A Powerful Foundation for making intelligent decisions in the stock market: Knowledge of fundamentals of the company and human behaviour (psychology)

In recent years, behavioural finance has shed light on the psychology of stock prices and financial decisions by market participants.

Eventually, two main forces affect stock prices in the market:

• the fundamentals of the company, and,
• human behaviour.

Both forces have a role to play.

However, a combined knowledge of the two should make a more powerful foundation for making intelligent decisions in the stock market than relying on fundamentals alone.  

Many investors make dumb decisions by chasing stock prices.  Do you?  If so, what can you do about it?

We will get better answers by studying psychology than by boning up on finance alone.


The dumbest reason in the world to buy a stock is because it's going up.
- Warren Buffett

Related:

****Be a Better Investor

Choosing the Right Share through Fundamental Analysis and Comparative Quantitative Analysis of the Figures

We have chosen SingTel, Starhub and MobileOne as companies for comparison.

COMPARING THE FIGURES

Let us apply the concepts.

Table 1 shows the ROE, ROA, PE, NAV and dividend yield of the 3 companies. 

• In comparison, StarHub has the highest ROE as it is highly leveraged with debt whereas MobileOne has the highest ROA. 
• In terms of PE and dividend yield, MobileOne offers an attractive PE of 10.1x and StarHub gives out the highest yield. 
• As service provider companies, all 3 telcos offer a NAV lower than their traded share price due to their low asset investment.

OUR PREFERRED CHOICE

Based on the findings, we would choose MobileOne as our preferred choice of investment. 

Mobile One

• MobileOne also has the lowest PE while giving out a healthy 5.5% dividend yield. 
• The low PE indicates that MobileOne’s share price can still rise higher to between 14-15x PE to catch up with its peers. 

StarHub

• StarHub may have the highest ROE but it depends too much on debt to fund its operations. 
• Even though StarHub offers a higher dividend yield, its PE shows downside risk as the share may slide to match its competitors.

SingTel

• SingTel’s dividend yield, ROE and ROA are the lowest among the 3 companies but it has the highest share capital and NAV. 
• High volume of transactions involving large number of shares are required for SingTel’s share price to appreciate. 
• SingTel is a good choice to invest in times of uncertainty due to its huge share capital and strong business foundation but its share price is the highest among the 3 telcos and could be an expensive choice to invest.

MobileOne, being the smallest player in the market, still has a lot to offer and would benefit the most from the Next Generation National Broadband project (NGN) as it would be provided with the necessary infrastructure to compete with the other big boys in the network industry once the project is completed. The high-barrier industry prevent others from jumping into the bandwagon and the expertise of MobileOne in the local market would encourage foreign partners to tie up with it.

CHOOSING THE RIGHT SHARE

Choosing a share to invest requires a lot of research on the background of the company and its potential to expand further. 

• Always compare companies from the same industry and in a similar business as you can never compare apples with oranges. 
• If you are looking for a share for long-term investment, always look for one with a stable dividend payout that adheres to your requirement. 
• Both fundamental and quantitative analysis are basic means to fully understand the potential of a company. 
• Remember to use the various forms of fundamental analysis before choosing your next rewarding share.

Read:

Understanding Fundamental Analysis (Part 4)

Understanding Fundamental Analysis

Understanding Fundamental Analysis

Understanding Fundamental Analysis

Understanding Fundamental Analysis (Part 2)

Understanding Fundamental Analysis (Part 3)

Understanding Fundamental Analysis (Part 4)

Understanding Fundamental Analysis (Part 5)

Understanding Fundamental Analysis (Part 6)

Techno-Fundamental Analysis, Anybody?

EDUCATION | 22 DECEMBER 2009

Techno-Fundamental Analysis, Anybody?

By Ernest Lim

Recently, I heard two university students debating over the effectiveness of technical analysis (TA) and fundamental analysis (FA). Much debate has been on-going for many decades on the usefulness of FA and TA and whether one method triumphs over the other. I will give a brief description on both methods, respective advantages and disadvantages and how to combine them to use it as techno-fundamental analysis.

DESCRIPTION OF FA

FA is a study of evaluating the intrinsic value of a security via analysis of the economic, industry, company, financial and other qualitative and quantitative factors. The intrinsic value is then compared with the security’s current price to determine the position that one has to take.

Table 1 lists some of the advantages and disadvantages of FA.

Advantages	Disadvantages
Identify sound stocks: FA enables the investor to identify sound companies with excellent management, strong financial position and in high growth industries. This significantly increases the returns that you can generate from the stock.	Time consuming: One has to familiarize himself with the country, industry, company in order to reach a conclusion in the stock analysis. Besides, different valuation models or relative valuation models apply to different industries.
Get rich through FA: Warren Buffett is a classic example who obtains his wealth (2nd richest man in the world) through FA. There are extremely few (if any) technicians who obtained tremendous wealth via TA.	Majority of the FA information comes from company: As most of the FA information comes from the company itself, it is typically biased, in favour of the company.
Develop thorough understanding of the company and industry: Through FA, the investor would be able to understand the company and the industry. This knowledge is important because the investor would know how to react to plunges in share price – i.e. he will have an idea whether the stock plunges because of impending bad news (e.g. unable to meet outstanding loan obligations) or mainly due to poor market sentiment.	Disregards momentum: Some companies considered as market darlings can continue to surge, despite their lack of profits or revenue. Some undervalued companies can remain undervalued for years before surging, thus momentum should not be disregarded.

Table 1: Advantages and disadvantages of FA

DESCRIPTION OF TA

TA is the study of price patterns and trends in the financial markets so as to exploit those patterns. It was brought to the forefront with the advent of Dow Theory at the turn of century. Dow Theory subsequently laid the foundations for what was later to become modern TA. TA hinges on three core principles:

• 
  
  
  Market action discounts everything
• 
  
  
  Patterns exist
• 
  
  
  History repeats itself

Below are some of the general advantages and disadvantages of TA, summarized in Table 2.

Advantages	Disadvantages
Ease of usage: For example, a head and shoulder pattern chart pattern has the same interpretation on a stock chart or currency chart or commodity chart.	Subjectivity: Given the same chart, one technical analyst may think that the stock is building a base, while another may think there is more downside.
Price incorporates all available information:Price shows the consensus of all the market participants to the latest information available. It should be more correct than wrong.	Crowd can be wrong: For example, during the dot com bubble, many people piled their life savings into the technology stocks, only to find themselves losing the bulk of their money.
Do not require in depth understanding of financial statements: TA does not require one to pore over the thick annual reports, quarterly reports. It also does not require the user to decide whether he should use discounted cash flow models or relative valuation models to value the stock.	Historical: Charts cannot be used to predict sudden positive or negative events. For example, if China suddenly put in a price ceiling on all abalone produced and sold in China, abalone companies such as Oceanus would definitely be affected.
	History may not repeat itself: History does not always repeat itself. If it always does, the richest people will be historians!

Table 2: Advantages and disadvantages of TA

TECHNO-FUNDAMENTAL ANALYSIS

In my opinion, both FA and TA have their advantages and disadvantages. Although they are founded on different basis, I would rather assimilate the strengths of both FA and TA into a techno-fundamental analysis. How do I do that?

I will use FA to identify which stocks to buy or short and TA to identify when and whether to do this. Assuming if FA warrants a buy on Sinotel, Midas and Broadway, TA can be employed to identify a good purchase price or an opportune time to buy. 

• A good purchase price is usually on or a tick above a strong support. 
• Opportune time can be identified like the confirmation of an inverse head and shoulder pattern where price makes an upside breakout above the neckline (signifying a price reversal) with volume confirmation.

Conversely, TA can also be used to identify which stocks to buy or short and FA can confirm whether andwhen to do it. For example, assuming if TA generates buy signals on Sinotel and Celestial on 29 Apr 09, I would use FA to confirm whether there are near term price catalysts and sound fundamental reasons to buy. FA would be able to filter out Celestial as it has impending convertible bonds to finance in June 09 (where it is rather apparent that it has problems financing them). FA can also provide an idea on when to take a position in the stock. For example, through a FA of Midas, one would know that it is likely to announce contracts in the next three months. Thus, if this is coupled with a buy signal from TA, one will have favourable odds of making a positive return on Midas.

CONCLUSION

In a nutshell, investing is a game of probability. 

• Only the insiders in the company know almost everything about the company. 
• For us, who are outsiders, although we may have gathered extensive sources of information on the company, industry, country, we may still be wrong. 
• Thus, it is wise to couple TA (price consensus of all market participants) with FA (specific knowledge of industry & company) to increase the probability of earning a positive return on your investments.

Next time, if you hear people debating over the usefulness of FA and TA, do go up to them and say “Techno-fundamental analysis, anybody?”

Ernest Lim currently works as an assistant treasury and investment manager. Prior to this role, he was with Legacy Capital Group Pte Ltd, a boutique asset management and private equity firm, as an investment manager since 2006. He received a Bachelor of Accountancy (Honours) from Nanyang Technological University in 2005. He is a Chartered Financial Analyst, as well as, a Certified Public Accountant Singapore. He is currently taking a short break before embarking on a new role.

http://www.sharesinv.com/articles/2009/12/22/techno-fundamental-analysis/

Buffett (1977): ROE is a more appropriate measure of managerial economic performance

Over the past many years Warren Buffett has been dishing it out in the form of letters that he religiously writes to the shareholders of Berkshire Hathaway year after year. Many people reckon that careful analyses of these letters itself can make people a lot better investors and are believed to be one of the best sources of investment wisdom.

Laid out below are few points from the master's 1977 letter to shareholders:

"Most companies define "record" earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. (Comment:  This leads to a drop in ROE).   After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding. Except for special cases (for example, companies with unusual debt-equity ratios or those with important assets carried at unrealistic balance sheet values), we believe a more appropriate measure of managerial economic performance to be return on equity capital."

What Buffett intends to say here is the fact that while investors are enamored with a company that is growing its earnings at a robust pace, he is not a big fan of the management if the growth in earnings is a result of even faster growth in capital that the business has employed. In other words, the management is not doing a good job or the fundamentals of the business are not good enough if there is an improving earnings profile but a deteriorating ROE. This could happen due to 

• rising competition eroding the margins of the company or 
• could also be a result of some technology that is getting obsolete so fast that the management is forced to replace fixed assets, which needless to say, requires capital investments.

"It is comforting to be in a business where some mistakes can be made and yet a quite satisfactory overall performance can be achieved. In a sense, this is the opposite case from our textile business where even very good management probably can average only modest results. One of the lessons your management has learned - and, unfortunately, sometimes re-learned - is the importance of being in businesses where tailwinds prevail rather than headwinds."

The above quote is a consequence of repeated failures by Buffett to try and successfully turnaround an ailing business of textiles called the Berkshire Hathaway, which eventually went on to become the holding company and has now acquired a great reputation. Indeed, no matter how good the management, if the fundamentals of the business are not good enough or in other words headwinds are blowing in the industry, then the business eventually fails or turns out to be a moderate performer. On the other hand, even a mediocre management can shepherd a business to high levels of profitability if the tailwinds are blowing in its favour.

If one were to apply the above principles in the Indian context, then the two contrasting industries that immediately come to mind are cement and the IT and the pharma sector. Despite being stalwarts in the industry, companies like ACC and Grasim, failed to grow at an extremely robust pace during the downturn that the industry faced between FY01 and FY05. But now, almost the same management are laughing all the way to the banks, thanks to a much improved pricing scenario. Infact, even small companies in the sector have become extremely profitable. On the other hand, such was the demand for low cost skilled labor, that many success stories have been spawned in the IT and the pharma sector, despite the fact that a lot of companies had management with little experience to run the business.

It is thus amazing, that although the letter has been written way back in 1977, the principles have stood the test of times and are still applicable in today's environment. We will come out with more investing wisdom in the forthcoming weeks.

http://www.equitymaster.com/detail.asp?date=6/21/2007&story=2

Technical analysts consider the market to be 80% psychological and 20% logical.

Technical analysts consider the market to be 80% psychological and 20% logical. Fundamental analysts consider the market to be 20% psychological and 80% logical. 

Psychological or logical may be open for debate, but there is no questioning the current price of a security. After all, it is available for all to see and nobody doubts its legitimacy. 

The price set by the market reflects the sum knowledge of all participants, and we are not dealing with lightweights here. These participants have considered (discounted) everything under the sun and settled on a price to buy or sell. These are the forces of supply and demand at work. 

By examining price action to determine which force is prevailing, technical analysis focuses directly on the bottom line: 

• What is the price? 
• Where has it been? 
• Where is it going?

Even though there are some universal principles and rules that can be applied, it must be remembered that technical analysis is more an art form than a science. As an art form, it is subject to interpretation. However, it is also flexible in its approach and each investor should use only that which suits his or her style. Developing a style takes time, effort and dedication, but the rewards can be significant.

Can you, or indeed anyone, consistently beat the market?

Can you, or indeed anyone, consistently beat the market?

In other words, is the market efficient?  This is a question that every investor needs to think about because it has direct, practical implications for investing and portfolio management.



If you think the market is relatively efficient,

• then your investment strategy should focus on minimizing costs and taxes.  
• Asset allocation is your primary concern, and you will still need to establish the risk level you are comfortable with.  
• But beyond this, you should be a buy-and-hold investor, transacting only when absolutely necessary.  Investments such as low-cost, low-turnover mutual funds make a lot of sense.  
• Tools for analysing the market, particularly the tools of technical analysis, are irrelevant at best.  
• Thus, in some ways, the appropriate investment strategy is kind of boring, but it's the one that will pay off over the long haul in an efficient market.

In contrast, if you think the market is not particularly efficient,

• then you've got to be a security picker.  
• You also have to decide what tools - technical analysis, fundamental analysis, or both - will be the ones you use.  
• This is also true if you are in the money management business; you have to decide which specific stocks or bonds to hold.

In the end, the only way to find out if you've got what it takes to beat the market is to try.

• Be honest with yourself:  You think you can beat the market; most novice investors do.  Some change their minds and some don't. 
• As to which tools to use, try some and see if it works for you.  If it does, great.  If not, well, there are other tools at your disposal.  

****Select A Good Stock Market Strategy For Good Returns

Select A Good Stock Market Strategy For Good Returns

Sunday, February 28th, 2010

Stock market can be a good money maker if you know how to play the stock market correctly. A lot of people get into the stock market thinking they can make big money but then lose money by making some rash decisions.

These decisions most often are based on gut feel and not on solid research. Stock market research is the key to making money in the stock market. There are two types of stock market research that can be done in the stock market. Each of the types of research can lead to good amount of money if proper investing discipline is followed.

The two types of research that can be done is

• the fundamental research and 
• the technical analysis research. 

 Both of these styles are very different and require different kind of discipline and methodology while buying the stocks.
In fundamental research you research a stock which has a long term potential and then keep on accumulating this stock for future gains.

• The time horizon for this type of investment strategy can be really long like say two years to four five years. 
• This type of style requires the art of stock picking to be perfected in terms of their fundamental strengths. 
• Also the attributes of this kind of a stock trader are that they are patient and have immense amount of perseverance. 
• They know the art of stock picking and can wait for some time to pick a good stock.

In the Technical research the main emphasis is on trending and the traders thrive on the volatility of the market.

• Based on the trending they buy and sell stocks. 
• Stock quality is important but not to the extent as in fundamental research. 
• Also the main aim here is to make money on a short term basis and do not hold the stock for long. 
• They exploit the inefficiencies in the system as a tool for buying and then selling or offloading the stock once they reach a threshold profit percentage or the stock reaches a particular trend. 
• These traders can also make money in a bearish market.

So if you are investing in the market you will need to enough discipline to follow any approach. There is no middle path and the middle path will not make you enough of profits. So make sure that you follow one strategy and make money from it. Remember patience is a virtue in any business.

New stock market for beginners need to learn about trading strategies. The author recommends stock market for beginners strategies for getting to know how to select a good stock.

The Best Strategy For Trading On Stock Market

The Best Strategy For Trading On Stock Market
By: Wall Street Window
Tuesday, February 02, 2010 11:59 AM


I've been a successful stock trader for over a decade now and thanks to the Internet my reputation has spread. I have a free email investment letter with over 50,000 subscribers in it and get questions from them all of the time.

Probably the most common question I get is what is the best strategy for trading on the stock market?

Well any strategy has got to incorporate some risk management principles and a real plan when it comes to making trading decisions.

Most people don't do this though.

They just turn on the TV and buy when some hot news comes out or read a story in a magazine and get in what looks like a hot stock.

But when you make money like this it is just look and odds are you are going to end up losing money. Even if your stock goes up you won't know what to do with it.

So first of all you need a good strategy when it comes to picking out stocks and making trades. Personally I've looked over decades of market data to figure out what chart patterns appear the most consistently before a stock goes up and then looked at the fundamentals that these stocks seem to have the most in common.

I call this combination the Two Fold Formula. I look for stocks that have both

• a low valuation and 
• high earnings growth. 

Most growth investors ignore valuation and just look for price, but I've found that when you usually find your best winners when you look at both.

One of my favorite indicators to do this is the PEG ratio. Unlike the P/E ratio, which just looks at one years worth of earnings the PEG ratio takes the price of a stock and compares it to its projected earning growth for the next five years.

So by using the PEG ratio you can make buy decisions based upon the price you are paying for earnings growth.

This can give you a great list of the 50 hottest stocks to keep an eye on.

After that l look for a specific chart pattern and technical condition that I've also found to be common to the biggest winners.

To me this is the best strategy for making money in the stock market and I spell it all out for you free in my Two Fold Formula guide. You can get it when you join my free email list.

I believe in providing maximum value for people on my list. This is not a list of pitches and hype, but real information that will make you money in the stock market.

 http://www.istockanalyst.com/article/viewarticle/articleid/3829746

Looking at the investment world by studying the numbers. (2)

Studying the numbers

That a company makes a popular product doesn't mean you should automatically buy the stock.  There's a lot more you have to know before you invest. 

• You have to know if the company is spending its cash wisely or frittering it away. 
• You have to know how much it owes to the bank. 
• You have to know if the sales are growing, and how fast. 
• You have to know how much money it earned in past years, and how much it can expect to earn in the future. 
• You have to know if the stock is selling at a fair price, a bargain price, or too high a price.

You have to know if the company is paying a dividend, and if so,

• how much of a dividend, and
• how often it is raised.  

Earnings, sales, debt, dividends, the price of the stock:  These are some of the key numbers stockpickers must follow.

People go to graduate school to learn how to read and interpret these numbers, so this is not a subject that can be covered easily in depth for others.  The best is to give a glimpse at the basic elements of a company's finances, so you can begin to see how the numbers fit together.

Investing is not an exact science, and no matter how hard you study the numbers and how much you learn about a company's past performance, you can never be sure about its future performance.  What will happen tomorrow is always a guess. 

• Your job as an investor is to make educated guesses and not blind ones. 
• Your job is to pick stocks and not pay too much for them, then to keep watching for good news or bad news coming out of the companies you won. 
• You can use your knowledge to keep the risks to a minimum.

Consistently losing money in stocks - don't blame the stocks, it is not the fault of the stocks. You need a plan.

When people consistently lose money in stocks, it's not the fault of the stocks.

Stocks in general go up in value over time.

In 99 out of 100 cases where investors are chronic losers, it's because they don't have a plan.

They buy at a high price, then they get impatient or they panic, and they sell at a lower price during one of those inevitable periods when stocks are taking a dive.

Their motto is "Buy high and sell low," but you don't have to follow it.

Instead, you need a plan.

What's in store for investors next?

 If we should have learned anything from the past 10 years, it is that valuation matters.

In a dynamic world, a static portfolio is by definition a fatally flawed strategy.

The price of investment success is constant vigilance.

The advice to buy and hold long term begs a critical question: buy and hold what?

My occasional rumination

One of the most fascinating figure in investing is the wide range of intrinsic value one can obtain from various types of valuations and by various analysts.

It is this inability to determine the intrinsic value or the lack of consensus of what constitutes the right intrinsic value that allows the price of the market to zig-zag but always tracking the intrinsic value.  Over the short term, the price may be up or down by a wide margin.  However, over the long term, it always reflect the fundamental value of the business.

Are you a bargain hunter? Are you a trend follower?  There are more than one way to make a profit from the stock market.  There are also more than one way to make a loss from the stock market.  The rules are generally fair, though one need to watch out for manipulations in certain price movements of certain stocks. 

There are those who discard the fundamentals and only study and follow the sentiment driving the supply and demand of the stock.  Buy low and sell high.  Buy high and sell higher.  It sounds so easy for an "expert" to pronounce that those who did not do this on the first trading day of this month by following the chart would have been stupid or foolish, given the chart patterns.  To these believers, fundamentals do not matter in their trades.

On the other hand, there are those who discard the charts.  They painstakingly study the fundamentals.  They patiently analyse their thinking and behaviour guiding their investing.  They are generally followers of value investing as practised by Benjamin Graham and his students.  They track a few high quality stocks and bargain hunt when the price is right.  They have strict rules too guiding their selling.  Their achievements are not measured by the days, weeks or months, but over a long period of years.  After an initial period of investing, their returns are often positive by a huge percentage over their initial cost.  Short term fluctuating prices in the stocks of their portfolio rarely cause a capital loss in their portfolio value.  The low markets significantly reduced the compound annual growth rate returns for the whole investment when these were measured at those times.  On the other hand, the compound annual growth rate rebounded when the returns were calculated at the time when the market shot up to stratosphere. 

Those who trade protects their downside with stop loss strategy.  They often take profit when a certain percentage gain is achieved.  They may also allow the winners to climb higher at the same time moving their stop loss value higher. 

Those who employ value investing, protect the downside through buying with a margin of safety and careful stock picking.  They often allow these stocks to eventually reflect the fundamental intrinsic value.  Often the carefully chosen stock can be held for long term, without the necessity to take short term profit.  Compounding over years provide the substantial returns.  The reinvested dividend returns contitute a substantial part of the return too, this return is not enjoyed by the chartists whose investing period are often short term..

While the traders may plough in a certain amount onto a certain stock, to make big gains over a short trading period, this amount has to be meaningful and substantial.  Short term volatilities are unpredicatable and this constitutes the main risk in trading. 

On the other hand, those who value invest can usually afford to keep a large amount in their portfolio permanently.  This is safe except druing those times when the market is truly bubbly.  The volatilities in the market over the short term do not affect their investment behaviour which is strategized for the long term.  The short term volatility is often treated as a "friend" when the price can be taken advantaged of.  Over the long term, these short term volatilities - often a tinyl blip on the long term price chart - is in fact very small for carefully chosen good quality stocks.

Cheap Is No Longer Good Enough, Company must be Excellent too.

Cheap Is No Longer Good Enough
By Toby Shute
January 11, 2010 |

After a recent college reunion/homecoming, I had a chance to connect with fund manager Harry Long, the managing partner of Contrarian Industries. Long's company specializes in alternative asset management, algorithmic system research and development, and strategic consulting. Harry and I had a wide-ranging conversation about fundamental and systematic approaches to investing. Here's an edited portion of our exchange.

Toby Shute: You've described your investing approach as an attempt to marry the qualitative with the systematic. This reminds me of Warren Buffett's description of his investment strategy as 85% Benjamin Graham and 15% Philip Fisher. Let's start with Graham. What was his most important contribution to the investment field?

Harry Long: Graham's most important contribution to investing was the brilliant way he went about systematizing it. He gave very clear, mechanical rules, which outperform most discretionary human investors, even today.

If you look at services like Validea.com, the American Institute for Individual Investors, and countless other services, they have taken his dictates from The Intelligent Investor and put them into a screen, which beats the pants off just about everything else developed since.

I think Joel Greenblatt is trying to follow in that tradition. We'll see how he stacks up to Graham. It's a noble pursuit.

Shute: Phil Fisher is known for focusing on the characteristics of a great growth franchise, some of which are impossible to quantify. Importantly, though, he weeded out potential investments using a 15-point checklist that he applied pretty strictly. Are checklists an effective way of systematizing a qualitatively oriented investment process?

Long: When it comes to checklists, I've seen many, but very few good ones. It's really multiple simple rules, when applied in combination, that get you performance. For instance, if investors automatically sold, or had a rule against investing in, any company with earnings decreases of greater than 14% in any quarter, they should have sold almost all bank stocks in 2008.

In practice, you'll find that a well-designed system, using objective data, will often key in on companies that Fisher would have appreciated qualitatively. You have to do both, but I would encourage your readers to find businesses with great metrics and then ask "why?" rather than trying to find great stories which may or may not be executing.

Shute: What else can investors learn from Phil Fisher?

Long: Most investors would do best to stick to Fisher's basic tenet -- buy businesses with strong competitive positions. As Fisher pointed out, if you avoid companies with unhealthy profit margins, you save yourself a lot of money, sleep, and heartache. On the other hand, there are occasionally companies such as Wal-Mart (NYSE: WMT) that have low margins on purpose.

As for his focus on R&D, it's pretty hit-or-miss. Apple (Nasdaq: AAPL) and Google (Nasdaq: GOOG) would be examples of great success stories. However, while the Intels (Nasdaq: INTC) of the world had great runs, they are still plowing billions into R&D and hitting a growth wall.

Investors should have a diversified portfolio of quality. Cheap is no longer good enough -- investors need to search for cheap and excellent. Competition is simply too brutal, unless you are in a position to take control of ailing firms.

Shute: Can you apply this advice to a particular sector?

Long: In the financial sector, rather than owning banks, which risk capital through lending and have infinite competition, [investors] could own something like MSCI, which gets fee income from its MSCI indices. It doesn't risk capital. Simple business -- you hand me money, I hand you information -- and it has very little strong competition in the index business. MasterCard (NYSE: MA) and Visa (NYSE: V) also don't have the same balance-sheet risk as an issuer like American Express.

I could go on and on. Just because you're investing in the financial sector, you don't have to be conventional.

[Michael] Bloomberg understood that the way to be successful is to sell the miners their picks and shovels. Why does everyone spend time studying banks, rather than his example? Why aren't people obsessed with studying FactSet Research Systems (NYSE: FDS)? Maybe it's a tabloid phenomenon where success is simply too boring.

Stay tuned as Toby's conversation with Harry Long continues tomorrow. Harry Long's comments are purely his personal opinions and should not be construed as financial or investment advice.

So, Fool, how do you weigh the quantitative and qualitative aspects of a business in your own investing decisions? Share your philosophy in the comments section below.

http://www.fool.com/investing/value/2010/01/11/cheap-is-no-longer-good-enough.aspx

The Process of Fundamental Analysis

http://spreadsheets.google.com/pub?key=thrIJu34ZkHzDDZwDLtNIHw&output=html

The figure outlines the 5-Step process of fundamental analysis that produces an estimate of the value.
In the last step in the diagram, Step 5, this value is compared with the price of investing.  This step is the investment decision.

The truth behind impressive headlines and write-ups

The crowds think in images and are impressed by images rather than the facts and figures behind the images. Very often, the images which so impress them are of their own creation. Since a crowd is impressed by images, it can become prey to figures which have very little relation to the fact.

Many corporate movers and doers are aware of this fact. They feed the investors with a steady diet of figures calculated to impress. The most impressive of a possible range of figures is always the published one.

Thus, instead of providing the average per year profit figure, the ten year or even twenty year cumulated profit figure is the one given prominence.

In order to be even more impressive, the gross sales figures for the next ten or twenty years is usually given the banner headline treatment rather than the average annual sales figure.

The typical small investor, who usually finds it difficult to discern the truth behind the impressive headlines and write-ups, is naturally impressed by big numbers: The bigger the number, the more impressed is he.

For example:

Company X would announce that such and such a project would generate $X billion of sales (over the next 20 years in minute print). Company Y, not to be outdone, would announce that its new project would cost $Y billion and would bring in $Z billion of sales over the next fifty years.

The small, non-analytic and emotionally charged investors are so impressed by these billion dollar figures that they can lose total touch with reality.

A very good example of how raw figures can so impress investors such that they lose touch with reality is the case of Antah in connection with the announcement of the Antah-Biwater joint venture.

In 1985, it was announced that Antah-Biwater had won a M$1.4 billion contract to provide water supply to dozens of villages. On the strength of that particular announcement, the price of Antah’s shares rose from M$1.20 to over M$9.00 within a short space of time. To put this price rise into the proper perspective, this price rise had meant that Antah’s total market value had increased from M$60 million to M$460 million. This means that the market had expected Antah to reap a total benefit of M$400 million purely as a result of this project. The ridiculouseness of this particular episode of speculation can only be seen if we analyse the figures carefully.

First, although the whole project is valued at M$1.4 billion, Antah’s share of the project is only 51 per cent. Even if Antah-Biwater were to make 100 percent profit from this project, its total share of the after tax profit would only be M$393 million. This figure is smaller than the increase in market value of Antah as a result of the announcement.

Of course the profit from a civil engineering project can never be 100 per cent. It is more likely to be 10-20 percent and occasionally, even a loss can be sustained. Let us be generous and assume that Antah-Biwater is likely to make a 10 per cent after tax profit (ie 18 per cent pretax profit) from this contract. This means that the total benefit which Antah will reap from this contract would be around M$71 million, which is a mere 18 per cent of the increase in market value. Besides, the life of the whole project is extended over five years and the benefit of the project will accrue only gradually.

Not unexpectedly, Antah’s price fell to below $2.00 again within a year.

How ridiculously over optimistic can the market get! How did those investors who chased its share to over $9.00 feel? Do they blame their bad luck or do they blame themselves for their own lack of judgement?


Ref: Stock Market Investment in Malaysia and Singapore by Neoh Soon Kean

Also read:
http://myinvestingnotes.blogspot.com/2009/11/lityan-selling-to-suckers.html

The Professionals' Trade Secrets or What Methods do They Use?

In order to make a profit in the stock market, an investor must have some ideas regarding how the prices of stocks behave.  If he knows the behaviour patterns of stock prices, he may be able to forecast correctly what the price of a stock will be in the future. 

If his forecasted price is higher than the present market price of a particular stock, he ought to buy and reap the profit when the price rises to his forecasted level.  The reverse also applies in that if he thinks the price of a stock he is holding will decline in the future, he ought to sell it now and buy it back later on when the price will be lower. 

Stock market investment has become a very sophisticated, very scientific pursuit in the West and several schools of thought, that is, ways of thinking regarding how the stock prices behave, have been developed.  Each school is different from the other and may even be totally opposite; each attracting different supporters. 

There are what may be termed THREE 'legitimate ' schools of thought and AN 'unofficial' one. 

The unofficial school of thought is generally called

• 'The Greater Fool Theory' or'Buy from a Sucker and Sell to a Sucker' 

while the three legitimate schools are as follows:

• (1)  Random Walk / Efficient Market Theory (Hypothesis)
• (2)  Technical/Chartist School; and
• (3)  Fundamentalist School.

The stock market behaviour knows no boundary in place and time.  These various stock market theories developed in the West can be applied here too and a serious investor has to be familiar with these theories. 

Which of these four schools of thought is/are applicable to the local Malaysian market?  I am of the bias opinion that the fundamentalist school of thought is the one most applicable here.  It is most likely that many do not agree.

No expert agrees exactly with another regarding stock values. 

"There is no such thing as a final answer to stock values.  A dozen experts will arrive at twelve different conclusions" - Gerald Loeb


Ref:  Stock Market Investment in Malaysia and Singapore by Neoh Soon Kean

Characteristics of ideal stock you plan to purchase

Some thoughts on Analysing Stocks

Ideally a stock you plan to purchase should have all of the following charateristics:

•A rising trend of earnings, dividends and book value per share.
•A balance sheet with less debt than other companies in its particular industry.
•A P/E ratio no higher than average.
•A dividend yield that suits your particular needs.
•A below-average dividend pay-out ratio.
•A history of earnings and dividends not pockmarked by erratic ups and downs.
•Companies whose ROE is 15 or better.
•A ratio of price to cash flow (P/CF) that is not too high when compared to other stocks in the same industry.

Keep It Simple and Safe.


Also read: 
8 signs of doomed stock
http://myinvestingnotes.blogspot.com/2009/08/8-signs-of-doomed-stock.html

It is the Business that Matters

Over the long haul, stock prices tend to track the value of the business. When firms do well, so do their shares, and when business suffers, the stock will as well. Always focus on the company's fundamental financial performance.

Analyst upgrades and chart patterns may be fine tools for traders who treat the stock market like a casino, but they're of little use to investors who truly want to build wealth in the stock market. You have to get your hands dirty and understand the businesses of the stocks you own if you hope to be a successful long-term investor.

P/S: Look at Hai-O to learn that price tracks the value of the company's business.

The Fundamental vs. the Technical in Stock Buy and Sell Decisions

The Fundamental vs. the Technical in Stock Buy and Sell Decisions
Author: Dr. Winton Felt

Positive technical signals tend to precede good financial reports from a company. That is, the technical patterns precede and anticipate the fundamental reports. Stock price patterns reflect the buying and selling of all the people who have intimate knowledge about the company. The rest of the investment world creates the noise in stock behavior that accompanies the pattern created by those with knowledge. That is why sell strategies based on fundamentals are too slow in a volatile market.

Before the crash in 2000, many investment managers had relied on "fundamentals" to tell them when to sell. However, as the market crash approached it was often the case that by the time the company announced that earnings were going to be "soft," the stock had already declined. Sell strategies based on fundamentals (earnings, cash flow, order backlog, etc.) turned out to be much too "sluggish" in relation to market action and in comparison with sell signals based on technical analysis (volume & price patterns of the stock). The problem was compounded by the fact that analysts were often far from accurate in their forecasts regarding the financial prospects of companies. Some of the shortcomings of fundamental analysis are addressed by technical analysis.

Technical analysis offers its proponents the opportunity of responding in "real-time" to a stock's behavior. Technicians do not have to wait for the next quarterly report from the company. In other words, technicians can quickly respond to what is (current stock behavior) rather than wait to see if what ought to be (projections by fundamental analysts) actually happens (if the company actually generates the earnings expected by analysts). Each company has links with suppliers, competitors, officers, and employees. These in turn have families and friends. Many of these people are investors. There are also outside investors, thinkers, reporters, and others who are watchers of these people and their companies. The total knowledge of all these people is reflected in stock behavior. The cumulative effect of all the buying and selling activity of these people, and of those who watch these people, defines the regions of supply and demand (resistance and support) evident in the market activity of the stock and consequently in the patterns evident in the stock's behavior.

That is why stock behavior often precedes a company's announcement about earnings performance over the last quarter. The suppliers of a company know if that company has been increasing or decreasing orders for the supplies, equipment, or support needed to produce products or deliver services (people associated with these suppliers and their friends buy and sell stock). The competitors of a company know who is exerting the strongest pull on customers (people associated with these competitors and their friends buy and sell stock). Family members of employees and all their friends also have a general "feel" for how well a company is doing even without the use of "insider information" (these people and their friends also buy and sell stock). The sum total of all this "knowledge" is reflected in stock behavior much faster than analysts can get their next quarterly report written and published. Statistically, their combined actions reduce "noise" ("noise" is created by the actions of the uninformed) and increase order or "pattern" in stock behavior.

After the last market crash, portfolio managers and strategists proclaimed that the old "buy and hold" philosophy of investing is no longer viable. They said, "the market is simply too volatile for that kind of approach. Even well-established companies can go bankrupt. The slightest bad news can cause a stock to plummet." Lately, some managers are once again investing with the prior intent of holding all positions for several years (though some do say they will sell if the fundamentals change). It is as if they have learned nothing from their recent experience. Such an attitude tends to lock an investor or advisor into a pattern of thinking that all losses are only temporary, and everything will be fine five years from now anyway.

The problem with this mentality is that it reduces vigilance. Why bother to watch a portfolio closely or even to think about strategy issues if everything will work out in the long run? What are these advisors being paid to do? We know from past experience that everything may not turn out okay in five years. We can recite a very long list of stocks that have dropped over 60% from what they were five years ago and they still have not come close to recovering (I actually named a number of these companies in another article). Many of these stocks no longer exist or are now virtually worthless.

The point is that all these stocks looked good to many of the analysts who studied the fundamentals of these businesses. There were, after all, some honest analysts who joined the dishonest ones in repeatedly recommending their purchase and who gave glowing reports about their prospects. These stocks were touted as great investments at prices that later proved to be much too high (they did not seem particularly high at the time because they had been much higher before that). Nevertheless, some of the analysts who studied these companies really believed that they were very good picks. They kept recommending these stocks even though they kept falling. Why? They did so because they concluded that these stocks ought to go higher. Technicians who study price, volume, and various other stock behavior patterns, on the other hand, sold when their stop-losses were triggered or when technical sell signals were registered. They did not argue with themselves that these stocks ought to go higher. They acted on what was, not on what ought to be. They were the smart ones.

Yes, some day these stocks may recover. However, an investor who ejected himself from these situations could have been accumulating profits during the following years rather than watching his stocks decline or hoping for a recovery some day. Those who merely hang on through "thick and thin" are the real gamblers. Contrary to their own opinions of themselves, they are not really investors but speculators guided by hopes and dreams. They have no real sell disciplines. They merely buy "good companies" and blindly hold on with no plans for selling except "someday, at a profit." It is far better to get rid of losers and to keep the winners. If you do not "weed your garden," you will end up with nothing but "weeds." If you keep pulling the weeds, your garden will have only flowers. The same is true of your portfolio. It is the percentage of time that most of a portfolio is invested in rising stocks that determines how good performance will be. Eject the losers and the winners will lift the portfolio.

We prefer to invest in companies whose long-term financial prospects are good because, in the long run, it is earnings that drive stock prices. In other words, a stock that is in an up-trend because the company is doing well financially (good fundamentals) will tend to hold that up-trend better than a stock that is rising only because of unjustified momentum. However, as the basis for a primary selling discipline, fundamentals leave much to be desired. They tend to evolve at a rate that is inherently too sluggish for them to serve in that capacity, especially in volatile markets. Poor fundamentals still give us a good reason to sell. However, a stock will usually give a technical sell signal long before the company reports the poor fundamentals. Stockdisciplines.com traders prefer to respond to whatever signal they get first. You can benefit from their experience by using the same approach. They found that the first sell signal is almost always technical rather than fundamental in nature. If you make it a practice to sell only when the fundamentals are deteriorating, then you must reconcile yourself to much larger losses.

The same things may be said regarding the buy side of investing. We usually see technical buy signals before the company makes a positive earnings report. In other words, all those "watchers" of the company mentioned above know the company is doing well so they have been buying its stock and have therefore caused the technical buy signal to be generated. The profile of a stock's accumulation pattern can reveal much about whether there is something substantive behind the new buying activity. When the fundamentals are released, those who bought the stock because of the technical buy signal will benefit from the new surge of buying that follows the release of positive fundamentals.

Even so, we have a very high regard for fundamentals. If we get a technical buy signal, we like to check the stock's fundamental profile in Value Line, Morningstar, or in The Valuator before we make a purchase. If the technical signal is good but not outstanding, then outstanding fundamentals can make a big difference in how we see a stock (fundamentals tend to have momentum). However, if a stock has a lousy technical profile, we are not going to be interested regardless of how attractive a stock is fundamentally (it doesn’t pass the "smell" test). There are also times when a stock's technical pattern is so compelling that we can feel justified in basing our buy decision on technical measurements, patterns, or signals alone. Good financial reports often follow in the wake of positive technical signals.

Copyright 2009, by Stock Disciplines, LLC. a.k.a. StockDisciplines.com

About the Author:

Dr. Winton Felt has market reviews, stock alerts, and free tutorials at http://www.stockdisciplines.com Information and videos about stock alerts and pre-surge "setups" are at http://www.stockdisciplines.com/stock-alerts Information and videos about traditional as well as volatility based stop losses are at http://www.stockdisciplines.com/stop-losses

Article Source: ArticlesBase.com - The Fundamental vs. the Technical in Stock Buy and Sell Decisions

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