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

Popular posts from this blog

Sound Advice: July 8, 2020

Jobs Are Up, But So Are New Infections Through the spring months, m ost of the economic data was extremely negative, with record declines in employment and consumer spending.  The speed of that decline had no modern precedent. We are now in a recession.   The shortest recession on record occurred in 1980 and lasted just six months.  Second place goes to a seven-month recession in 1918-19, which was tied to the Spanish flu pandemic.  The big question is: When will this recession end? Given surprisingly strong data in May, April may have been the bottom of this economic cycle.  If so, it will have been the shortest recession on record.  With massive support from the Federal Reserve, the federal government, and the reopening of previously closed businesses, employment surged unexpectedly.  At the same time, pent-up demand, stimulus checks, and generous unemployment benefits led to a reacceleration of commercial activity. Still, not all is rosy.   In his recent testimo

Sound Advice: December 13, 2023

What You Need To Know About Long-Term Care Insurance Long-term care insurance (LTCI) is a type of insurance that helps cover the costs of long-term care services, such as assistance with activities of daily living (ADLs) such as bathing, dressing, and eating. It can also cover the expenses associated with care in a nursing home, assisted living facility or at home by a professional caregiver. Here's what you need to know about long-term care insurance: 1. Not Covered by Health Insurance or Medicare: Long-term care services are generally not covered by health insurance or Medicare, which only provide limited coverage for skilled nursing care and rehabilitative services. Medicaid covers long-term care, but you need to meet strict income and asset requirements. 2. Costs of Long-Term Care: Long-term care can be expensive and can quickly deplete your savings. LTCI helps to cover these costs, providing financial security and ens

Sound Advice: December 27, 2023

“Well, we have a whole new year ahead of us. And wouldn’t it be wonderful if we could all be a little more gentle with each other, a little more loving, and have a little more empathy, and maybe, next year at this time we’d like each other a little more.” ― Judy Garland   N. Russell Wayne, CFP Sound Asset Management Inc. Weston, CT  06883 203-895-8877 www.soundasset.blogspot.com