Stock markets today are probably the most booming business in the world, which do not seem to go out of fashion anytime soon around the money makers. Every year, a huge number of people try their luck on the stock charts to excel stock market returns, some of whom do bloom while others relying on mere hit and trial do not. On the other hand, serious advanced investors follow a set of well-defined principles to make profits and use various investment strategies to increase their stock market returns. This article shall discuss some of the best ways to increase stock market returns.
Look before you leap:
“Go for a business that any idiot can run, because sooner or later, an idiot is going to run it”
The investment strategy for ensuring an appreciable amount of stock market return is investing wisely in the first place. Several indices for the reliability of stocks and their expected stock market returns are available for use by traders and must be consulted before making commitment to one particular company’s stocks. One such index is the Piotroski F-index, which ranks companies on the basis of their financial strengths. It is a popularly used index by investors.
According to the famous Wall Street business personality Peter Lynch, companies with a growth rate of more than 50% per year are termed as Fast-Growing companies. Such companies tend to be unstable and returns for such stocks are usually volatile in nature. Slow growing companies, on the other hand, are a safer choice. In his book “One Up the Wall Street”, he quotes a few of the scales and investment strategies that he used to rank companies such as percent of sales, Price to earnings ratio, PEG ratio, debt to equity ratio scale, etc.
Peter Lynch, as the manager of the Magellan Fund, used the investment strategy to look for smaller companies that were generally overlooked by other Wall Street mutual fund managers because of the growth potential of such companies being more than the investment giants that are generally preferred by mutual funds. Such investment strategy of looking for smaller companies is also applicable on a personal level.
The Magic Formula:
Joel Greenblatt boasts of the success of his investment strategy named “Magic Formula” for value investing in his book “The Little Book That Beats the Market”. He suggests to make a list of companies with low-priced stocks on the basis of their stock market returns on capital and earning yields. Of all the companies ranked in the list, the investor is suggested to buy stocks for the top few companies, and time the sale of the stocks around the end of the financial year and the start of the next one. For maximum stock market returns, this investment strategy is to be used for a period spanning from 5 years to a decade, including balancing the stock portfolio from time to time.
According to an experimental study conducted by the author himself, the Magic Formula produced a stock market return of 24% averaged for a time frame of study of 21 years. This investment strategy outperforms index funds by a significant figure, leaving behind the stock market returns offered by the highest stocks in the stock exchange index of various countries such as US, UK and China. A few tests on this investment strategy were also conducted by other third parties. The results, although a bit shy of those obtained by Joel, showed optimism in the stocks trade model that was offered.
Diversifying the Portfolio:
To not put all the eggs in one basket is the basic investment strategies advice given to all stock traders. Suffice to say, an investor is encouraged to buy shares for more than one stocks to create diversity in the portfolio. For this purpose, stable stocks such as commodities and services are preferred. On the other hand, there are stocks which undergo periodic rise and fall, described by Peter Lynch as “Cyclical Stocks”, the stock market returns of whom undergo cycle of boom and recession. Investment in stable companies along with such stocks is encouraged, as it tends to balance the stocks market return to investment ratio of the portfolio as a whole. For example, stock returns of manufacturers such as Nike and entertainment services groups such as Disney have undergone periods of recession in the span of their time on the stocks market. In such times of depression, diversifying the portfolio and investing at other places tends to improve stock returns.
The above shown graph illustrates the behavior of Nike Inc stock prices in the stock market, with the cycles of crests and troughs clearly visible. For a capital investment of a huge sum in such cyclical stocks, drastic changes in the portfolio equity can be generated. Thus, it is well-advised to couple such stocks with non-cyclical ones which have a fairly balanced variation over the years.
Investing in Defensive Stocks:
These stocks provide a fairly constant dividend regardless of the overall conditions of the stock market. This includes stocks of various companies such as those dealing with commodities such as food, energy and services, which remain stable throughout the cycles of crests and troughs of the stock market. As an extension of Peter Lynch’s investment strategy, these can also be termed as “non-cyclical stocks”. Investment in such defensive stocks leads to an increased stock market return even in times of recession. Various commodity conglomerates can be taken into account for such non-cyclical stocks. For example, PepsiCo recently has been trading recently at a stock price of at about $137.94 (as of 12/14/19) with a P/E ratio of 15.73 and Dividend yield at meager 2.77%.
Dividend Investment and Reinvestment Plans:
Dividend stocks are those which offer a fixed amount of returns to the buyer without considering the conditions of the stock market. Dividend stocks are a very safe investment because of the guarantee of fixed stock market return after a certain time period. Warren Buffet, the biggest stocks alchemist himself uses this investment strategy and has himself invested in dividend companies that make up to more than 40% of his own portfolio.
A dividend reinvestment plan is an investment strategy that offers the investor to reinvest his periodic stock market return from the dividend in the stocks. The dividend reinvestment plan saves the person from paying up additional charges in terms of commission for investment and compounding the time frame for investment along with the returns. In this investment strategy, the investors have the advantage of being offered a price lower than the market (up to 10% usually) and the stock market returns being exponentiated with the passage of time. As a long-term investment strategy, Dividend Reinvestment Plans are usually very popular.
- Covered Call – the shrewdest choice out there:
The best way to ensure the safety of the invested amount by a trader is investment strategy known as “Covered Call”. This strategy can be used to increase stock market returns, hinder the changes in volatile nature of stock prices and hence can be used to add stock return to low-paced value stocks, all the while protecting the losses in the case of a growth stock. Basically, a covered call is written by the owner of large-capital stocks that are put for sale on the market for investors. In case of anyone buying a covered call, the person is entitled to buy the stocks from the original owner at or before the ending of a predetermined time frame at a price that is also decided at the time of the purchase. In simple words for the layman, this is analogous to putting out the stocks at rent for anyone to occupy at a certain price, giving him the rights to buy it at a specified price. An investor can buy the stocks from the original owner when the prices of the stock hit a predetermined level, which is referred to as the “strike price”. This buyer can be a person who speculates a change (rise) in the price of the stock over a time frame and intends to buy it at that level.
It is often asked how this investment strategy benefits the stock market returns of both the stock holder and the investor for the call option. For the buyer, buying the option gives him the sole rights to gain possession of the stocks as he or she wills, giving him, in theory unchecked growth chance if the prices of the stock rise high. As of the stock holder, the call option is sold at a price higher than the original stock price, the difference being termed as “option price”. The Option Premium is the percentage of the original price payed by the investor buying the covered call option that is paid above the original stock price for buying the rights of selling the stocks at the strike price. The Option Price is the additional investment that can be used by the stock owner and thus additional revenue that is generated.
Being an advanced investment strategy, covered call is often used by the big players of the industry. For example, a case study shown by Madison Inc reveals the usage of this investment strategy by various firms such as Apple Inc. As of closing of stock market on 3rd July, 2016, the stock prices of Apple stood at $101.86. The Call Option was set at $106.95, which puts the Option Premium at 3.36%, with the Option price being at $3.42. After the completion of the financial year, the annualized performance stood at 12.1%, meaning that Apple Inc put out the covered call and used up the capital gained by selling the option to buyers to grow and increase its own stock returns.
In case of a slowly declining or receding market, covered calls perform extremely well as compared to not taking up this investment strategy, because the stock market revenues are compounded by the original dividends payed for the stock as well as the revenue generated from selling the calls.
Covered calls is probably the only investment strategy that is least associated with risks and losses, because selling the calls generates additional stocks revenue practically out of nowhere. Also, in case the buyer decides to take possession of the stocks, the Option Premium usually compensates for the loss. As a result, the ratio of ROI (Revenue of Income) to the original capital investment remains within the originally intended bounds.
As quoted from Morningstar, the covered calls for Ibbotson BXM and S&P 500 produced results that were similar to the original equity in cases of a volatile and unstable market.
- Investing in a Put Option:
In contrast to the Covered Call option, the buyers of a put option investment strategy have the entitlement to sell the stock at the strike price for a time frame up to the date of expiration. Just like the Covered Call Option, Put Option can be in, out or at the money, where “In” the money option means that the market price of the stock is held at a level lower than the strike price, “Out” of the money option means the strike price being at a higher level than the stock price in the market, while “At” the money option means that both the strike and the original market stock price are at the same level. It can thus be concluded that it is beneficial for the Put option buyer to sell the stocks at the “IN” situation, where he or she can obtain additional revenue from the stocks.
Although generating less stock market returns than the Covered Call option, the Put Option produces additional capital and helps to stabilize the ratio of Revenue of Investment and the original capital investment.
- Rebalancing the Portfolio:
Consider the above given pie-charts. For hypothesis, the pie on the left side represents the increase in the percentage of the equity in the portfolio of an investor at the end of a financial year. It is evident that stock returns annotated by the green region make up the 25% of the total equity residing in the portfolio while the blue region represents 70% of the equity. It is necessary to use the investment strategy of “rebalancing” the portfolio to maximize the profits and stock market returns, that is to reallocate the capital in the portfolio to stocks producing more amounts of stock market returns. Supposedly if the stock represented by green region is forecasted to produce lesser revenues as compared to its previous fiscal years and the stocks represented by blue are expected to show a boom, reallocation by removing capital from one stock to another can increase the return on investments and save from losses.
The above described graph shows the effect of the investment strategy of rebalancing as noted by J.P. Morgan Asset Management. An exercise of rebalancing annually improved the capital volume up to 60%, as compared to not partaking the exercise.To conclude, stocks operations require various investment strategies for increasing the stock market returns and ROI values. It is thus necessary to invest wisely in the first place, patiently wait for the results, rebalancing the portfolio and making strategic use of options such as call and put. The wise investment strategist and stocks trader knows when and where to look for and get rid of the proper stocks for maximized stock market returns.