Skip to main content

Sound Advice: December 16, 2020

 SEEING THE FUTURE: Sunny, with occasional clouds

Estimating earnings (the prime determinant of stock prices) can be a fascinating task, especially if there’s a substantial basis for making such estimates. Some analysts develop their numbers starting from an overall economic and industry perspective. Others build their numbers from the bottom up. 

Either way, the critical factor when considering estimates of earnings is the level of confidence in the numbers. The level of confidence is indicated by the Coefficient Variance, a technical term that measures the dispersion of estimates. If, for example, the mean of all analysts’ earnings estimates is $2.00 a share, with a low of $1.00 and a high of $3.00, that’s a wide dispersion and the Coefficient Variance will be high, probably 5.00 or greater. In such a case, it seems as if everyone’s guessing, since there’s little agreement on what the number will be. In contrast, when the mean is $2.00, with a low of $1.90 and a high of $2.10, that’s a narrow dispersion and the Coefficient Variance will be low, probably 2.00 or under.

This is a simple enough concept. If the CV is low, the perceived risk of an earnings disappointment is low and investors will look more favorably and pay more for a stock.


Free cash flow is another important factor. A company that is generating and keeping more of the cash that it is generating is in much better shape financially to move ahead than one strapped for funds and always scratching about for the wherewithal to keep its balance sheet on an even keel.

The trend in profit margins is another important indicator. Ideally, one would want to see profit margins widening over time, as fixed costs become a steadily lower proportion of company overhead. This is a reasonable expectation for smaller and midsized companies, but it becomes less doable with companies that are mature. A useful comparison is current pretax profit margins with the average of the past five years. Those able to show advances are worthy of consideration.

Although I find little credibility in what purports to be technical analysis, it would be unwise to totally ignore the trend in stock prices. If the fundamentals appear strong, but the stock price is plunging, there may be a problem. One part of the equation may be wrong and on occasion the fundamental view may be flawed. 

A simple method for reducing error exposure is to view the relative strength of candidates being considered for purchase and assigning them to quintiles. Thus, relative strength of 80 to 100 would be the top quintile, 60 to 79 would be the second quintile, and so on. Once the quintiles are assigned, only those in the top two quintiles would be considered for purchase. Those in the middle quintile could be held. Those in the bottom two quintiles would not be considered for purchase and should be sold, if held.

N. Russell Wayne, CFP®

Questions?  Please contact me at nrwayne@soundasset.com

Sound Asset Management Inc.

Weston, CT  06883

203-222-9370

www.soundasset.com

www.soundasset.blogspot.com

 

 

 

Comments

Post a Comment

Popular posts from this blog

Sound Advice: January 3, 2025

2025 Market Forecasts: Stupidity Taken To An Extreme   If you know anything about stock market performance, you can only gag at the nonsense “esteemed forecasters” are now putting forth about the prospective path of stocks in the year ahead.   Our cousins in the UK would call this rubbish.   I would not be as kind. Leading the Ship of Fools is the forecast from the Chief Investment Strategist at Oppenheimer who is looking for a year-end 2025 level for the Standard & Poor’s Index of 7,100, a whopping 21% increase from the most recent standing.   Indeed, most of these folks are looking for double-digit gains.   Only two expect stocks to weaken. In the last 30 years, the market has risen by more than 20% only 15 times.   The exceptional span during that time was 1996-1999, which accounted for four of those jumps.   What followed in 2000 through 2002 was the polar opposite: 2000:      -9.1% 2001:     -11.9% ...
Post a Comment
Read more

Sound Advice: March 10, 2021

The ABCs of Stock Picking After decades of analyzing stocks (and funds) and investing for clients, I'm happy to share in plain English what's involved, what works, and what doesn't.  Keep in mind the reality that successful stock picking is an effort to maintain a good batting average. In baseball, a batting average of .300 or better is considered quite good.  With stock picking, you need to do better than .600, which means you have many more winners than losers. No one gets it right all of the time.  It's not even close.  Wall Street shops all have their recommended lists and the financial media regularly hawk 10 stocks to buy now. Following that road usually is a direct route to disaster.  Don't be tempted. Let's begin with the big picture: The stock market goes up and down over time, but the long-term trend is up.  When there's a rally under way, everyone feels like a genius.  When the market hits an air pocket, though, with few exception...
Post a Comment
Read more

Sound Advice: June 17, 2020

Rock and a Hard Place Regardless of your age, impressions from childhood linger.  As the first days of summer approach, we all remember the feeling that accompanied the end of a school year.  Yet as much as many of us would like to believe we again have the summertime freedom to do as we wish, the reality is quite the opposite. Although months of confinement and limitations on social interaction have increased our personal discomfort and severely impacted the business community, our current situation is not analogous to the end of any school year.  It’s quite the opposite. There is every reason to continue wearing face masks, social distancing, and avoiding close contact with others.  Nothing suggests that we can modify our behavior significantly or resume patterns of daily living we enjoyed only a few months ago. There are no meaningful advances in medical treatments.  At best, there are attempts to combine different approaches...
Post a Comment
Read more