I often get queries about my approach to fundamentals in choosing a stock. First, let me say that if there is one fundamental that is head and shoulders above the others, I believe it to be earnings. The old adage "follow earnings, follow earnings, follow earnings" says a great deal. One of the failings of so many participants in the dot com debacle in the late 90's, early 2000's was that many companies whose stock prices were soaring simply had no earnings. When considering earnings, it is important to compare like periods of time. While I would like to see earnings increasing quarter over quarter, that simply is not going to be the case in some sectors. Retail, for example, is not a sector where we would ordinarily expect 1st quarter earnings to exceed 4th quarter earnings. In retail, the huge earnings season is ordinarily the 4th quarter so it is important to compare the most recent 4th quarter to the previous 4th quarter as well as to compare year over year.
I should also point out that simply because a company has good fundamentals does not assure that its stock will perform especially well in the short or even mid-term. I consider Microsoft (MSFT) to be a great fundamentally sound company with loads of cash. However, if we look at price performance over the last 4 years, we find that it has essentially traded between $20 and $30 a share. That is not to say that a trader cannot make money on the up and down moves, it is simply to point out that a good company does not necessarily mean it will have an upwardly moving stock. Compare MSFT to Google (GOOG), for example. From its IPO in 2004 to the present, GOOG has jumped from $100 to over $500 a share.
In my view, fundamentals help us determine what to buy but do little in telling us when to buy it. Technicals, on the other hand give us information that assist us in determining when to buy and when to sell. In the Microsoft (MSFT) case, for example, while the stock may become a bullish trade when it bounces off a support in the $20 range, the expectancy is that it will likely remain range bound and the trader may want to tighten stops as it approaches resistance in the $30 range. At the moment, it does not look like a great buy in the $29 to $30 range. However, if it breaks up out of the range, it may engender a great deal more interest from a bullish player.
Fundamentals encompass a wide array of factors. Earnings, as I suggested are very important and should be compared to past performance of the stock as well as to other stocks in the same sector. I also believe debt is the enemy of corporations as well as of individuals so, after earnings, I like to see debt within reasonable bounds and certainly within proximity to other companies in the same sector. Again, P/E (price to earnings ratio) in general should not be too far out of whack with the market and sector within which the company trades. I also like to see a fairly low price to book value ratio since the break up value of the company is an important factor to consider.
I consider it important to realize that fundamentals can, and sometimes do, change within the blink of an eye. What would happen to Berkshire Hathaway, for example if Warren Buffet decided to step down? Have you seen the affect of the prosecution of a high corporate officer on the price of a company's stock. What if a competitor comes out with a new and better product? As many of you know, I edit a $10 and Under service where I send alerts concerning cheap stocks I like. Rarely do I expect great fundamentals on cheap stocks. Generally they are cheap for a reason so I make most of those plays on a purely technical basis. That does not mean I can't make money as profits can be realized on companies without particularly great fundamentals.
Bill Kraft, Editor
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