Not every investor or trader will execute the same strategy when attempting to make money in the stock market. While everyone will insist that their way is the best market strategy, I believe that you need to stick to the approach that best fits your talent and experience. It's a complicated market, and just as there are many ways to fail, there's more than one way to find success.
I categorize investing/trading styles into four different categories:
1. Fundamental : Decision making based on quantitative analysis of the company's financial information and qualitative analysis of its business, competition and economic environment.
2. Technical : Using stock charts and chart patterns to discern trading decisions.
3. Statistical: Developing trading models derived from a database of multiple variables.
4. Arbitrage: The simultaneous purchase and sale of a security, securities or derivatives in order to extract a low-risk profit.
My personal style is to primarily utilize a fundamental approach to investing. In addition, I have developed a series of statistical index trading models, which I also trade on, but this accounts for only a fraction of the assets I manage. From time to time, I will also employ arbitrage techniques as well as incorporate technical analysis when making a trading decision or risk-managing a position. For this installment, I will focus on the fundamental approach to investing.
Are You Using Fundamental Analysis for Growth or Value?
There are two primary schools of thought to fundamental investing: growth and value.
Fundamental Investing: Growth
If you consider yourself a "growth investor," then you are concerned with the rate at which a company will increase its earnings stream over a period of time. Growth investors seek out companies with accelerating or high levels of sustained growth, while companies with declining growth rates will be avoided. As an example, Netflix has seen incredible growth of late, blasting past expectations in their earnings report for the first fiscal quarter of 2018. By late May of the same year, the shares had seen an increase of 111% over a 12 month span.
However, stocks can hit the virtual brick wall of growth and exhibit growth deceleration. Companies that once been the hot stock that couldn't stop rising start to mature, and their growth rate is no longer what it once was. You're looking for sustained growth, but it's not always going to sustain that growth rate as long as you'd prefer. . As a result, growth is a two-sided equation where the seductive aspects are balanced by its risks.
Fundamental Investing: Value
Value oriented investors can trace their origins back to Benjamin Graham and David Dodd who in 1934 published the ground-breaking textbook titled Security Analysis. Value investors seek to purchase companies that are selling (trading) at less than their intrinsic value. This intrinsic value can be calculated by analyzing the discounted cash flows of future earnings, valuation of assets less liabilities, or via certain ratios such as the price-to-earnings ratio (P/E or multiple) and the price-to-book ratio (stock price divided by book value per share). The most famous value investor of all-time is Warren Buffett.
Some value "purists" do not place any value on growth. Others value investors, such as Warren Buffett, believe that value and growth are inextricably linked. Some follow the theory of "growth at a reasonable price" (or GARP), which was pioneered by another famous investor, Peter Lynch. GARP combines elements of both value and growth investing.
How Fundamental Traders Analyze Stocks
Fundamental stock analysis begins with assembling the necessary information that will provide the basis for your complete understanding of a company that you're interested in. There's no shortage of public data available at your fingertips to help give you a better idea of where a stock could be headed, and if you want to come even close to a clear picture on the direction you want to take, you'll need all of it.
If you're serious about fundamental analysis, here is a list of the information you'll need to gather in order to get started:
- Financial Statements: If you understand how to read financial statements, now is a perfect time to utilize that. At a minimum, make sure you read the most recent annual report and the two most recent quarterly reports.
- Conference Calls: Make sure you're also listening to and analyzing earnings calls. Many companies have archives of these calls online. Listen to the two most recent earnings calls. Otherwise, there are some services from which you can purchase conference call transcripts.
- Press Releases and News: Do a search on news and financial websites and read all the press releases, news items and commentary for the company that have been published since the last earnings report.
- Analysts Reports: Review as many analysts reports as you can. However, here are two important caveats: Make sure the report is recent and stick to analysts with a solid reputation for coverage of that company or industry. Look for the "axe" in the name. The axe is the go-to analyst with the best historical call on that stock.
- Historical Data: Recent statements and reports are extremely helpful, but historical data can be of use as well. Some websites and programs provide historical metrics for individual stocks, with data and, in some cases, grades and recommendations for what to do with the stock.
- Analysts Estimates: Wall Street analysts provide clientele with their estimates for EPS and revenues. This data is then accumulated by information providers and an average (or consensus) estimate is then calculated. This consensus then becomes the basis for the "earnings expectation," which is often talked about in financial media.
With all of the above company-specific data, you can start to determine if a company's stock is a fundamental buy, hold or sale (or perhaps even a short-sale). But before you can do that, you need to first get comfortable with all these different sources of information. So, to help you learn the ways of the fundamental investor and analyst:
- For your favorite public company, obtain all of the data I listed above and carefully read (or listen) through it all.
- Investigate what analysts have to say to about the company.
- Check out a copy of Graham and Dodd's Security Analysis at your local library or obtain a copy online.
At the time of publication, Rothbort was long AAPL and MCD although positions can change at any time.