Unit 3
Fundamental and Technical Analysis
This section covers basic approaches used to determine which stocks/industry/markets to
buy, when to buy them, and when to sell them. It corresponds to the Implementation
stage of the Portfolio Management. The approaches are often classified into
fundamental, technical analysis or a combination of the two. At the conclusion of this
unit, students should be able to:
-Use fundamental analysis approaches to identify buy and sell signals
-Utilize the CANSLIM approach to identify stocks to buy
-Utilize stock screens to identify potential stocks to buy or sell/short sell
This unit section is divided into several parts.
• The first presents definitions and briefly discusses issues that are of interest to the
typical participant in the stock market.
• The second section includes a discussion of fundamental analysis,
• The third concentrates on technical analysis.
• The fourth section presents specific examples of approaches.
• This is followed by a section on stock search and tools available to perform
searches.
I. Introduction and Definitions
Fundamental and Technical Analysis are approaches to determine:
(1) Which stocks to own and
(2) When to buy and
(3) When to sell these stocks
It is important to underscore the necessity of making a decision on when to sell a stock
prior to buying it. Many of the losses in the stock market are due to the fact that a stock
is owned even when the conditions that formed the investor’s decision to buy have
changed.
Fundamental analysis is based on the premise that the price of a stock is the net present
value of all future dividends. This value is estimated by an investor based on variables
such as sales, growth rate, quality of management, expected growth of the industry and
its potentials. Technical analysis is an approach based on the premise that certain market
data such as price movements, volume, and open interest can help predict future trends
(future, often short term, prices of a stock).
Some argue that the efficient market hypothesis makes it futile to attempt to search for
stocks regardless of the approach used (technical or fundamental). The efficient market
hypothesis (EMH)1 is an idea partly developed in the 1960s by Eugene Fama, and it
1
Source: http://www.investopedia.com/university/concepts/concepts6.asp
1
states that it is impossible to beat the market because prices already incorporate and
reflect all relevant information. As such, under the efficient market hypothesis, any time
one buys and sells securities, one is engaging in a game of chance, not skill. If markets
are efficient and current prices always reflect all information, then there is no way one
will ever be able to buy a stock at a bargain price. This is a highly controversial and often
disputed hypothesis, and is covered elsewhere in this course.
While supporters of EMH believe it is pointless to search for undervalued stocks or try to
predict trends in the market through any technique (fundamental or technical analysis),
others believe that it is possible to outperform the market2. For example, value investors
and technical analysts believe that it is possible to outperform the market, and many real
life examples favor this belief. As such a new approach in finance, behavioral finance,
evolved. The main argument used by the supporters of the new approach is that many
investors base their expectations on past prices, past earnings, track records, and other
indicators. Since stock prices are largely based on investor expectation, it only makes
sense to believe that past prices do influence future prices. .
The terms investors, traders, day-traders and swing-traders are not used in the first
few paragraphs of this write-up on purpose. All four terms refer to people who attempt to
make money in the stock market. Though there is no “agreed upon” definition, the terms
often stand for the following:
•
•
•
Investors are individuals who use fundamental analysis,
Traders are individuals who use technical analysis.
Day-traders: Day trading refers to the practice of buying and selling financial
instruments within the same trading day such that all positions are usually closed
before the market close for the trading day. Traders that participate in day trading
are called active traders or day traders. That is a typical day-trader buys at the
beginning of the day and sells at the end of the day, thus ending each day with no
money in the stock market. Finally, individuals who may leave their money in
the market for few days are called swing-traders. This section is not concerned
with the techniques and practices of day and swing traders.
The terms investors and traders3 evolved to indicate different activities (fundamental
versus technical analysts) and a legal differentiation has developed for tax
considerations4. The differences are based on two dimensions: duration (length) of a
stock ownership and number of transactions. Fundamental analysts determine which
stocks to buy based on the difference between their evaluation of the stock value and the
market value (i.e., price of a stock). This process often results in a long term ownership
The term outperform the market is often used to mean outperform the SP 500.
In other contexts the term traders is used to refer to individuals who work in security
firms and stock exchanges.
4
Source: http://www.nysscpa.org/cpajournal/old/14903863.htm
2
3
2
since it may take the market a long time to reach the same evaluation that an investor has.
As such investors have both a long term dimension and a limited number of transactions,
while traders often mean short term and a large number of transactions.
Fundamentalists often discuss trading in a disapproving tone insinuating negative
connotations. This section assumes no such notions.
Other terms are often found in investment literature. These include Bear market and
Bull market and their derivatives Bearish and Bullish. A Bear market is used to state
that the market is declining while a Bull Market is an advancing market. Long and
Short; Long (or long position) means owning a stock, and Short (or short position)
means selling a stock (i.e., opposite of long) that you do not own.
No discussion of investments maybe complete without the study of how psychology play
are role in investment decisions. Investors are people that share all the positive and
negative attributes of human decision making. Investors often develop what is described
in psychological terms as Cognitive Dissonance5. A psychological phenomenon that
refers to the discomfort felt at a discrepancy between what you already know or believe,
and new information or interpretation. Cognitive dissonance manifests itself when an
investor decides on acquiring a stock with the expectation that it will go up, and then the
stock starts to go down. The investor often insists that this slide in the stock price is due
to circumstances that do not contradict the analysis, and refuse to sell the stock and in
some cases continue to acquire additional shares.
In order to avoid many of the shortfalls of human decision making, it highly
recommended that an investor must decide on when to sell the stock prior to buying any
shares of the stock.
5
A complete discussion of the subject is available online from (the Third Edition of A
First Look at Communication Theory by Em Griffin, 1997, McGraw-Hill, Inc.
3
II. Fundamental Approach
Definition and Introduction
The fundamental approach is based on the academic hypothesis that the price of a stock is
the net present value of all future dividends. This value, often called intrinsic value, is
estimated by the investor based on the company’s fundamentals, i.e., variables such as
sales, growth rate, management, industry and potentials. The intrinsic value is compared
to the current share price. Companies that are undervalued should be acquired, and those
that are overvalued should be sold.
Fundamental analysts study everything from the overall economy and industry
conditions, to the financial condition and management of companies6. The method uses
revenues, earnings, future growth, return on equity, profit margins, and other data to
determine a company's underlying value and potential for future growth. A good source
of information on the fundamentals approach is at
http://www.investopedia.com/university/fundamentalanalysis/
Two common approaches in fundamental analysis are: Value and growth. Value
investing identifies undervalued stocks. Warren Buffett is one of the legendary names
that use this approach. The Growth approach identifies companies that are on the verge
of growing at a rate that exceeds that of others. Peter Lynch is another legendary name
that is associated with growth.
Value Investing is used by Warren Buffet and his followers, it is a disciplined approach
to investing. The objective is to identify companies that are selling below their intrinsic
value, are run by “good” managers, and have “good products”.
Investors should choose stocks of companies that have value. Questions to answer when
assessing a company’s value:
➢ Is this a good business run by smart people?
➢ What is the company worth?
➢ How attractive is the price for this company, and what should I pay for it?
➢ How realistic is the most effective catalyst?
➢ What is my margin of safety at my purchase price?
The Growth approach is very similar to value investing and it advocated by Peter Lynch.
You have to choose carefully the companies where you are going to invest. You should
develop the story of the company:
➢ What is the size of the company?
➢ What stage of growth is the company at?
➢ Is it a simple business?
➢ Is it engaged into the production of something solid and relatively safe?
➢ Is it a spin-off?
➢ Institutions don’t own it and analysts don’t follow it.
4
➢
➢
➢
➢
➢
It’s got a niche
It has no major competition
Its product is something people will keep buying forever like razors
Insiders are buyers
The company is buying backs shares
The remainder of this section outlines a fundamental analysis approach. However, an
excellent source of information for fundamental analysis is “Guide to stock picking
strategies”7 found at the investopedia web site.
Approaches and Examples
Fundamental analysis is the study of the company health and well being. Several
financial ratios allow us to achieve this objective. A few of the financial ratios that are
often considered are:
• P/E ratio
• P/E/ relative ratio
• Projected EPS (Earnings per share)
• EPS growth over 3 years
• Return on Equity
• Company Growth ratio
• Debt/Equity Ratio
• Insider Trading
• Cash Flow Growth over 3 years
Each of the ratios (or measures) on the list may assume one of three categories; Good,
Neutral and Bad. Good means that the company is exceeding expectations (as represent
by industry average or market average). P/E (Price/Earnings ratio) is a good example.
P/E ratio is the price a stock over its earnings. A typical ratio for an S&P 500 stock is
between 10 and 23. However, specific industries may have lower or higher P/E ratios
(these numbers change over time). Internet companies at one point exhibited a much
higher P/E ratio (90 and even more). P/E ratio in new industries (e.g., gene related
companies) is very different than P/E ratio in well established industries (e.g., utilities
companies). Some suggest that a good ratio should be slightly better than that of the
industry, but not exceedingly high. For example a good P/E ratio in the automobile
industry may be 14, but a P/E ratio of 50 may mean that the share price does not have a
great deal of room to increase. At the same time a low P/E ratio (e.g., 4) may signal that
investors believe that the company is performing poorly.
In addition to the various ratios, there are other fundamentals that must be considered.
These include the changes in Wall Street profit estimates for the company. Zacks report
studies the estimates and compares them to last quarter, to last fiscal year and to the next
5 years. Estimate should show an increase that is better than the industry and with an
annual growth of 20% or more. CANSLIM (discussed later) suggests 25% increase. In
7
Source: http://www.investopedia.com/
5
addition to the Zacks, the Market Guide reports past performance. It includes ratios such
as Return of Equity, Growth rates, Revenue Growth, and EPS Growth. Value Line
Investment Survey is another example of a source that relies on fundamental analysis to
rank stocks of about 1,700 companies and about 93 industries. In most cases
sophisticated fundamental analysts rely on complicated econometric models to help them
in ranking stocks and industries.
Many sites including Yahoo Finance and MSN8 show these ratios and assist investors in
assessing the companies. This is often carried out through the use of filters (software
tools that search stocks and list those that meet specific criteria). In addition to these free
sites, there are paid sites (e.g., QUICKEN and Morningstar, a company known for their
evaluation of mutual funds but has an extensive web site), and dedicated software
packages.
8
see Markman, J. “Online Investing” for searches available on MSN.
6
III. Technical Analysis
Definition and Introduction
Fundamental analysis is an attractive approach for those who believe in economic
rationality, however, research suggests that economic rationality is not always a human
trait. An investment approach that does not share the same theoretical foundation of
fundamental analysis is technical analysis.
Technical analysts believe that future performance can be studied based on the statistical
analysis of historical performance of stocks and markets. That is a stock price is the result
of the behavior of the investors. Investors in a specific stock (company or in an industry)
often behave is similar manner, and as such a specific stock is expected to behave in a
specific pattern. Technical analysts often study charts and graphs that represent the
historical performance of the stock, which explains why they are often called chartists,
and why fundamental analysts relate to them in the same manner that astronomers view
astrologists.
Approach and Examples
Technical analysts study stock charts. Charts show several stock characteristics including
stock prices and volume of sales. For example figure 1 shows IBM stock prices for the
year 2006. Along with the price line, the chart shows the volume (number of shares that
were sold each day) at the bottom as a vertical line.
Technical analysis uses indicators that identify potential movement of the stock, i.e., buy
and sell signals. For example, figure 2 shows IBM with its price line and 50 day moving
average (the average stock price for the previous 50 days). Whenever the stock price
crosses the moving average line in upward direction, it is a buy signal and whenever the
line crosses the 50 moving average while going down, it is a sell signal.
INTL BUSINESS MACH (NYSE)
7
Figure 1: IBM Stock chart for 2006
Figure 2: IBM stock chart with 50 day moving average shown in red
Many of these indicators use statistical analysis and variables such as moving averages,
variance and standard deviation. They are, as such, implementation of statistical tools in
predicting price movements. Indicators are often based on mathematical formulae using
the price and volume movement of the stock. Examples of such indicators are MACD
and Stochastic. MACD (Moving Average Convergence Divergence) is calculated by
subtracting a 26-day moving average from 12-day moving average. The result oscillates
8
around 0. A positive number is a bullish signal, while a negative number is a bearish
signal. Stochastic9 compares a security closing price relative to its price range over a
period of time. It is calculated using the following formula =
Today' s _ Close Lowest _ Low _ In _ Time _ Period
Highest _ High _ In _ Time _ Period Lowest _ Low _ In _ Time _ Period
Stochastic, for any time period, varies from 0 to 100. When the value crosses 75% in an
downward direction, it is a sell signal. While when it crosses 25% in an upward
direction, it is a buy signal.
Figure 3 shows IBM with Moving Average, MACD and Stochastic as well as buy and
sell signals shown as green and red vertical arrows.
Figure 3 IBM Stock with Moving Average, MACD, Stochastic and Buy/Sell signals
Indicators are classified into leading and lagging indicators. Leading indicators attempt
to predict future price movements, while lagging indicators help identify trends. They
may also be classified into lines (MACD or 50 day moving average) or bands (such as
stochastic). Crossing a line (in either direction) represents an action signal (i.e., buy or
sell). For example, in figure 3, the MACD line is crossed in a downward direction during
9
Definition is based on Achelis, S. “Technical Analysis from A to Z”, McGraw-Hill, 1995
9
the month of Feb. This is a sell signal and is identified using a red arrow on the chart.
Similarly, during the month of March the MACD line is crossed in an upward direction.
This is a buy signal and is identified using the green arrow. The same is true with the
bands as shown in the stochastic portion of the graph.
In addition to stock indicators, there are industry and market indicators that predict the
movement of an industry or the overall market. For example table 1 shows the
movement of money into or out of industries10 for a 12-week period. Red squares
indicates that investors are moving money out of the industry (selling the stocks), a green
square means that investors are moving money into the industry, while an orange square
means that there are no major movements in either direction.
Market indicators are grouped in three categories; monetary, sentiment and
momentum11. Monetary indicators are similar to interest rates and money supply.
Sentiment indicators include put/call ratio and other option related measures. Finally,
momentum indicators study the current performance of the stock. Examples include the
number of stocks that made new highs and new lows.
In addition to indicators, technical analysts utilize price charts. Support, resistance, head
and shoulder, and cup and handle are common names used to describe specific
meaningful patterns. Support level is a minimum price that a stock may reach before
bouncing back. Stocks that cross below the support level are expected to decline to the
next support level. A resistance level is a price where a stock often has difficulty
crossing in an upward direction. If a stock crosses a resistance level it is expected to
continue to a new resistance level. The old resistance level is often considered the new
support.
•
Cup and Handle - This is a pattern on a bar chart that can be as short as 7
weeks and as long as 65 weeks. The cup is in the shape of a U. The handle
has a slight downward drift. The right hand side of the pattern has low trading
volume. As the stock comes up to test the old highs, the stock will incur
selling pressure by the people who bought at or near the old high. This selling
pressure will make the stock price trade sideways with a tendency towards a
downtrend for 4 days to 4 weeks, then it takes off.
It looks like a pot with handle. Traders have made a lot of money using this
pattern, which is one of the easier to detect.
Industry groups and symbols used in this table are not universally accepted, some
financial entities may use other symbols or groups
11
Source: Achelis, S. “Technical Analysis From A to Z”
10
10
Click Here for another example of a cup and handle chart.
•
Head and Shoulders - A chart formation that resembles an "M" in which a
stock's price:
- rises to a peak and then declines, then
- rises above the former peak and again declines, and then
- rises again but not to the second peak and again declines.
The first and third peaks are shoulders, and the second peak forms the head.
This pattern is considered a very bearish indicator.
Click Here for another example of the head and shoulder pattern.
•
Double Bottom - Occurs when a stock price drops to a similar price level
twice within a few weeks or months, the double-bottom pattern resembles a
“W". You should buy when the price passes the highest point in the handle. In
a perfect double bottom, the second decline should normally go slightly lower
than the first decline to create a shakeout of jittery investors. The middle
point of the “W” should not go into new high ground. This is a very bullish
indicator.
The belief is that after two drops in the stock price the jittery investors are
out and long-term investors are still holding on.
11
Many of the current financial markets sayings (e.g., trend is your friend) and hypotheses
are based on technical analysis. The Dow Theory is such an example of a technical
analysis based hypothesis. It states that the market is in an upward trend if one of its
averages (industrial or transportation) advances above a previous important high and is
accompanied or followed by a similar advance in the other average. The theory also says
that when both averages dip below previous important lows (support levels), it's regarded
as an indicator of a downward trend.
A more complete study of technical analysis and indicators maybe found in Achelis, S
“Technical Analysis From A to Z”, which is available as a book and online. Other
sources include Inevstopedia.com.
12
2004
Name
Symbol
Computer/computer services
Building/roofing-wallboard
Finance
Finance/leasing
Leisure/casinos-gaming
Textiles/synthetic fibers
Basic/mining/coal
Building/plumbing
Telecommunications/foreign
Transport/shipping-shipbuilding
Basic/metal
Basic/steel-iron
Vehicles/auto rental-service
Beverages
Building/homebuilding
Beverages/wines and liquors
Broadcasting/equipment
Transport/cargo-charter
Machinery/construction
Machinery/flow control filtration
Utilities/water
Computer/computer systems
Finance/pawnshops
Tobacco/leaf/snuff
Building/contract-eng-constr
Home/hotels-motels-inns
Conglomerate/diversified
Energy/Oil-gas
Finance/receivables
Food/serving/fast foods
Home/furnishings
Finance/real estate-land develop.
Electronics
.DSE
.BRW
.FIN
.FLE
.LCG
.TSF
.MCL
.BPL
.TFO
.SHI
.MET
.STE
.ARS
.BEV
.BHO
.BWL
.BEQ
.ACC
.MCM
.MFC
.UWA
.DCS
.FPA
.TLS
.BCE
.HOT
.CDI
.OIL
.FRE
.FFF
.HOM
.LAN
.ELE
# 17
405 99
3 97
23 96
4 96
32 96
2 96
11 95
2 95
27 95
29 95
6 94
12 94
5 94
20 93
28 93
13 84
13 84
5 84
13 83
10 83
15 83
95 82
3 82
4 80
24 79
26 79
26 78
103 78
6 78
19 78
7 78
65 77
104 76
Dec
10 3
99 99
97 96
96 94
93 85
92 92
96 96
92 92
83 93
38 44
96 93
81 84
78 96
91 93
79 67
65 39
83 82
95 92
95 96
77 78
83 84
78 70
83 79
82 84
52 46
50 96
82 73
78 72
71 73
53 78
66 53
66 77
67 52
72 72
Table 1
Money movement in/out of industries
13
26
99
96
84
79
92
96
96
84
36
96
93
96
93
53
51
82
82
95
76
82
73
73
82
43
49
57
74
83
48
46
82
56
55
Nov
19 12
99 99
96 96
86 86
59 29
93 93
96 69
85 84
58 27
49 36
96 96
93 95
96 96
94 95
49 42
67 55
82 80
93 78
96 96
82 73
85 83
66 80
73 63
83 85
47 32
32 30
75 80
74 75
80 75
13 8
49 57
47 55
65 64
55 57
5
87
99
89
34
90
23
82
20
43
99
82
99
90
64
48
82
17
99
70
83
72
48
81
33
49
71
71
77
31
41
45
70
15
29
88
93
80
44
88
40
76
13
38
93
54
92
92
66
61
76
12
99
35
71
64
42
52
37
18
70
67
72
61
37
16
68
14
22
74
99
76
49
76
19
79
2
38
99
68
80
99
69
34
76
10
99
33
75
56
64
81
37
23
70
68
81
69
37
10
68
11
Oct
15 8
77 25
77 79
89 84
80 82
80 81
30 9
72 82
16 6
27 30
91 93
64 85
89 89
99 99
70 76
32 53
72 71
13 9
93 99
33 53
55 76
38 40
47 37
80 80
39 63
16 31
78 82
62 72
82 90
54 61
54 45
3 67
78 80
12 10
1
17
73
86
84
78
6
86
30
22
91
90
87
99
73
77
71
6
99
62
62
34
33
41
71
38
80
70
92
70
59
59
80
8
IV. Other Approaches
CANSLIM12
CANSLIM is a set of rules that maybe used in selecting stocks to buy. It was developed
by William O’Neil, the publisher of Investors Business Daily (IBD), a daily investment
publication. The approaches combine both technical and fundamental analysis, and
identifies stocks of small but successful public companies, that are leaders in their fields,
that is innovative in one or more ways, with a history of increasing earnings, trading
some thousands of shares- per day- on a major stock exchange, has an innovative
product, has been noticed by institutional investors, is currently being bought in quantity,
and is owned in part by its management.
CANSLIM is one of many methods. For example Peter Lynch advocated a similar
method in his book. Other methods are discussed in a variety of books and websites.
One reason for presenting CANSLIM in this section is that it is a comprehensive method
and that IBD has performed research that supports the method.
The CANSLIM method advocates timing the buying of these quality companies as they
emerge from "consolidation periods" before the price runs up dramatically. The method
is based upon past histories of companies that have done just that. Investors Business
Daily web site (www.investors.com) discuss the approach and outlines tools available to
implement it.
C = Current Quarterly Earnings per Share Growth over the same quarter of the previous
year- Investors Business Daily web site (www.investors.com) recommends that current
quarterly earnings must be up 25%.
A = Annual Earnings Growth - Studies by Investor's Business Daily (IBD) show that
winning stocks over the last 50 years had annual earning per share growth of at least 2025% in the last 3 to five years, an annual return on equity (ROE) of 17% or more. Stocks
must demonstrate this ROE in each of the last three years. It is suggested that the higher
the annual growth, the better the stock as a candidate.
N = New Products, Superior Management, and New Highs – The company should offer
new products/services, with superior management and/or industry innovations. A pivotal
technical consideration of this point is to buy only stocks that are emerging from basing
chart patterns13 and that have put in a new stock-price high out of the base or
consolidation. Some recommend looking for companies with these characteristics that
don’t have a high institutional investments (i.e., not owned by large institutions – see the
12
Source: This section is heavily dependent on www.investors.com and on an article on the
Invesopedia web site
13
A basing pattern is a technical term that identifies a new base (or support level) for the
stock. That is a price movement that suggests a bottom has been reached and that it is
expected that the price will go up.
14
“I” below). This often means that when the company is discovered by large institutions,
the stock price will move up. However, this is easier said than done since it is often
difficult to stay ahead of large institutional investors with their research capabilities. It is
however, possible when investors limit themselves to industries that they are familiar
with, a basic recommendation of Peter Lynch. A recent article in the Wall street Journal
stated that there is evidence that investors can outperform the market when they
concentrate on few industries.
S = Supply and demand in share volume/shares that float – The question of when to buy a
stock is an important one. CANSLIM uses technical analysis to determine entry points.
The supply part (shares available for purchase or shares outstanding) is of less
importance here than demand. The company should demonstrate increasing volume as
price moves out of a basing chart pattern such as a cup and handle, saucer bottom, or
head and shoulders bottom. Other patterns such as flags or pennants and bullish wedges
also represent excellent buying opportunities when the breakouts are accompanied by
greater-than-average volumes. Other major factors are the total number of shares that the
public can buy, and this is known as the float. A small number of shares in the float
means that fewer shares have to be bought to push up the stock price.
L = Leader (or Laggard)? - Buy market, sector and industry leaders. Sell laggards. Own
the industry leaders and sell them when they no longer lead. This also applies to the
sectors and groups in which they reside.
I = Institutional sponsorship - Look for stocks with a good degree of institutional (i.e.,
professional) participation. This includes those with a higher degree of corporate
executive ownership.
M = Market direction - As much as 70% of a stock's price movement is determined by
the direction of the overall market. Even a winner will be fighting a strong current to get
to higher prices in a market that is tanking. It is best to be long winners in a bull market
(and short losers in a bear market).
The Contrarian Approach
The contrarian approach was developed because of the belief that investors (as human
decision makers) do not follow a rational actor paradigm. And in their decision they
reach extreme swings (either go up or down more than they should). One such recent
example occurred on Friday Dec 17th, 2004. Pfizer, the pharmaceutical company,
announced that one of its drugs, Celebrex, causes an increase risk of heart attack.
Immediately after the announcement the company shares dropped from $29.00 (the
previous day close) to around $25.00 then decline to $22 and end the day at $26.00. In
other words the immediate reaction of investors was to sell (over 20%, which is a large
drop) then to stabilize to 10.34% (see figure 4).
15
Figure 4 Pfizer Stock Performance
The contrarian approach uses sentiment indicators and adopts a strategy of buying stocks
that are out of favor (either as a company or as an industry). A more complete study of
the approach is available online at http://www.contrarianinvesting.com/topics.php
The Dogs of the Dow
This investment strategy advocates buying the 10 DJIA stocks with the highest dividend
yield at the beginning of the year. It is assumed that members of the Dow are good
companies and that the worst performers may be going through a difficult time, but
because of their size and history they will turn around and perform better that the
remaining companies. Go to http://www.dogsofthedow.com/ for an evaluation of the
performance of this approach.
V. Stock Search Approaches
Stock selection methods may take one of two approaches; top down or bottom up.
Both approaches utilize the same four steps, each in opposite direction (e.g., the top down
approach follows step 1 through 4 while the bottom up approach follows steps from 4 to
1). Step one of the top down approach evaluates the short and long term market trends to
determine the short and long term direction of the market. This first step helps us in
determining what position we should assume (short or long positions). The second step
is to investigate an industry. We search for an industry trend that meets our market
forecast. The third step is to determine an appropriate company within the selected
industry. The last step assists us in determining whether now is the appropriate time to
execute a transaction (e.g., buy the stock). The following few paragraphs explain each
one of these steps.
16
Step 1: Market Trend Evaluation:
One method of market trend evaluation uses volatility indices. Volatility is defined on
the Chicago Board of Exchange (CBOE) web site as a measure of the fluctuation in the
market price of the underlying security. Mathematically, volatility is the annualized
standard deviation of returns. Volatility indices were developed by the CBOE for many
of the major indices and are used to forecast future direction of them. The charts below
show VXN (NASDAQ volatility index) and the NASDAQ index for the same period..
The charts reflects that the two measures move in opposite directions, which has resulted
in the saying “when the VXN is low, it is time to go, and when the VXN is high it is time
to buy14. As such future moves of the market are determined through the study of the
volatility indices.
Charts showing VXN and NASDAQ index daily moves
14
CNBC University Investment seminar, Los Angeles 2003.
17
Step 2: Industry Investigation:
The industry investigation studies two main issues; the flow of money (large investors)
into or out of industries, and the direction of the industry index. The flow of money is
published by financial organization including CNBC and other similar news outlets.
There are subscription based sites, such as CNBC University, that include charts showing
the flow of money in a color coded format (see technical analysis section in this write up)
that makes reading the chart easier and less time consuming.
Many organizations have established indices that are used to track markets and industries.
Dow Jones average, S&P 100, S&P 500, Russell 2000 are few of the commonly known
market indices. In addition to market indices there are industry based indices that follow
the performance of stocks in specific industries (the table below shows one such list).
These indices are created by many institutions, and as such may be found in more than
one source. In addition to industry indices, some financial institutions have created ETFs
(discussed elsewhere in this course) that follow stocks in an industry. All of these
instruments may be used to study the performance of an industry in a manner very similar
to technical/fundamental analysis of a regular stock.
Symbol
.BAN
.BSB
.BSL
Description
Banks
Banks/savings banks
Banks/savings & loan
Symbol
.JSW
.OFU
.OFS
18
Description
Home/jewelry-silverware-watches-china
Home/office/equipment
Home/office/furniture
.ALU
.MET
.MOF
.MIN
.MCL
.MCP
.MGO
.MSA
.MSI
.MEX
.MJG
.PAP
.STE
.SMI
.SOI
.SST
.SOS
.SOP
.SSP
.SMN
.MUR
.BEV
.BBA
.BBO
.BDI
.BSD
.BWL
.BRO
.BCA
.BEQ
.BPE
.BRA
.BTV
.BUI
.BBC
.BCC
.BCE
Basic/aluminum
Basic/metal
Basic/metal/other fabricating
Basic/mining
Basic/mining/coal
Basic/mining/copper
Basic/mining/gold
Basic/mining/south african gold
Basic/mining/silver
Basic/mining/exploration-development
Basic/mining/junior gold
Basic/paper-products
Basic/steel-iron
Basic/steel-iron/major integrated
Basic/steel-iron/other integrated
Basic/steel-iron/stainless
Basic/steel-iron/other specialties
Basic/steel-iron/ore producer
Basic/steel-iron/converter/processor
Basic/steel-iron/minimill
Basic/uranium
Beverages
Beverages/beer & ale
Beverages/bottlers
Beverages/distillers
Beverages/soft drink syrup
Beverages/wines and liquors
Broadcasting
Broadcasting/catv
Broadcasting/equipment
Broadcasting/programming
Broadcasting/radio
Broadcasting/television
Building
Building/brick-cement
Building/climate controls
Building/contract-eng-constr
.PET
.INT
.LEI
.LGA
.LBO
.LBB
.LCG
.FIL
.FTH
.FST
.LMI
.LMU
.LPF
.LRT
.LRH
.LSC
.LSO
.LTR
.LTG
.MAC
.MAG
.ARM
.MCG
.MBE
.CNT
.AAA
.CPA
.CPL
.MCM
.MFC
.GLA
.MID
.MMT
.MSP
.MAN
.MCN
.MIU
19
Home/pet & supplies
Internet
Leisure/amusement
Leisure/amusement & gaming equip.
Leisure/boating
Leisure/bowling-billiards
Leisure/casinos-gaming
Leisure/film/entertainment
Leisure/film/theaters
Leisure/film/services-equipment
Leisure/misc
Leisure/musical instruments
Leisure/photo
Leisure/race tracks
Leisure/records-home video
Leisure/sports collectibles
Leisure/sports-outdoor equip
Leisure/tourism-resorts
Leisure/toys-games
Machinery
Machinery/agriculture
Machinery/arms & ammunition
Machinery/components
Machinery/bearings
Machinery/containers
UNKNOWN
Machinery/containers/paper
Machinery/containers/plastic
Machinery/construction
Machinery/flow control filtration
Machinery/glass products
Machinery/industrial
Machinery/machine tools
Machinery/specialties
Machinery/manufacturing/distrib
Machinery/manufacturing/Consumer
Machinery/manufacturing/industrial
.BFP
.BHH
.BHO
.BPL
.BRW
.CHE
.CAG
.COA
.CIG
.PLA
.RUB
.RFB
.DAT
.DCO
.DCS
.DSE
.DLD
.DPE
.DSO
.CON
.CDI
.DBI
.DRU
.DET
.DRE
.DDW
.ELE
.ECC
.EEE
.EDE
.EIL
.EHA
.EIC
.EMO
.OFF
.ERT
.ESE
Building/forest products
Building/hardware-handtools
Building/homebuilding
Building/plumbing
Building/roofing-wallboard
Chemicals
Chemicals/agricultural
Chemicals/coatings-paint-varnishes
Chemicals/industrial gases
Chemicals/plastics/products
Chemicals/rubber
Chemicals/rubber fabricating
Computer
Computer/components
Computer/computer systems
Computer/computer services
Computer/leasing/distributor
Computer/peripherals
Computer/software
Conglomerate
Conglomerate/diversified
Drugs/biotechnology
Drugs/generic and OTC
Drugs/ethical
Drugs/research
Drugs/wholesalers
Electronics
Electronics/component-control
Electronics/electronic equipment
Electronics/defense
Electronics/industry leaders
Electronics/household appliances
Electronics/info-comm services
Electronics/motors
Electronics/office equipment
Electronics/radios-tv-tape
Electronics/semiconductors
.MED
.MLR
.POL
.MUT
.PUB
.PBO
.PEL
.GRA
.GPR
.GSE
.PNE
.PPE
.PTE
.COT
.COD
.RME
.RET
.RAP
.RCF
.RDE
.RDI
.RDR
.RFA
.RFU
.RFS
.RMC
.RSC
.RSP
.RWC
.SER
.ADV
.EDU
.HEA
.HHC
.TEL
.TES
.TFO
20
Machinery/medical equipment/suppl
Machinery/medical equipment/res
Machinery/pollution control
Mutual funds
Publishing
Publishing/books
Publishing/electronic
Publishing/graphics
Publishing/graphics/printing
Publishing/graphics/supplies
Publishing/newspapers
Publishing/perodicals
Publishing/textbooks
Retail/cosmetics & toiletries
Retail/cosmetics-drugs-toiletries
Retail/merchandising
Retail/stores
Retail/stores/apparel
Retail/stores/convenience foods
Retail/stores/department
Retail/stores/discount
Retail/stores/drugs
Retail/stores/fabric
Retail/stores/furniture
Retail/stores/food supermarkets
Retail/stores/mail order-catalogs
Retail/stores/showrooms-catalogs
Retail/stores/specialty
Retail/stores/warehouse clubs
Services
Services/advertising
Services/education
Services/health care/centers
Services/health care/services
Telecommunications
Telecommunications/equipment-service
Telecommunications/foreign
.SPE
.OIL
.OCA
.OCP
.ODO
.OFO
.OIN
.ORF
.ORE
.OWD
.FIN
.FAE
.FCL
.FDM
.INS
.ILH
.IBA
.IPC
.IMU
.INV
.FLE
.FMB
.FPA
.FRE
.LAN
.REA
.SEC
.FSE
.FSB
.FOO
.FBM
.FCG
.FCR
.FDP
.FDS
.FFR
.FMP
Electronics/specialty instrumnts
Energy/Oil-gas
Energy/Oil-gas/Canadian
Energy/Oil-gas/crude producer
Energy/Oil-gas/domestic
Energy/Oil-gas/foreign
Energy/Oil-gas/international
Energy/Oil-gas/refiner
Energy/Oil-gas/retailer
Energy/Oil-gas/wells
Finance
Finance/agency
Finance/consumer loan
Finance/diversified misc
Finance/insurance
Finance/insurance/life-health
Finance/insurance/broker-agency
Finance/insurance/property-casualty
Finance/insurance/multiline
Finance/investment
Finance/leasing
Finance/mortgage banking-brokers
Finance/pawnshops
Finance/receivables
Finance/real estate-land develop.
Finance/REITs
Finance/securities
Finance/services
Finance/S.B.I.C.
Food
Food/bakery-mill-sugar
Food/candy-gum
Food/corn refiners
Food/dairy products
Food/distributors
Food/frozen
Food/meat-poultry
.TLO
.TLD
.TMC
.TSA
.TEX
.TAM
.LEA
.LSP
.LSM
.LLE
.TPR
.TSF
.TOB
.TCI
.TLS
.TRA
.AER
.AMC
.ASC
.ARD
.ATR
.AIR
.ASV
.TBU
.ACC
.TFF
.REQ
.RCL
.RPA
.RAI
.SHI
.TRU
.UDI
.UEL
.UOP
.UHO
.UGA
21
Telecommunications/local
Telecommunications/long distance
Telecommunications/mobile-cellular
Telecommunications/satellite
Textiles
Textiles/apparel manufacturer
Textiles/leather shoes
Textiles/leather shoes/producer
Textiles/leather shoes/mfr.-distrib
Textiles/leather
Textiles/producer
Textiles/synthetic fibers
Tobacco
Tobacco/cigarettes
Tobacco/leaf/snuff
Transportation
Transport/aerospace
Transport/aerospace/contractors
Transport/aerospace/components
Transport/aerospace/R&D
Transport/air
Transport/aircraft manf/components
Transport/aircraft manf/services
Transport/bus
Transport/cargo-charter
Transport/freight forwarding
Transport/rail equipment
Transport/rail car leasing
Transport/rail parts-accessories
Transport/railroads
Transport/shipping-shipbuilding
Transport/trucking
Utilities/diversified
Utilities/electric
Utilities/electric/operating
Utilities/electric/holding
Utilities/gas
.FPS
.FSA
.FOS
.FFS
.FFF
.FRS
.HCF
.HOM
.HFU
.HOT
.HOU
.HSW
Food/packaged-snacks
Food/seafood
Food/serving
Food/serving/servicing
Food/serving/fast foods
Food/serving/restaurants
Home/carpets-floor cover
Home/furnishings
Home/furniture
Home/hotels-motels-inns
Home/household products
Home/housewares
.UDS
.UIN
.ULG
.UPC
.UPG
.UWA
.APT
.ARS
.AUT
.MOB
.AMH
.ATT
Utilities/gas/distributors
Utilities/gas/integrated
Utilities/gas/LP gas
Utilities/gas/pipeline
Utilities/gas/producer-gatherer
Utilities/water
Vehicles/auto parts-equipment
Vehicles/auto rental-service
Vehicles/manufacturers
Vehicles/mobile-modular homes
Vehicles/motor homes
Vehicles/trucks-trailers
One method to determine how attractive an industry is to study the flow of money
into/out of the industry. Table 1 shows such a study. It shows the flow of money during
the last 12 weeks into or out of all industries. The red square represents money flowing
out of the industry while a green square represents money moving into an industry.
Attractive industries may be studied further by studying their performance in the last few
weeks using a chart similar to figure 6. The figure shows the performance of the banking
industry for one year, and it appears that it is on the rebound. Further analysis may be
carried out using additional technical indicators such as moving averages and trends.
Figure 6 Banks/savings banks Widx (.BSB)
Step 3: Company Investigation:
22
The next step is to study a specific company within an industry. Since one expects many
companies to exist in an industry, one way to narrow the list down is through the use of
services such as Value Line that gives a ranking on several factors for all the stocks that it
follows.
An investor may further investigate each company on the list using technical/fundamental
analysis discussed in a previous section of the document.
Step 4: Decision Time
The next step once a company is found is to determine if “now” is a good time to buy.
This phase uses technical analysis discussed in a previous section of the document.
23
VI. Software & Websites
Introduction
The process of identifying a potential candidate for investment can be overwhelming. In
2002, there were over 7000 companies listed on the NYSE, NASDAQ and AMEX (see
figure 1).
Fig 1: Number of Listed Companies* with NYSE, NASDAQ and AMEX
Data through October 2002
Source: http://www.marketdata.nasdaq.com/asp/Sec1ComComp.asp
There are many software packages and web sites that allow investors to locate
potential stocks. These tools may be:
• a specific program such as MetaStock (www.equis.com) , or TradeStation
(www.tradestation.com).
• A Web site such msn.com, quicken.com, yahoo.com, and others.
• A subscription based sites such as CNBCU.com, Business Week, Value Line and
others.
24
0 Recommendations
All reports should include recommendations or at least suggestions. It is important to make sure that
there is at least an indicator of what the Return on Investment would be. Make sure that your
recommendations clearly follow whar is said in the conclusion,
EACH student writes his/her best idea of a long-term investment, distressed/turnaround or short
sale investment idea fitting the following description:
UPDATED DATA
TURNAROUNDS: FOCUS ON LEFT-FOR-DEAD SECTORS/STOCKS For example, an analyst
covers a sector that is very out-of-favor and mentions that XYZ Inc. hit estimates and you realize it's
the first time in many quarters that they didn't miss. You look at the chart and its very saucered out as
the market has run out of sellers to depress it further. You ask the key turnaround GRID question: is
there any quantitative evidence that the worst is behind XYZ (this means you are looking for some
sign that the fundamental problems inflicting XYZ have abated or turned course). You then run XYZ
through the rest of the GRID.
TURNAROUND GRID: Left for dead, leading to deep undervaluation given healing process
underway
VALUATION: Deep discount (P/E, EntVal/Sales, EntVal/EBITDA) to group or historicals
FUNDAMENTAL TRENDS: Quantitative signs that the worst is behind the company
SENTIMENT: Negative or neutral (mostly hold ratings on sellside and buyside doesn't care)
BALANCE SHEET: Non lethal (coverage of debt service by 2 to 1)
TECHNICALS: Seems "bottomed out" on a chart
MANAGEMENT: Either new (replaced) or improved (admitted they had problems and are
fixing them)
The wall street 1987: Corporate raider
proxy fight
.
SHORTS: FOCUS ON BUY-RATED STOCKS (Streetwide - use ANR function- Analyst
recommendations and consensus rating) with toppy charts (e.g. MACD W chart) and estimate trends
(e.g. EE- earnings estimates chart). Typical tip offs are when an analyst keeps a buy rating on a stock
but either a) slightly cuts estimates or b) hasn't raised estimates in a quarter or two.-- some quantitative
evidence of deceleration at a company.
SHORT GRID: The best is behind the stock given signs of deceleration
VALUATION: Steep premium (multiple contractions will kill the stock):
✓ FUNDAMENTALS: quantitative evidence of deceleration (estimates not going up anymore or
-frace
if so, barely)
j
SENTIMENT: Positive/complacent (almost all buy ratings)
v
BALANCE SHEET: Preferably lethal: debt, receivable and/or inventory trends worrisome
High Ligh
CHART: Topping out: weekly chart forming a lid over stock
ap
MANAGEMENT: Arrogant and promotional
fours in Enquiry
等等
Investment Report Guideline
double spaces
Your final report, limited to 8-10 pages plus references, tables, exhibits, and appendix, should include
(Main body)
the following parts:
No Portor Ø5 forces
1. Summary
The executive summary should include a summary of all of the key points, the idea is that an investor
(most important)
can read the summary and if it appears logical and in line with expectations the recommendations can
be followed without the need to read further This is in fact the most important part of the report and
should be written last. The summary should include a summary of all parts of the report including
recommendations.
2. Contents
The Contents of the report should be consistently laid out throughout the report and you should include
both page numbers and title numbers.
3. Introduction
The introduction should say why the report is being written.
4. Main Body
The main part of your report will be the information you have found. With thorough research and
analysis you will be able to come to effective conclusions and create recommendations. He skapning og
5. Conclusions
The conclusions should summarize the main body section, do not include diagrams or graphs in this
area. This area should be short, clearly follow the order of the findings and lead naturally into the
recommendations.
Purchase answer to see full
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