Grade
9 -12 Winner
Student: Braxton G
Teacher: Daniel Adler
School: Polytechnic
High
Location: Long Beach, CA
Question
When making
decisions about investing during The Stock Market Game, what are the five most
important items you should research before buying a stock, bond or mutual fund?
Choose an investment and explain how your research led you to select that
investment based on your choice of one of the following:
1. Shorter
term / Higher risk
2. Longer
term / Lower risk
Given your current saving goals and using your research strategy,
if you were making a “real world” investment, what percentage of your current
portfolio would you place in this kind of investment and why?
Essay
The ability to analyze a company’s
product offerings, financial statistics, and place within its market has become
ever more important to investors looking to make a long-term investment. Even
with the daily mood swings of Europe, China, and U.S., top market analysts are
able to decipher profitable long-term investments for their clients through a
variety of methods. These five strategies include competition and market share,
relative future growth valuations, analysis of moving averages, cash flow
statements, and executive leadership. The company that best exemplifies these
methods is Nike, a stable and profitable long term future investment.
The first stage is investigating
sector competition. In a company such as Nike, there are multiple opponents:
Adidas, Sketchers, Under Armor, and K-Swiss. This has caused Nike to innovate
and use non-price competition. As a result, Nike has successfully dominated the
market place with a 60% share in the U.S. basketball market and an even more
impressive 35% share in the European soccer market over German producer Adidas.
Overall investigation into a company’s competition and relative market share is
vital to determining the ultimate success of an equity. The opportunity for
large long-term return rests upon strength and dominance in a stock’s sector.
The second key component to
researching an equity lies in the analysis of its prospective growth
projections. Arguably the most important statistic is the Price/Earnings to
Growth (PEG) ratio. Unlike the standard Price/Earnings (PE) ratio, the PEG
ratio normalizes a company’s valuation by offsetting for a company’s estimated
growth. A lower PEG ratio represents the equity as undervalued and therefore
seen as a solid long term investment. This ratio is beneficial in comparing
future growth valuations between companies within the same industry. The higher
stock price of Nike in relation to its competitors may deter some investors,
but research into its PEG ratio would conclude that it has a relatively low
ratio of 1.4 and therefore undervalued in contrast to its seemingly “expensive”
price.
Though considered a short term
technical methodology, trend analysis of a company’s medium to long term moving
averages is key to understanding buying opportunities. If considering an equity
purchase, research that shows a company trading below its 50-day moving average
is demonstrating a downtrend. Buying into a downtrend, even when planning to
hold for the long-term, presents a dangerous risk as market bears may continue
to push the stock lower; below its support levels. Nike has been trading
consistently above its 50-day and longer term 200-day moving averages for
almost two years.
Another crucial factor to a stock
investment is the company’s cash flow. Considered similar to the income
statement, the cash flow report is fundamentally more important. Positive cash
flow is crucial to project how a company will pay for operations and even more
importantly, future growth costs. Nike has reported positive operational cash
flow in each of the last four years while competitors such as Under Armor and
Sketchers have reported negative cash flows. Nike saw a 34% increase in net
cash balance in 2010 while shoe competitor Sketchers saw a 14% loss. Therefore,
cash flow bears great value.
The last and sometimes overlooked
necessity in researching a company is its executive leadership. Strength and
trust between the investor and executive is sometimes hard to achieve. Defined
by economists as the “principle-agent problem”, this issue lies in the fact
that at times the interests of the executives and shareholders collide. While
shareholders prefer dividends and long term profitability, executives prefer
bonuses based on short term performance. Nike balances these differences
perfectly. Management commits to the shareholders by providing them with a
consistently increasing dividend. Nike raised its dividend in each of the last
12 years; most recently in November by 16%. The overall mutual interests and
goals between the executives and investors at Nike has allowed for greater
cooperation and efficiency that projects an outstanding model for future profit
and returns.
Given current market values and continuing
worldwide economic volatility, I would place 60-70% of investments into longer
term, lower risk equities with high future returns, with strong holdings in
Nike. The company’s ability to stay profitable through difficult times, strong
fundamentals and opportunity for tremendous future growth outweigh any
short-term volatile risks.