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3 essential qualities to help you buy share market winners

Different investors will have different styles and place a different emphasis on qualitative or quantitative factors when making investment decisions.

For example the last decade has seen the rise of quantitative trading funds such as Applied Quantitative Research (AQR) that now has US$226 billion under management, some of which is sourced from Australian institutional investors.

Set up by a few former Goldman Sachs traders it applies almost nothing but quantitative analysis (algorithms and computer power) to trade shares and other asset classes in its investment funds.

While most share market investors will focus more on the qualitative factors of a business such as management, brand, and competitive strength – alongside factors that fall under the traditional quantitative umbrella such as yield or valuation.

Some ‘day traders’ will even try to just use charts to base trades on using price momentum or “the tape” (a historical concept that uses price direction and assumptions over supply and demand) as an indicator of likely movements.

This may provide guidance over the very short term (an hour or a day), but as charts are backward looking they cannot show anything about the medium term direction of forward-looking markets or share prices that move on future events.

By definition a chart reader or technical trader must look backwards to come to their trading conclusions (unless they’re guessing like a lot do) and as such they cannot have any insight into the direction of a stock over a longer period as the “trader” has no data to look at.

As such I’d give chart reading a miss unless you’re highly experienced, lucky, or a big enough player to absorb trading costs.

I’d look to these three factors in order of priority when coming to an investment decision.

  • Business quality. Is this a high-quality business with a brilliant product, attractive economics, growing profits, an outstanding track record, brilliant founder, or at least some of the above? If not the business is probably not worth your hard earned cash and not investment grade. So look elsewhere.
  • Management. Is the business founder led? Or if not, is it run by a management team focused on medium term shareholder returns with a good track record? A lot of businesses on the share market are run by management teams keener on enriching themselves than shareholders. This is not a big surprise as it’s human nature, but if a business is not founder led you need to be sure it’s being run on behalf of shareholders.
  • Valuation – some investors will describe themselves as ‘growth’ or ‘value investors’ but really growth and value are indivisible in terms of total returns and investing. A growth stock growing quickly will probably offer superior returns to a value stock with falling profits. Valuation is important, but don’t fall into the trap of looking for value stocks before the imperatives of business quality and management.

Investing is not rocket science, although many investors will feel it’s too complex (risky) to do themselves, or over complicate it in thinking it’s akin to rocket science.

If you just focus on the above three factors I expect you will beat the market’s returns that are commonly held back by perennial under-performers that you will probably exclude if you just avoid businesses with poor track records.

A racehorse that hasn’t won a race its entire career may look attractive odds to the untrained observer, but you’re more likely to make money backing the proven winners.

Some stocks on the local market I don’t currently own, but with impressive track records include the likes of Carsales.Com Ltd (ASX: CAR), Fisher & Paykel Healthcare Corp Ltd (ASX: FPH) or Sydney Airport Holdings Pty Ltd (ASX: SYD).

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Motley Fool contributor Tom Richardson has no position in any of the stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited. The Motley Fool Australia has recommended carsales.com Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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