Two Ways to Look At Stocks Analytically

May 12, 2009

When it comes to selecting stocks, you’ll find everyone has their own opinion and few experts can ever agree. There are two main schools of thought on how to select good investment stocks - and they are quite different.

When it comes to selecting stocks, you’ll find everyone has their own opinion and few experts can ever agree. You can ask two analysts from the same company which they recommend as the very best investment and the odds are that you will get two different answers. There are two main schools of thought on how to select good investment stocks - and they are quite different.

Fundamentalists — Fundamental Analysis

A Fundamentalist argues that the best way to select a winning stock is to carry out exhaustive research on the prospective company. Your goal is to determine a stock’s intrinsic value. You conduct extensive studies by:

• Dissecting annual statements

• Determining top and bottom lines for past and future growth

• Comparison of price to earnings ration

• Management interviews

• A comprehensive market study

• Evaluation of the competition and their history

A Fundamentalist, when asked why he does not review a company’s stock chart to help determine future value, is likely to scoff with scorn or impatience. The Fundamentalist believes that price gives you no idea where a stock is going — only where it’s been. A Fundamentalist is basically a long term investor.

Technicians — Technical Analysis

One of the main tenets of Technicians is that stocks move in trends. This trend will continue until an equal or greater opposing force affects the stock. This could be an unexpected change in earnings, the loss of a large contract, or a force that affects investor sentiment. A technician evaluates:

• Support and Resistance Trends

• Market Indicators

• Charts of a stock’s past performance

• Analysis of short term price movements

There is some convincing evidence for the Technician’s arguments when you recall what happened to investors in WorldCon or Enron where they were supplied with numerous financial disclosures. Yet, they saw their portfolios wiped out by their disastrous investments in these companies. A Technician is generally a short to medium term investor.

A Winning Combination

Investors who never buy a stock without researching its fundamentals may totally ignore the technical aspects. A winning combination is a blend of the principals of Fundamental Analysis with the discipline of Technical Analysis. Studying a company’s history, future plans, the direction of revenues, margins, insider sales and other key factors, gives you valuable information for deciding whether to buy the stock. But you should also take time to study the charts of the stock to determine its present direction and current trends. An oversimplification of this combination is that Fundamental Analysis tells the investor what to buy or sell and Technical Analysis tells him when to do it.

This is a good comparison of the difference in the way a Technician and a Fundamentalist look at a potential investment:

The two go to a shopping mall to buy a sweater. The Fundamental Analyst goes to several stores and studies the various sweaters, evaluating their price, the manufacturer, how well the sweaters are made, the supply of this sweater, etc. Then he decides whether he will buy a sweater.

The Technical Analyst sits on a bench and watches customers go into the stores. He ignores the intrinsic value of the sweaters, does not study each one but he watches which sweater other shoppers are choosing most often. He bases his decision whether to buy on the behavior patterns of the other shoppers.

Oprah Winfrey said “Luck is preparation meeting opportunity.” In these days of an up and down, roller coaster stock market, by combining these investment strategies, with discipline and savvy, you may be able to catch a winning ride.

Michael Doran is Managing Director of the long/short equity fund, at Emerald Bay Partners LP. Mr. Doran can be reached at (530) 677-1635 or sierracap@directcon.net.