fund Index Sentiment Readings
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  • Fundamental Ranking of U.S Business Sectors
  • Best and Worst Future Consensus Estimates
  • Occasional: Firm Fundamental Strength Report
  • List of Technicals to Look for While Trading

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