Investing in securities involves a risk of loss that clients should be prepared to bear.
At CFS, we have a great respect for the general trend of the market as a whole. So we always begin with a look at how the S&P500, the NASDAQ, and the Dow Jones Industrial average are performing. During general uptrends, we tend to be fully invested. In general downtrends, or during periods of high market volatility, we tend to hold higher levels of cash.
Then we look at the general direction of all market segments. We do this by monitoring indexes for these market segments, and the performance of ETFs and mutual funds which focus on particular market segments.
We then use Fundamental Analysis techniques to form the universe of stocks, bonds, ETFs, and mutual funds from which we select securities to purchase. We select stocks with good track records of performance which show evidence of having a solid, capable management team and good business fundamentals. For all stocks in our universe, we monitor price-to-earnings ratios, daily changes in price and volume, yields, and dividend payouts. We use this information to determine which stocks to purchase.
But fundamental analysis, taken alone, examines only the past performance of a company. There is no guarantee that this performance will repeat. We are looking in the rear-view mirror all of the time. And there can be a significant amount of time between when the stock is actually underperforming and when the data actually shows up in the stock fundamentals.
We then identify the better-performing stocks in the better-performing market segments and attempt to buy those securities at the best price-points. If those securities fail to meet expectations they are sold.
We use Technical Analysis techniques to make judgments on when to buy or sell any stock. For growth stocks and ETFs, our focus is on Relative Strength, and its trend, which we monitor regularly. But we also use many other indicators from the universe of indicators used regularly by market technicians.
But technical analysis, taken alone, only indicates current market action without taking into account the important fundamentals for the stock. It is mainly a measure of the non-logical emotional components associated with the stock and the overall market. It is also a measure of the hopes that other investors have for the future of the stock or the market. That future may, or may not, be realized.
For our growth stocks, we look for stocks and mutual funds with price appreciation rates which tend to outperform the S&P 500.
For income stocks, we look for a history of consistent and growing payouts of dividends together with price appreciation over time. We prefer stocks with dividend payout rates that exceed the dividend payout rates of the stocks in the S&P 500.
So, at CFS, our investment strategy has both a strategic and a tactical component. This is in contrast to strategies that are based upon Modern Portfolio Theory. Modern Portfolio Theory treats the stock market strategically as a totally random walk, focusing on asset allocation as the primary investment strategy. The emphasis is on long-term holding of stocks throughout market cycles.
At CFS, although strategic elements are present in our decision process, we emphasize a tactical active management approach which deals with the markets and the overall economic conditions as they currently are rather than how we forecast them to be. This allows us to deal with the components of the stock market which are not random, but instead have a cyclical component. Some of these cycles are familiar to most investors: the Business Cycle, the Interest Rate Cycle, the Presidential Cycle, and Elliott Waves. It is important to note that none of these cycles would be observable if the market were only a set of totally random events.
However, we do use elements of Modern Portfolio Theory to help evaluate risk. We measure the standard deviation of stock prices and compare it with their price appreciation rate to measure a reward-to-risk metric for all stocks in our investment universe.
And, finally, as the market experiences sector rotation over longer periods of time, we actively adjust our portfolio accordingly.