Yahoo Finance Focus on 5 Elements to Achieve Alpha
The Power of Compounding
Albert Einstein, often attributed as the most intelligent human to ever live, once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.” Investors and folks who have conducted their due diligence understand the importance of socking away capital into a retirement fund in a low-risk mutual fund or an equity index like the S&P 500 Index ETF (SPY). If one is to put a small portion of their paycheck away per year and simply let the world’s greatest stock market do its job, when it’s time to retire, they should have little in the way of financial concerns.
What is Alpha?
While all investors should have a “low-risk”, long-term plan, some more sophisticated and adventurous investors strive to achieve alpha in their investments. Alpha measures an assets relative performance compared to an index – most often the S&P 500 Index. In simpler terms, if an investment has outperformed the market, it has achieved positive alpha, and vice versa. For example, if the S&P 500 Index gains 10% in a year, and an investment or portfolio gains 20%, ten percentage points of positive alpha has been accomplished.
Below are 5 elements to consider when attempting to achieve alpha:
Bull Market
Because three in four stocks follow the market’s direction, the most crucial facet of any strategy is to be on the right side of the market, that is, trade in the same direction as the underlying trend. What investors use to size up the trend depends on time-frame; however, the best tool to use to gauge the long-term trend is the 200-day moving average on the S&P 500, the Nasdaq 100 ETF (QQQ), the Russell 2000 Index ETF (IWM), and the Dow Jones Industrial Average ETF (DIA). If the majority of these indexes are above the 200-day moving average, investors should be buying stocks.
Image Source: Zacks Investment Research
Top Industry Groups
To achieve outperformance, investors should focus on the top stocks within the top-ranked industry groups. Studies have shown that roughly half of a stocks’ price movement can be attributed to its underlying industry group. On average, the top 50% of Zacks Rank Industries outperforms the bottom 50% by a factor of 2 to one. You can find a stock’s industry rank on the quote page on Zacks.com.
Image Source: Zacks Investment Research
High-Growth & Strong Estimates
Stocks are forward-looking entities that gain momentum based on future earnings expectations. All else equal, investors should hone in on the companies that are growing the fastest and have the most rapid expected growth in the future.
Image Source: Zacks Investment Research
Relative Strength
“An object in motion tends to stay in motion” is a saying that parallels momentum stocks. The most straightforward way to achieve outperformance is to latch onto stocks already outperforming. One of the best ways to find the next stock to double is to look at the previous year’s list of stocks that doubled. For momentum investing, use a comparison chart to find stocks drastically outperforming their benchmark.
Image Source: Zacks Investment Research
Position Size
“Diversification is a protection against ignorance.” If you want to achieve super returns and outperform the market, your portfolio should not be spread too thin. Methodically pyramiding into quality stocks is the path to outperformance. Remember, if you have a 5% position in a stock and it doubles, your portfolio only gains 5%. How often do you find doubles? Furthermore, if you have too many positions, your portfolio becomes impossible to monitor and track.
Conclusion
Sophisticated and adventurous investors seek alpha – that is, outperformance. The five elements outlined in this article will put you on the pathway to investment outperformance.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Invesco QQQ (QQQ): ETF Research Reports
SPDR S&P 500 ETF (SPY): ETF Research Reports
SPDR Dow Jones Industrial Average ETF (DIA): ETF Research Reports
iShares Russell 2000 ETF (IWM): ETF Research Reports
