Article written by Jennifer Black and Dedicated Financial Solutions.
How do fund managers earn their fee?
You like a name brand detergent but you feel it is expensive. Therefore, when it is reduced in price, you stock up. You don’t want to ever pay the regular retail price, but you think it does a better job than the generic brands.
That is what one of our fund managers does when he buys businesses. He may have a business that he would like to buy because of its low debt, increasing earnings, large market share and great business model. He feels it is a better, more valuable business than most, however, if the company’s stock is trading at a premium, our manager won’t buy it yet. He will watch and wait for a sale. He may have to wait for a year or two, but usually some negative news will cause the stock to drop in price to where he feels there is significant upside potential. Then he starts to buy.
How does he know if the stock is trading at a premium? He and his team value each company they are interested in by studying the company’s financial statements, etc. There is no guess work involved. They calculate the value of the business several different ways including using the revenue stream, the net income, and the assets minus liabilities.
What if he purchases the stock and it goes down further in price? For a stock that is volatile, the manager is able to play “day trader”, selling some of the stock when it goes up in price followed by purchasing more each time it falls. This lowers the cost base which will increase the capital gain when they sell.
If it is a great business, why does the manager care what he pays for it? He wants to reduce his downside risk. If he purchases the stock at full price, the stock price could fall more in a negative environment. Stock prices of good companies, with great earnings, can still fall when there is negative news or people are feeling pessimistic. Because the stock market values each stock every day, current news causes prices to fluctuate. Do you think the real value of a company changes that much from day to day?
Using some of these techniques, a mutual fund can consistently outperform the market.
Is your portfolio consistently outperforming the market? For a 2nd opinion and complete portfolio analysis contact us today.