Skip to main content

Sound Advice: September 21, 2022

The Professional Approach To Stock Selection

There are various approaches to stock selection, but the two that predominate are fundamental analysis and technical analysis.  Fundamental analysis is a numbers-based method that evaluates key factors such as income and financial health, including the past, present, and future.  Technical analysis emphasizes movements and formations of stock prices.

Fundamental analysis is based on factors that over time have proved to have a meaningful impact on stock price movements.  The optimal picture of corporate profitability is steady growth, both in the past and, prospectively, in the coming years.  Steady growth is rewarded by higher valuations of underlying earning power than those accorded companies with erratic progress.

When professionals screen (filter) the data of the broad universe of stocks, they look for companies that move ahead every year, regardless of the prevailing economic conditions.  Although high past growth is no guarantee of what’s to come, it does tend to build greater confidence in where things are likely to go in the period ahead.

Growth companies are not the only ones worth considering.  Cyclical companies, those whose results reflect changes in the economy, may be interesting candidates when their stock prices are depressed prior to a time of rebound.  For these, however, timing is critical.

In all cases, an evaluation of financial health is essential.  A simple measure of same is a view of free cash flow.  Companies that earn enough to more than cover their expenses, debt obligations, dividend payments, and the like, are in the best possible shape.  That’s true even if they begin with relatively little in the bank.  The ability to generate excess funds every year makes weak companies strong and strong companies stronger.

Another important part of fundamental analysis is valuation.  Stock prices are generally based on a multiple of underlying profits.  If, for example, a company earns $2.00 a share (e.g., company profits of $2 million divided by one million shares), a fast-growing company’s stock might sell for 20 times $2.00 a share.  That’s a price of $40.  A slower growing company might sell for 10 times earnings, i.e., the price-earnings multiple.

Then there’s technical analysis, a school of bizarre thought that suggests that future pricing can be divined by the range of prices and price patterns of a stock’s history.  There are numerous different shapes and theories considered by those who subscribe to this approach.  Unfortunately, however, there is nothing in the literature of investing that in any way supports the forecasts these folks would have you believe.

Even so, please note: If the fundamental analysis is favorable, but the stock’s price is tumbling, there’s probably something wrong with the fundamental analysis.

N. Russell Wayne, CFPÒ

www.soundasset.com

www.soundasset.blogspot.com


Any questions?  Please contact me at nrwayne@soundasset.com 

Comments

Popular posts from this blog

Sound Advice: July 26, 2023

Is Day Trading a Good Idea? Day trading can be both exciting and potentially profitable, but it also comes with significant risks and challenges. Whether it's a good idea depends on several factors, including your financial situation, risk tolerance, time commitment, and knowledge of the markets. Here are some considerations to keep in mind: Risk and volatility: Day trading involves buying and selling securities within a short time frame, often within the same day. This exposes you to the inherent volatility and risks of the market. Prices can fluctuate rapidly, and unexpected events can have a significant impact on stock prices, making it challenging to consistently make profits. Time commitment: Day trading requires a substantial time commitment. It involves closely monitoring market movements, conducting research, and executing trades. It can be stressful and demanding, as you need to be actively engaged in the market during t...

Sound Advice: May 31, 2023

High Yields, Yes!  But There Are Risks Now that failure to get much done in Washington seems to be the bottom line for lots of talk, but little action, it’s hard not to wonder whether we’re missing something.  Yes, the Federal Reserve Board has aggressively raised interest rates in the hope of putting a damper on excessively high inflation, but one would think that there might be some good news as a result of these efforts. The hoped-for result is that inflation is indeed moderating.  Also of importance, though, is the sharp improvement in interest rates on fixed-income investments, usually a.k.a. bonds.  For much of the past decade or more, interest rates have languished at or near historical lows, which created considerable shortfalls for folks living on fixed incomes. Thanks to the Fed’s hikes, the returns on bonds and the like are beginning to be of interest.  But . . . and that’s a big but . . . there are risks involved. For short-term investing at ...