A Successful Blend for Stock Selection

December 19, 2008

As a physician, you know it takes many different disciplines working together to achieve the maximum well-being of your patient. You cannot prescribe effectively without reviewing both the patient’s history as well as the clinical picture. A similar approach can yield success when investing.

As a physician, you know it takes many different disciplines working together to achieve the maximum well-being of your patient. You cannot prescribe effectively without reviewing both the patient’s history as well as the clinical picture. A similar approach can yield success when investing.

There are many strategies for selecting stocks. Sometimes, two seemingly opposing theories can be successfully blended into a winning combination. Systematically incorporating the basic aspects of fundamental analysis with the opposite end of the spectrum, technical analysis, can result in a productive mix.

Fundamental analysis is a good starting point in the selection of a winning company. The goal is to find a stock’s intrinsic value, which is a term for what you really believe its worth to be as compared to the value at which it is being traded. This is also called a stock’s fundamental value. Fundamental analysis involves looking at company data exhaustively, researching annual statements, cash flow, growth rate, and capitalization rate. The price-to-earnings ratio is studied, as is the company’s management team, the current market for the product, and its competition. If the intrinsic value is more than the current share price, it makes sense to buy that stock.

Many devotees believe the fiscal study of a company that is carried out by an investor using fundamental analysis is a waste of time. Technical analysts, also known as chartists, review charts of past prices, patterns, and various indicators to forecast future movement. Stocks are selected by studying statistics generated by past market activity, prices, and volume. The basic premise is that all factors that influence market price: fundamental information, natural disasters, politics, psychological factors, will be evidenced by price movement, either up or down. Technicians focus on trends shown by past data and charts, and they often make money trading companies about which they know very little.

Technical analysts do not concern themselves with the intrinsic value of a company, its management or business models, competition or any of the other factors that preoccupy fundamental analysts. They are usually short- to medium-term investors and very active traders, holding positions for short times to capitalize on price fluctuations. If a stock does not perform the way the technician thinks it should, little time is wasted, and they get out of the market quickly. This is in contrast to a value investor following the principles of fundamental analysis, patiently waiting for the market to correct its undervaluation of a company’s stock

A successful investment strategy integrates both fundamental and technical analysis,

combining a studious review of charts showing a stock’s performance as well as an in-depth analysis of the company. The basic fundamentals and technical characteristics of a company’s overall strength and anticipated growth helps predict a positive future.

Investing purists who do not use both the technical and fundamental data often miss crucial pieces in the trading puzzle, leaving them at a distinct disadvantage. You can become proficient in the utilization of technical and fundamental information to develop a winning market strategy and improve the financial health of your investment portfolio.

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

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