Money: Common sense is the winning formula

A beginners guide to Investing In Shares: The Holy Grail of a market theory can become a poisoned chalice, writes Magnus Grimond
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Investing in shares can be hugely time-consuming. Some people get hooked on the newspapers' business pages, annual reports and electronic forms of information. But these are a minority; most of us do not have the time, energy or inclination to pore over performance details or share prices. Yet we still want the higher returns shares can offer.

Perhaps not surprisingly, there are plenty of people working on our case. Much time and effort has gone into the search for the Holy Grail of an investment formula that gives maximum returns from individual shares for minimum effort. The results have been mixed, at best, and have probably generated more income for those peddling the theories than those using them.

At one extreme, these can involve the close scrutiny of graphs and charts of price movements used by "chartists", much as astrologers use the stars. Whether shares move in set patterns, forming "double top" or "head and shoulders" formations, remains hotly debated. Chartists certainly believe their graphs can help them predict price movements. There is no doubt shares do often move in patterns, meeting "resistance levels" at a certain price that can prove to be a barrier after a rise or a support after a fall. But mulling over the required data is a full-time job, so chartist theories are of little use to "leave-and-forget" investors.

There are plenty of more accessible methods. One, briefly popular two or three years ago, particularly with personal equity plan (PEP) holders, was a system based on the "O'Higgins principle". Using research involving the US Dow Jones Industrial Average index, Michael O'Higgins, an American investment manager, showed that you could consistently beat the market by picking the five shares with the lowest price in actual dollars and cents from those with the 10 highest dividend yields. Performance calculations back to the early 1970s appeared to show it would have worked well here, spurring the launch of several PEP-linked investment products.

The reality has been somewhat mixed. The four O'Higgins-based "Podium" PEPs launched by brokers Bell Lawrie White have produced at best a return of 26 per cent in just under a year and at worst a loss of 4 per cent in 18 months. That compares with equivalent growth of around 25 per cent and 30 per cent respectively for the FT-SE 100 index. Johnson Fry's Hy1 portfolio, which picks just one company, has been even more erratic, producing a range stretching from a 100 per cent underperformance to an 87 per cent outperformance. And many of Johnson Fry's Hy5 investors (investments in five shares) will have been disappointed to date.

Mr O'Higgins is said to be distancing himself from his invention, and Bell Lawrie and Johnson Fry admit that the so-called "value" stocks the system throws up (the likes of the old British Gas, Hanson and BTR) have not been favourites with the stock market recently. They emphasise the need to view this as a five-year commitment at least.

One investment method in much better odour with advisers is that popularised by Jim Slater of Slater Walker notoriety - the investment company collapsed in the 1970s. The unit trust run by Mr Slater's son Mark, which uses the technique, was the top-performing unit trust of its peer group last year. The Johnson Fry Slater Growth Fund is also the top UK growth fund over three years, having comfortably doubled the value of investments in that period.

The Slater method is less a mechanical system and more a screening process for choosing growth shares. It is based on the principle that risk is reduced and performance more assured if a fast-growing company can be acquired cheaply. You may say that, if the market is working well, that should not be possible. But Slater uses a system known as PEGs - simply the forecast price-earnings ratio divided by expected earnings growth. With the stock market as a whole on a PEG of around 1.5, Mark Slater says: "I'm looking at PEGs of 0.7 or less. It may be a company on a p/e ratio of 15 growing at 20 to 30 per cent. I'm trying to buy growth cheaply as it gives a big margin of safety."

The results so far speak for themselves. However, the Slater approach still requires huge subjective judgement. Critics also question how well the process will work in a bear market or if growth shares fall out of favour.

One other formula method worth mentioning is "pound cost averaging". This involves investing a fixed amount of money on a regular, usually monthly, basis in a share, unit or investment trust.

The idea is that when the price rises, you buy fewer shares, limiting the risk of paying too much: when it falls you buy more, potentially increasing gains when things improve. The advantage is that you are not risking all on the timing. For regular savers in investment and unit trusts, this can make sense. But dealing costs may hamstring efforts with individual shares, and it can be a capital gains tax nightmare.

Don't expect marvels from any of these methods. The best need hard work and judgement. Others require years of patience and strong nerves. And listen to your common sense. If anybody really had a foolproof investment formula, why would they be using it to make us rich and not themselves?