Companies

So far, we’ve spent a lot of time talking about the potential downsides of investing in individual companies (lack of diversification, amount of research required, and emotions), but if you want to dive in, there are benefits! 

Let’s talk emotions again

We know a bit about passive Index Funds and the idea that people who actively pick shares can often wind up worse off than just letting the markets do their thing. Well, on the other side, there are investors who strongly believe in the value of actively picking their own investments (or getting an expert to do it for them). The reason, once again, comes down to emotion.

Active investors (AKA people who believe in actively picking the shares they invest in) believe that as a whole, investors swing regularly between euphoria and pessimism. Euphoria leads to things like the dot.com bubble, where the price of shares in tech companies soared well above the actual value of the companies. At other times, the share markets have dropped in value by 25% or more IN ONE DAY, which means they were either very overvalued the day before or have just become very undervalued. Given the underlying value of companies listed on the share markets don’t usually change much from one day to the next, neither option can be attributed to a bunch of investors making logical, rational decisions.

Emotion = opportunity (or does it?)

Active investors believe share prices don’t always reflect their true value. They use various calculations and research to decide on what they think a company is worth, then decide if the share price is lower than what it’s worth.

Value investors look for companies that are undervalued.

These investors believe that for whatever reason, companies often fall out of favour. Investors (aka ‘the market’) overreact to good and bad news, resulting in share prices that don’t represent a company's long-term value.

Fun Fact: Warren Buffet is probably the best known value investor today.

Value investors think the share market is very similar to a big retail store, like Briscoes. You can go into Briscoes on any given day and get the exact same toaster, but often that toaster goes on sale. Depending on how you time your shopping spree, you get the exact same thing for less. Value investors believe a toaster is no different to shares.

There are a few common measures investors use to attempt to understand the true value of a company. They study financial performance as well as things like branding, business models, target market and the company’s competitive advantage.

Growth investors 

Growth investors look for companies that they think will grow in value the most. Many growth stocks are newer companies with innovative products that are expected to make a big impact in the future; the sorts of companies that revolutionise industries and the way we go about our daily lives.

Growth investing is considered highly attractive because investing in emerging companies can provide sweet sweet returns if the companies are successful. It’s also a strategy that doesn’t necessarily require delving into financial reports and analysis – you already have all the knowledge you need to pick stocks. Just look at your own habits and how they’ve changed… And more importantly, what companies have been active in changing them. Do you order in food? Watch TV online? Rent clothes? You know more than you think you do about mega trends that are shaping the world, and the companies at the forefront of them.

However, we already know that high rewards come hand in hand with higher risk, and often these companies have unproven track records and an unknown future. You may be as good as anyone else, but you still don’t have a crystal ball!

Income investors 

These investors have a different motivation than growth or value investors: they want to receive actual money every year from their investments (aka income). Income investors buy shares (and property, bonds and other things) that generate the highest possible annual income at the lowest possible risk.

With shares, the income comes in the form of dividends, which are typically paid out one or more times a year. Relying on dividends for income can be risky, since a company can decide at any time to stop paying them out.

Jargon alert! Dividends

Dividends are money that a company pays out regularly to its shareholders, usually out of its profits. Dividends can be paid out as new shares or cash, and often shareholders get to choose how they want dividends paid out to them. They are considered ‘passive income’ because it’s money landing in your account that you can live off without having to sell your underlying shares.

Investing for income is a slow and steady approach.

Traditionally, income investors aimed to live off their income, but if you are investing for the long term, it’s a good idea to reinvest your dividends to grow your investments; some companies allow you to automatically reinvest them, or you can just include them in your next trade.

However, dividends aren’t like interest on your savings accounts, and if you pick companies purely because of their previous dividends, you may be making the same mistake as investors who pick companies based on past performance. Many income investors also evaluate companies based on other criteria to ensure the dividends they receive are from solid companies.

There are many, many different factors to consider

Now for the bad news. We’re not going to tell you exactly how to analyse the value of a company. Why? Because there are a thousand different measures investors look at, and picking only a handful would lead you astray. It’s also important to be aware that no single or group of measures has been proven to accurately predict the future all the time.

Learn-by-doing is an option

A few new Hatch investors have started with a learn-by-doing strategy, where they take a small portion of their investments (i.e. around $200–300) and pick a company they know well, and believe will be more valuable in the future.