Getting a More Complete Picture

Many experts feel that mixing fundamental and technical analysis is like trying to mix oil and water, but I believe that screening fundamental data and viewing weekly chart patterns are equally important in measuring a stock's risk/reward.

The difficulty that comes with interpreting both data sets is that when all factors are equal, a stock becomes more fundamentally positive when its price goes down and less fundamentally positive as the price goes up. But when the price of a stock is moving higher, the technicals tend to improve, and when the price of a stock is declining, the technicals tend to deteriorate. This makes combining the two disciplines extremely difficult, but in my opinion, it is a necessary challenge.

The way I go about balancing the two is to view the economy and the markets as a system, and look for cause-and-effect relationships among the variables that can lead to trading decisions in the U.S. capital markets, and in stock evaluation and selection.

That is part of the reason I use the ValuEngine Stock Valuation Model in my fundamental valuations. The model supports my theme of technology leadership for 2005, as technology began 2005 undervalued by 11.78%. The table at the bottom of the page cleanly lays out the case relative to other sectors.

This model employs a three-factor approach to stock valuation: a company's trailing 12-month earnings per share, the analyst consensus estimate of the company's forecast 12-month EPS, and the 30-year Treasury yield. Those variables are all combined and used to create a more accurate reflection of a company's fair value. Armed with these framework features, the model paints a detailed picture of a company's fair value, which is represented by the "model price." Below are some of the variables that lead to the model's price of a stock and calculation of the percentage undervalued or overvalued.

Firm-specific variables:

Correlation between the company's earnings per share and the interest rate environment.

Long-term earnings growth rate.

The duration of the company's business growth cycle.

The company's systematic or beta risk.

Interest-rate-related criteria:

Long-term history of interest rate climate.

Interest rate volatility.

The duration of the interest rate cycle.

Technology Valuation vs. Other Sectors
Sectors	Valuation on Dec. 31, 2004	Valuation on Feb. 11, 2005
Basic Industries	24.50% overvalued	13.53% overvalued
Capital Goods	17.65% overvalued	7.98% overvalued
Consumer Durables	12.41% overvalued	4.32% overvalued
Consumer Non-Durables	17.34% overvalued	12.08% overvalued
Consumer Services	11.88% overvalued	3.72% overvalued
Energy	22.15% overvalued	19.98% overvalued
Finance	14.44% overvalued	5.54% overvalued
Health Care	1.32% overvalued	5.48% undervalued
Public Utilities	9.02% overvalued	6.26% overvalued
Technology	11.67% undervalued	18.49% undervalued
Transportation	28.44% overvalued	8.85% overvalued
Source: Richard Suttmeier