Monday, December 26, 2011

Season's Greetings


This is the time of year when we should step back from the markets and think about what has true significance in our lives.  December is a month of celebration for people everywhere.  To those of you who visit this blog from around the world, I offer you my best wishes as you celebrate Ashura, Bodhi Day, Boxing Day, Channukah, Christmas, Kwanza and Las Posadas.

If I failed to include your particular way of celebrating this time of year, please believe that my attempt at a global greeting in this time of peace and family extends to you and yours as well. 

Please feel free to comment and share your particular way of celebrating this blessed season.

We will return to the markets and technical analysis next Monday.

Monday, December 19, 2011

The Trend Is Your Friend - Moving Averages


Warren Buffett said that once he had purchased a stock, he could forget about the market and its gyrations.  Al Frank had the following to say in his classic, Al Frank's New Prudent Speculator:

Still, we do know that markets have fluctuating periods of advancing and declining cycles.  Markets become overvalued from time to time and thereafter decline, after which they become undervalued and subsequently advance.  Markets alternate: they become overbought, and thereafter sell off, after which they become oversold - which lays the foundation for the next rally.  These swings from overbought and overvalued to oversold and undervalued are not neat, nor are the turning points easily predictable, if at all.  Market movements are further complicated by the nature of short-term, intermediate-term, and long-term "trends", which sometimes yield conflicting current readings

When technical investors are poring over their charts, what are they looking for?  There are any number of signs to be divined by the chartists, but discovering the overall trend of a stock or a market is one of the most popular.  Studying moving averages is one of the most basic exercises of the technical analyst.  A moving average ("M/A") provides the price history of a stock or a market. Each analyst has his or her favorite time period for looking back.  The speculator or trader looking at an individual stock will create a chart showing an M/A for the stock over a set time frame.  One of the most basic of these is the 10 day M/A for a stock.

We will create a 10 day M/A for an individual stock since it is easily calculated.  It helps to have graph paper on which you can create a vertical line of price numbers and a horizontal time line.  Since you are calculating a number which is the average price of a stock over a given 10 day period, your graph will show only that one number (the average price) for the 10 days going backwards (the chosen time frame).  For our example, you will keep track of a stock's price over 10 consecutive days.  When you have prices for 10 days, add the prices up and divide by 10, which gives you your first average.  Note that on your graph.  Each day thereafter, you drop the price of the stock 11 days ago and add in the latest price.  You then recalculate the average for the new 10 day period and plot it on your graph.  Over time, as you do your daily calculations and add the results to the graph, you will start to see one of three trends:  the stock is going up, down or remaining unchanged.  Technical analysis holds that each of these trends can provide insight into where the stock price may be headed in the future.

Since you are creating your own chart, you can pick any time line for your average: 5, 10, 30, 45, 60 or 200 days or any other number of days of prices.  It is a personal decision as to how many days to use in creating your M/A.  Regardless of the number of days used, the exercise is the same.  You drop the oldest price, add the newest and average them.  There is a very good explanation of time periods to use when creating your own M/A on the website, Trading  It provides guidance on tailoring your graph to your investment horizon, which is the time period over which you expect to hold your investment.  If you will be speculating over the long term, an M/A of 200 days may be what you want.  It would be of little value if you are trading on a daily basis since it will not provide the immediacy you need.  Conversely, if you intend to trade or speculate over an intermediate period of time (45-60 days), a 10 day M/A does not give you the longer term chart your investment strategy may need.  

If the analyst is looking at an entire market, he or she looks to the Advance/Decline Line ("A/D Line"), which is the ratio of the number of stocks in the market going up compared with the number of stocks going down over a prescribed period of time.  If there are more stocks rising than falling, then the A/D Line is telling the chartist that the market is on the rise.  If the declines exceed the advances, the chart is indicating future declines.  We will be looking at the A/D Line in greater depth in a future blog.

You will note that I use the words "speculator" and "trader" in this blog; not "investor."  This is intentional, since, as I said in an earlier blog, technical analysis lends itself to short or intermediate periods of holding a stock.  For the long term value investor, market moves are seen as less important.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

Comments are always welcome.

Monday, December 12, 2011

Foundations of Technical Analysis


I have referred to fundamental investors as gold miners, digging for valuable nuggets of information on a stock and technical investors as hang gliders, riding the winds of market sentiment looking to profit from a stock's updraft or downdraft in price.  Technical investors are often referred to as "chartists" since they graph the action of the market and/or individual stocks.  They study their graphs of price movement and trading volume, looking for trends which reveal where market levels or an individual stock price might go (up or down) based on past performance. 

Technical analysis is grounded in economics.  I think that it also relies, arguably, on a  basic law of physics.  It is governed by the economic law of supply and demand first described in 1767 and borrows from one of the basic tenets of physics: Sir Issac Newton's first law of motion, published in 1687.

The law of supply and demand provides a model for analyzing what affects price in a market.  The rules apply regardless of what the item is; consumer goods, commodities, food, tuition for college, airplanes or financial investments.  If demand equals supply and buyers and sellers agree on price, the market is in balance, also called economic equilibrium.  If such is not the case, the law states that there are four possible outcomes, depending on existing circumstances in a market, for the price of anything for sale:

1.  If demand for the item increases (more buyers) and the supply of the item (how many are for sale) remains unchanged, the price will rise.
2.  If demand  decreases (less buyers) and the supply is unchanged, the price will decrease.
3.  If the supply of the item increases (more for sale) and the demand (number of buyers) remains unchanged, the price will decrease.
4.  If the supply decreases (less for sale) and the demand is unchanged, the price will rise.

Sir Issac Newton (1642/1643* - 1727) remains one of the most famous physicists of all time.   Since I had to take four years of Latin in high school,  I can't resist giving you his first law of motion in its original version:

Corpus omne perseverare in statu suo quiescendi vel movendi uniformiter in directum, nisi quatenus a viribus impressis cogitur statum illum mutare.

This is the scholarly version (during Sir Newton's time) of, "A body at rest tends to stay at rest; a body in motion tends to stay in motion, until it doesn't."  Technical investors believe that a stock price, whether rising or falling, will continue in that direction for awhile.  Their goal is to buy in early on the trend and sell out before it stops.  The moment in time at which the trend stops or changes direction is called the point of inflection.

I think the technical form of investing rests on these two principles. We will continue to explore this strategy in further detail in upcoming blogs.

Comments are always welcome.

* I use two dates for Newton's birth year since England's accepted form of annual calendar changed during his lifetime.

Monday, December 5, 2011

You Have to Follow The Money - What Is The Price?


Chartists map the action of the investment in which they are most interested.  This could be a particular stock, an entire market, a commodity or anything else with a readily available market price.  Al Frank was a self avowed value investor.  However, he admitted that he did pay attention to some technical analysis to improve the timing of his value investing.  He discussed some of the technical investing tools which he used in his career in his book, Al Frank's New Prudent Speculator.  To him, the following summarized technical analysis:

When an equity issue - a common stock, preferred stock, or master limited partnership - trades, only one of three things can happen with its market price.  At that day's close each issue can have advanced, declined, or remained unchanged in price compared to its previous close (not necessarily the previous day)...Advancing-in-price issues represent buying - or at least more buying than selling at the moment - on the basic notion that an excess of buyers over sellers (or greater demand than supply) tends to bid up prices.  Conversely, selling is represented by stocks declining in price.  On any given day the fluctuations represented by buyers and sellers often appear to be random, as orders pour in from all over the world, some to trade "at the market" (the current asking price) or at a price limit with the trader hoping to to get a better deal than the current bid or ask price of a sale or a purchase.

Notice the gentle jab Frank takes at Random Walk proponents.

There is a book which is considered by many to be the bible of technical analysis; much like The Intelligent Investor by Benjamin Graham is widely seen as the bible of fundamental analysis.  Technical Analysis of Stock Trends was coauthored in 1948 by Robert D. Edwards and John Magee.  Its 8th and 9th editions, both edited by WHC Bassetti, are still in print today.  Some consider the following excerpt from the book to be the all time best description of technical analysis:

The market price reflects not only the differing fears and guesses and moods, rational and irrational, of hundreds of potential buyers and sellers, but it also reflects their needs and resources - in total, factors which defy analysis and for which no statistics are obtainable.  These are nevertheless all synthesized, weighted and finally expressed in the one precise figure at which a buyer and seller get together and make a deal.  The resulting price is the only figure that counts.*

If you look back at the advice of the value investors, you will see that, for the most part, they recommend investing for the long term.  It seems to me that, given the daily movement of the market, technical analysis looks at a shorter time horizon.  It appears to be more of a tool for speculation, looking for a profit within days, weeks or months - not an appreciating investment over several years.  We will continue to explore this strategy in further detail in upcoming blogs.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

*Excerpt from Technical Analysis of Stock Trends, by Robert D. Edwards & John Magee, copyright 1948 by Robert D. Edwards & John Magee, page 5.

Comments are always welcome.



Monday, November 28, 2011

Conflicting Commentary on Technical Analysis


You may recall Burton Malkiel's discussion of some research done on technical investing in last week's blog.  He said that the results showed little, if any, correlation between past and future prices of stock.  So, we know that Professor Malkiel does not hold much store in technical analysis.  A proponent of technical analysis might, rightly, ask for more details about the scope of the tests.

Norman G. Fosback, a well respected investment adviser and co-founder of The Institute of Econometric Research, disagrees with him.  Fosback's enduring work, Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, was first published in 1976.  The twenty-second edition was printed in 1993.  In his book, Mr. Fosback took random walkers, such as Professor Malkiel, to task.  He criticized the academic studies on which their conclusions about technical analysis were based; writing that the research conducted by them was superficial and not done in sufficient depth to support their conclusion that market timing was of no value.  His research led to a different conclusion.  In referring to a table of daily price/volume relationships for the period 1965-1972 depicted in his book, he wrote:

The most important conclusions to be gleaned from the table are: (1) rising price is a relatively bullish portent for future price changes and falling price is relatively bearish; (2) rising volume is even more bullish and falling volume is relatively bearish; (3) rising price accompanied by rising volume is the most bullish of all and falling price accompanied by falling volume is consistently bearish.  Almost all price/volume tables created with alternative averaging and change parameters,  be they in terms of days or weeks, and the author has created dozens of them, show similar results and lead to identical conclusions.*

Based on his research, Mr. Fosback concluded that there was a correlation between historical price and volume levels with future price movement.

There are two types of research: deductive and inductive. The researcher either starts with a hypothesis and finds supporting facts (deductive) or starts with facts and finds the resulting hypothesis (inductive).  They are mirror opposites. Mark Twain popularized the statement, "There are three kinds of lies: lies, damn lies and statistics."  Depending on your level of cynicism, this may be one of the truest statements ever made.

I suspect that you can find research results to support just about anything you want.  As individual investors, we must decide what form of investing works best of each of us and stick to it.   Consistent application of an investor's chosen strategy is the only way to improve the results of his or her portfolio.

We will continue looking at technical analysis in the next blog.

* Excerpt from Stock Market Logic, A Sophisticated Approach to Profits on Wall Street, Norman G. Fosback, copyright 1976, 1993, The Institute for Econometric Research, page 148

As always, comments are welcome.



Monday, November 21, 2011

Technical Analysis - Hang Gliding / Burton Malkiel's Opinion


When I finished the blogs on fundamental analysis, I posted a blog with Professor Burton Malkiel's comments on this investment strategy from his excellent book, A Random Walk Down Wall Street.  We are about to start exploring the technical form of analysis, which  I referred to as "hang gliding" in an earlier blog.  To mix things up, this time I will start with his comments and then move on to books by proponents of this form of investing.

Although he describes it accurately, he does not have much respect for the technical form of investing.  This is how he described it: 

Technical analysis is essentially the making and interpreting of stock charts.  Thus its practitioners, a small but abnormally devoted cult, are called chartists.  They study the past - both the movements of common stock prices and the volume of trading - for a clue to the direction of future change.....Charts, of course, tell only what the other players have been doing in the past.  The chartist's hope, however, is that a careful study of what the other players are doing will shed light on what the crowd is likely to do in the future.

Malkiel referenced results of some research into technical investment rules.  He reported the following:

One set of tests, perhaps the simplest of all, compares the price change for a stock in a given period with the price change in a subsequent period.  For example, technical lore has it that if the price of a stock rose yesterday, it is more likely to rise today.  It turns out that the correlation of past price movements with present and future price movements is slightly positive but very close to zero.  Last week's price change bears little relationship to the price change this week, and so forth.  Whatever slight dependencies have been found between stock price movements in different time periods are extremely small and economically insignificant.  Although there is some short-term momentum in the stock market, as will be described more fully in Chapter Ten, any investor who pays transaction costs cannot benefit from it.

As I said, Professor Malkiel does not hold technical analysis in high regard.  Nevertheless, we will learn about technical investing in subsequent blogs and will return to A Random Walk Down Wall Street for more of Professor Malkiel's discussion of this strategy.

 The material from A Random Walk Down Wall Street by Burton G. Malkiel, copyright 1999, 1996, 1990, 1985, 1981, 1975, 1973 by W.W. Norton & Company, Inc is used with permission of W.W. Norton & Company, Inc.

Comments are always welcome.

Monday, November 14, 2011

Word Of Mouth - Stock Tips


Robert J. Shiller, in his excellent book, Irrational Exuberance, wrote about the innate human trait of sharing information, especially in person to person exchanges:

The human mind is the product of evolution almost entirely in the absence of the printed word, e-mail, the Internet, or any other artificial means of communication.  Human society has been able to conquer almost all habitats of this planet primarily because of its own innate information processing ability.  A fundamental component of this information processing ability is effective communication of important facts from one person to another.

This superior ability to communicate knowledge has been made possible over the past few million years by evolutionary changes within the human brain that have optimized the channels of communication and created an emotional drive to communicate effectively.  It is because of this emotional drive that most people's favorite activity is conversation.....The incessant exchange of information is a fundamental characteristic of our species.

Word of mouth transmission of ideas appears to be an important contributor to day-to-day or hour-to-hour stock market fluctuations, even though direct word-of-mouth transmission cannot proceed across the nation as fast as markets move.

Human communication is basically the sharing of knowledge; something that has been going on between people since language first developed.  Any time two or more people meet, they communicate; they pass information of one sort or the other.  In light of the inherent uncertainty in the market, individual investors are always open to information that is seen as reducing investment risk.  You must remember that any such information, regardless of how presented, can be only one of three things: fact, rumor or opinion.  

As human beings, we strive to learn things in order to reduce life's uncertainty.  As investors, however, we must resist the urge to act upon one form of communication:  the stock tip.  In the last post, we ended with the caution against gambling on Wall Street.  One type of market gambling is investing on a tip from someone.  Usually that person will claim some inside information; facts not generally available to the investing public at the time.  The investor needs to "go slow" when presented with a tip.  Facts and rumors can be checked out.  Opinion is just that, which makes it no better than an investor's personal analysis of a situation.  Opinions differ.  As they say, "That's what makes a horse race."  The investor must weigh the other's opinion against his or her own information.  If the tip is truly inside information, acting on it is illegal in the USA.  Investors can't hide their trades from the government computers monitoring the market.

Although recounted in an earlier blog about Philip Carrett's book, The Art of Speculation, I feel his advice on "inside information" is worth repeating.  Avoid "inside information" as you would the plague. Looking at the psychological aspects of "tips", Mr. Carret said that they appealed to an investor's vanity since such confidential news sets the recipient apart from the rest of the market.  He recommended that the investor view him or herself as being the thousandth rather than the first or second person to get the story.  Such lack of self pride would, in Mr. Carrett's view, be "well rewarded."

SHILLER, ROBERT J.; IRRATIONAL EXUBERANCE, copyright 2000 Robert J. Shiller, published by Princeton University Press, Reprinted by permission of Princeton University Press.

The The Art of Speculation by Philip L. Carret, remains in print today.

Comments are always welcome.

Monday, November 7, 2011

Who The Hell Are You? (2)


Having cleaned up the birthday cake crumbs from last Monday's anniversary blog, we pick up  the topic of investment vs. speculation from my October 24th blog.  We have seen how Philip Carrett and Benjamin Graham addressed the subject.  Al Frank in his book, Al Frank's New Prudent Speculator, wrote about the two words, but felt that the difference was more about semantics than investment strategy.  He cited a dictionary definition of speculation:

Engagement in any business transaction involving considerable risk for the chance of large gains.

In contrast, the same dictionary defined investment as follows:

The investing of money or capital for profitable returns.

Frank pointed out the absence of the words risk, chance or large gains in the definition of investment.  He wrote about this obvious bias: speculation = risky and investment = safe; a viewpoint with which he totally disagreed.  He explained his position as follows:

Right off, let us agree to a stipulated definition that all so-called investing in common stocks is a form of speculation.  I believe it is important at the outset, throughout the pages of this book, and indeed in our everyday thinking about the stock market, to be aware and admit that when we trade stocks or buy them for their long-term potential, we are speculators.

The point of this discussion is not to clarify the distinctions being drawn by these authors, but to suggest that you, as an individual investor, must ask yourself a question before you buy a security.  Regardless of how you may define the words, are you thinking like an investor, a speculator or a gambler?  In any event, whether you are looking for long term appreciation or quick profit, you should save the gambling for Las Vegas, not Wall Street.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

As always, I welcome your comments. 

Monday, October 31, 2011

Acknowledgements On A First Anniversary


I posted the first blog on Wall Street Smarts on November 1, 2010.  I have been gratified by the more than 2200 visits to this site in the past year by people in the following countries (alphabetical order):

Albania                                     Argentina                            Australia
Bangladesh                              Belgium                               Brazil
Canada                                    China                                  Croatia
Czech Republic                        Estonia                                Fiji
Finland                                     France                                Georgia
Germany                                  Greece                               Hong Kong
Hungary                                    India                                   Indonesia
Ireland                                      Italy                                     Japan
Latvia                                       Lithuania                             Malaysia
Mexico                                     Moldova                               Morocco
Netherlands                             New Zealand                        Pakistan
Philippines                               Poland                                 Portugal
Romania                                  Russia                                 Singapore
Slovenia                                  South Africa                         South Korea
Spain                                       Sweden                                Switzerland
Taiwan                                     Thailand                               Turkey
Ukraine                                    United Arab Emirates           United Kingdom
United States                           US Virgin Islands                  Yemen

An unexpected opportunity grew out of this endeavor.  I now share some of the blog material on WUWM, 89.7 FM, which is my local National Public Radio station, as a volunteer contributor on Lake Effect, a local morning program.

Heartfelt thanks to all of you for supporting my blog.  We will pick up from the last post next Monday.

Monday, October 24, 2011

Who The Hell Are You? (1)


Although I would probably be laughed at by most serious cinema critics, I like Arnold Schwarzenegger movies.  Arnold is best known for the Terminator trilogy in which he is a relentless robot from the future; however, in one of his lesser known roles, he played a special ops commando battling an alien in the 1987 sci-fi movie, Predator.  At the end of the movie, he, of course, has defeated the grotesque alien.  Standing over the dying creature, he asks it, "Who the hell are you?"  The extraterrestrial, with its last dying breath, looks at him and repeats the question back to him.  Schwarzenegger's character survives the subsequent explosion and lives to fight another day.

You should ask yourself that very same question with respect to your investment strategy.  In your forays into the stock market, are you an investor, a speculator or a gambler?  Philip Carrett, Benjamin Graham and Al Frank each discuss these distinctions in their books.

I posted the following excerpt in my April 4th blog, but it is worth repeating.  Philip Carrett viewed investors, speculators and gamblers on a continuum.  In his book, The Art  of Speculation, he distinguished between them as follows:

"Your articles deal with speculative investments rather than with speculation." said an astute observer of both fields of activity when he had read the greater part of this book in serial form.  To this charge the writer was forced to plead guilty.  After all, it is by no means easy to draw the line between investment and speculation, between speculation and gambling.  If one is to discuss the topic of speculation and perhaps induce some readers to attempt it who might otherwise have left speculation alone, it is much more helpful to the average reader, much less dangerous to the reader who might misinterpret what he reads, to discuss the sort of speculation which is on the borderland of investment than the more dangerous and less useful type of speculation which borders on gambling. *

Mr. Carrett believed the difference between investment and speculation was the investor's motive.  Was the investor looking for quick profit (speculation) or for long term appreciation (investment)?   

Benjamin Graham was strict in his distinction between investment and speculation.  In the opening paragraphs of The Intelligent Investor, he said:

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.  Operations not meeting these requirements are speculative. **

He did concede that there could be intelligent speculation as well as intelligent investment; however, he did not waiver from the differences he saw between the two forms of market operation.

Next week marks the first year of this blog, so there will be a special post.  In two weeks, we will see how Al Frank distinguished between investing and speculating.

* Quote from the edition of The Art of Speculation by Philip L. Carret published in 1995 by Fraser Publishing Company.

** Quote from the revised edition of The Intelligent Investor by Benjamin Graham published in 2003 by HarperCollins Publishers.

Comments are always welcome.

Monday, October 17, 2011

Fundamental Analysis - The Gold Miners


You may recall my blog, Gold Mining, Hang Gliding and Power Walking.  We started exploring fundamental analysis, gold mining, in April of this year.  We have looked at Philip Carrett's work, The Art of Speculation; Benjamin Graham's classic, The Intelligent Investor; Al Frank's book, Al Frank's New Prudent Speculator; Philip Fisher's Common Stocks and Uncommon Profits, among others.  If you consider how many financial characteristics they all mentioned, you can probably come up with a fundamental formula for your own investment strategy.  Here are some of the consensus ideas:

1.  Buy companies, not stocks.  They all agreed that investing should be conducted in a business like manner; based on financial facts, not emotion.

2.  Diversify.  Each author suggested investing in a number of companies.  Al Frank recommended that no one stock should account for more than 5% of an investor's total equity portfolio.  Mathematically, this means that a well rounded portfolio would hold approximately 20 stocks in different industries.

3.  Earnings and dividend growth.  Everyone recommended companies with histories of, at least, three and, preferably, five years of both earnings and dividend growth.  Philip Fisher looked for companies with earnings which exceeded the market's overall earnings growth.  When looking at dividends, the investor must also check the payout ratio, i.e., how much of each dollar of earnings is distributed to shareholders.  A lower percentage indicates that the dividend is safer than the dividend of a company which distributes a large percentage of its earnings to its owners.

4.  Low debt and high return on equity.  When hard times hit, the company with a small percentage of debt in its capital structure has a better chance of weathering the down turn.  Although they do not all agree on an acceptable amount of debt, you get the sense that a company whose capital consisted of 70% equity and 30% debt would be one that these investors would consider a solid investment opportunity.  A return on equity (ROE) of 20% is considered a sign of a good company.

5.  Avoid a high price/earnings (P/E) ratio.  The lower the P/E, the cheaper the stock's earnings.  The P/E measures how much an investor is paying for each dollar of earnings.  David Dreman pointed out that a high ratio is usually an indication that the market crowd has taken over and the price is being bid up based on frenzy, not finances.  Some companies might deserve a low P/E due to poor performance or business prospects; so an investor can not rely solely on this ratio.

6.  Be patient and invest long term.  All of the authors recommended viewing investments as long term commitments.  Warren Buffett said his time line for holding a stock was "forever."  Al Frank cited research that concluded that the volatility of the market is taken out of play if an investor holds his or her stocks for years, not weeks or months.  He referred to this as time diversification.  Each one also counseled investors to maintain patience, ignore market gyrations and stick with their investment strategy.

With this summary, we conclude our study of fundamental analysis.  Reading the books written by these investment greats will provide an individual with the necessary information with which to formulate his or her personal fundamental investment strategy.

Comments are always welcome.  I just published and replied to two recent comments from readers; one of which commented on Stocks and Used Cars.  The other one was a comment on On-Line Brokers:  Stock Screens and Stock Research.

We investigated the "Inner Investor" in earlier blogs.  In the next blog, we will look at a topic related to an investor's personality.

Monday, October 10, 2011

Peter Lynch - Finding Investments At Home


We have discussed finding promising companies using stock screens and stock research reports in the last few blogs.  This is the typical way a fundamental investor would find new investment opportunities.  You could call this the "top down" method, i.e., start with a universe of stocks and whittle the list down to a few companies which meet the investor's financial metrics.  The other method could be described as "bottom up."

Like Philip Fisher before him, Peter Lynch is a growth investor.  Mr. Lynch was the portfolio manager for the Fidelity Magellan mutual fund from May, 1977 to May, 1990.  During his legendary career, he posted market leading returns for his fund investors year after year.  It has been calculated that if someone had invested $10,000 in the Magellan Fund in 1977, by 1987 the money would have grown to $190,000, an enviable return by any calculation.  This outstanding performance resulted in the Fidelity Magellan Fund growing from $20,000,000 when he took over in 1977 to $14,000,000,000 (yes, you read that right - 14 billion dollars) when he retired exactly thirteen years later.  At that point, it was the largest stock mutual fund in the world.

Mr. Lynch wrote his best selling book, One Up On Wall Street, in 1989 with noted financial writer, John Rothchild.  Although a poster boy for Wall Street success, Mr. Lynch tells his readers that individual investors have an advantage over him and other Wall Street professionals.  He opens his book with the following:

This is where the author, a professional investor, promises the reader that for the next 300 pages he'll share the secrets of his success.  But Rule number one, in my book, is: Stop listening to professionals!  Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks as well, if not better, than the average Wall Street expert.

In an conversational manner, Mr. Lynch writes about the highs and lows of his career and explains why the individual investor can win over the professional investors.  His advice is to look around you and find the companies whose products or services you use or are familiar to you.  News of how well a company's new product or service is doing might not reach Wall Street, in many instances, until well after the company's stock has started to rise as a result. 

His best example concerns L'eggs.  I do not know if they are still being sold, but L'eggs were panty hose packaged in plastic eggs and displayed on racks in grocery stores in the nineteen seventies.  Mr. Lynch explains that the manufacturer of L'eggs realized that women went to department stores to buy their stockings only once every six weeks.  However, they found that these same women went to the grocery store usually twice a week.  L'eggs remains one of the most successful products of its era.  Mr. Lynch points out that he did not discover this investment opportunity; his wife did.  She told him about the product and he found out that Hanes was the company which came up with this unique selling concept.  He did his research and discovered that the company was financially solid.  His investment in Hanes stock turned into a "sixbagger", Mr. Lynch's term for a stock whose value increased sixfold.

This is what I would call "bottom up" stock research.  Surely there are products or services you buy all the time without thinking about it.  You use the product or service on a regular basis and are a satisfied customer.  Well, maybe there are several million (or billion in this global economy) other folks who agree with you.  You start with a good product or service.  You then identify the manufacturer or service provider and research the company if it is publicly traded.  If the company meets your fundamental investment requirements, buy the stock!

I know an individual who had a bout with cancer several years ago.  Fortunately, his form of cancer was very treatable.  His doctor recommended daily radiation treatments for a couple of weeks.  Every day, he climbed up on a moving table and was run through a radiation machine.  He noticed the brand of radiation machine and checked out the company.  This story has a happy ending.  Both he and the company's stock, which he bought, are doing fine more than seven years on.

One Up On Wall Street has gone through several editions and is still in print.  You will find it to be as entertaining as it is informative.

Comments are always welcome.

Monday, October 3, 2011

S&P's Take on Coca Cola (2)


We will pick up with page four of the the August 27, 2011 Standard & Poors (S&P) report on The Coca Cola Co. (stock symbol - KO).  Let me repeat that I am neither suggesting that you consider this company as an investment nor recommending that its stock is a buy.

Page Four  This page is devoted to the soft drink business, which is referred to as a sub-industry of the Consumer Staples category of business.  Analyst Esther Y. Kwon, CFA discusses the soda business in her Sub-Industry Outlook.  Accompanying her analysis is the Stock Performance for soft drinks, comparing it to Consumer Staples and the S&P 1500 Index, which shows month-end price performances of KO from 2007 through July of 2011.  Below this is data on Coke's peer group, which includes several Coca Cola bottling companies, Dr. Pepper, Pepsico and others.

Page Five  This page contains what is termed S&P Analyst Research Notes and other Company News, which includes reports and announcements about Coke going back to February, 2011.

Page Six  This page is devoted to reports on the way Coca Cola is viewed by the Wall Street analysts who cover the companyThe page starts with a review of Analysts' Recommendations of Buy, Buy/Hold, Hold, Weak Hold and Sell going back to 2009.  It lists the number of analysts covering Coke and its stock price.  The page also contains the Wall Street Consensus Opinion of Buy/Hold and a list of the research companies in addition to S&P offering coverage of Coke.  The page also includes Wall Street Consensus Estimates for earnings for 2011 and 2012.

Page Seven  On this page S&P provides a Glossary of various financial measures contained in the previous pages, including S&P Stars, S&P Core Earnings, its Qualitative Risk Assessment, S&P Quality Rating and more.  This page describes S&P's proprietary modeling systems such as the S&P Fair Value Rank, Fair Value Calculation and Investability Quotient, among others.

Pages Eight, Nine & Ten  These pages contain what could be called the "fine print", S&P's disclosures and disclaimers concerning its report on Coke.

The fundamental investor will find in this report most, if not all, of the investment data and financial statistics on The Coca Cola Co. he or she might need in order to analyze the company.  Based on this information, the individual investor can decide if KO's stock meets the investor's qualifications for a good investment opportunity based on the investor's personal investment strategy.  To make an investment in a stock without reviewing a report such as this one is the same as embarking on a cross country car trip without maps or GPS; in either event, the person ends up lost.

S&P reports, like this one on Coke, provide the individual investor with the same sort of data used by Wall Street analysts.  It goes a long way toward providing a level playing field for individuals when they compete against Wall Street professionals in the market.

Comments are always welcome.

Monday, September 26, 2011

S&P's Take On Coca Cola (1)


To start, I need to make an important point.  In no way am I recommending Coca Cola as an investment opportunity or a good stock to buy.  I picked this company because, as I said in the last blog, I suspect that this blog's visitors from around the world have all had a Coke at one time or another.  My can of Diet Coke sits on the desk as I post this.

With that disclaimer out of the way, let's look at the August 27, 2011 Standard & Poors (S&P) report on The Coca Cola Co. (stock symbol - KO).  Hopefully you were able to obtain a copy, which will make it easier to follow my description of the ten page report.  I am going to give only a brief description of each page.  I am not going to review the information in the report in detail.

Page One  The S&P recommendation (5 star - Strong Buy), current price ($68.50 as of Aug. 26th), twelve month target price ($79) and a description of KO's investment type (Large-Cap Growth) are at the top of the page.  The next section gives Key Stock Statistics, such as the stock's 52 week range, trailing twelve months (TTM) earnings per share (EPS) of $5.37, TTM price/earnings (12.8) and additional information which would be of interest to the individual investor.

This page contains a price performance chart going back to 2008, which graphs what KO's stock has done over the last few years.  These statistics are flanked by S&P's Qualitative Risk Assessment, which shows that S&P considers the company relatively stable.  Coke receives a Quantitative Evaluation of A+ and a Relative Strength Rank of strong.   The Highlights of the company and the Investment Rationale/Risk prepared by the analyst, Esther Kwon, CFA, are located beneath the Price Performance Chart.  To the right of this analysis are Revenue and Earnings Data going back to 2006.  The section on Dividend Data for the previous four quarters is just below that.  Quite a bit of information is provided on just this first page of the report.  It would take an investor a lot of time to ferret out this data on his or her own.

Page Two  This page contains the analyst's Business Summary.  Next to this summary is Corporate Information including the company's address, telephone number, Executive Officers, Members of the Board and additional facts about KO.  Coca Cola, like most companies, has an individual listed as the Investor Contact.  When I look at a company's S&P report, I sometimes call that company's investor contact with questions.  I have always found the contact person to be cordial and helpful, willing to answer my questions, subject to securities laws restrictions.  Don't expect to get any insider information.

Page Three  Here is the most sought after information for the fundamental investor.  At the top of the page are S&P's Quantitative Evaluations of the company including its Fair Value Rank and Calculation for KO, the company's Investibility Quotient Percentile, Volatility, Technical Evaluation and Insider Activity.  Next to this section is the Expanded Ratio Analysis which provides the price/sales ratio, the price/EBITDA ratio, the price/pretax income ratio, the price/earnings (P/E) ratio and the average diluted shares outstanding for the years 2007 to 2010.  An investor may consider one or more of these ratios significant in his or her personal investment strategy.  It would take a good deal of time for an individual to determine them with a calculator.

The lower half of page three contains a lot of data titled Company Financials.  This section includes per share data, income statement analysis, balance sheet and other financial figures for the past ten years.  This is a treasure trove of information for the fundamental investor.  The individual investor will find all of the data he or she may need in order to decide if KO might meet the investor's requirements for a good investment.

We will continue our review of S&P's report on The Coca Cola Co. in the next blog.

Comments are always welcome.

Monday, September 19, 2011

On-Line Brokers: Stock Screens and Stock Research


When we completed our stock screening in the last blog, Stock Screen (2), we were left with 64 possible investments.  Since the screen was pretty basic and for illustration purposes only, we won't bother looking at the companies with these rudimentary financial characteristics.  On the other hand, it is worth exploring the next step an individual investor must take in order to find the investment candidates to consider in making his or her final buying decision.  The computer saved us quite a bit of time, but now an investor must spend that time reading.

Many companies produce stock market and individual stock research; however, their reports are not free to the public.   Standard & Poors (S&P) and Value Line are two well known US research companies.   Although their websites provide information and commentary, an investor must subscribe in order to receive stock reports.  Such research companies sell their reports to individual investors and to stock brokerage companies.  In order to access them at no charge, the individual investor must establish an account with a brokerage firm.  Obviously, this is not a real issue since the investor has to do this anyway in order to place buy and sell orders in the market.

I recommend that the individual investor open his or her account with an on-line broker in order to save trading fees and expenses.  Most of them have a fixed trade fee, which is usually less than $10 per transaction.  Some of the well known US on-line companies are Charles Schwab, E*Trade, TD Ameritrade and Scott Trade.  I assume these companies offer their services over the internet to investors in other countries.  There may be similar on-line companies in other countries around the world since stock trading is such a global business.

All of these on-line firms have a link on their websites which will send the investor to their research tools.  Those tools include stock screeners, third party stock reports, such as those published by Standard & Poors, and research reports provided by the broker.  I have not seen the Value Line reports offered by any brokerage firm I have used; however, they are available at most public libraries.  For no cost, the investor can set up a stock screen with the investor's requirements and then review reports on the matching companies identified on the screen; all without leaving the broker's website.  In the last blog I also provided a link to the Google stock screen site, which is also free.

I have been gratified by the number of viewers who have read this blog.  Since I started posting in November of last year, over 1,700 people from more than 40 countries have visited this site.  I can think of only one product which is undoubtedly familiar to all of them.  In next Monday's blog, I will describe the contents of an S&P report on a publicly traded company with a truly global product, Coca Cola.  If you have access to S&P reports, either through a broker or, maybe, at your local public library, try to get a copy of their August 27, 2011 report on KO, the company's stock symbol.  It will be more informative to follow my review if you have a copy in front of you.  It's your choice if you want to have a Coke as you read.  It is said that Warren Buffett's favorite drink is Cherry Coke.

Comments are always welcome.

Monday, September 12, 2011

Stock Screens (2)


We explored the general idea of stock screens in the last blog, Stock Screens (1).  Essentially, stock screening is a process of elimination.  With each new metric you add, the number of companies meeting your requirements is reduced.  This is the first research step for a fundamental investor.  For this blog, I will set up a stock screen and report how it winnows the number of stocks available in the market down to stocks I might want to research further.  I will use the stock screen option offered by my on-line brokerage company.  The different criteria I set for my screen will be identified in bold.

I will start by selecting the stock exchanges I want to search.  Under Basic Criteria I will choose the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), the NASDAQ and the over the counter market (OTC).  That results in a total of 7,029 stocks.  There are other types of Basic Criteria I could add, but I'll just use exchanges for illustration purposes.

Although I do my own stock research,  I know that many investors rely on what research analysts have to say.  Therefore, I want companies tracked by Wall Street since it is hard to make money on a stock if nobody has heard about it.  It helps if analysts follow a company and bring it to the attention of the investing public.  I will add Analyst Ratings, specifically, the Standard & Poors (S&P) Earnings and Dividend Rankings.  I want to see companies rated from B to A+ by S&P.  I pick this range of ratings solely for purposes of example.  An individual investor must decide what, if any, rating level to use in limiting his or her search.  This reduces the number of stocks to 1,417 companies meeting just these two requirements.  Similarly, I will select Analyst Coverage and set it at a minimum of five analysts covering the companies.  This reduces our group of companies 897.  At this point, the screen is not identifying specific companies, just the number meeting the three criteria I have set so far.

Now I look at Company Performance.  I set two categories in this section: Revenue Growth History for the past five years and Earnings Growth History for the same time period.  I choose a minimum of a 15% growth rate.  A Revenue Growth History of 15% or better lowers the number of companies to 193 and a similar requirement for Earnings Growth History drops the number to 103.  As you can see, the number of companies is lowered with each new financial metric I add.

The next available criteria is Price Performance.  Since I am just trying to narrow the field of companies to look at, I am not going to pay any attention to price at this point.  If price is a factor, I can look at that once I have my list of companies.  Therefore, I do not select anything from this section.

The sixth general criteria I will look at is Valuation.  Here is where we can pick companies with the ratios discussed in the books on fundamental analysis we have previously reviewed.  To keep things simple, I am going to select only one; the price/earnings ratio for the trailing twelve months (TTM).  I will set it at 20 or below.  This reduces our field of stocks to 72.

I now limit my search based on Financial Strength.  This field includes quite a number of criteria, but, again, I am going to choose only one; a return on equity of 20% or better.  The resulting number is now down to 64 companies meeting all of the measures I have established so far.

The final section is Technicals, but since we are approaching this exercise as a fundamental analyst might, I will skip this section.

My final step is to hit the "View Matches" button.  The stock screen provides a list of the companies matching my criteria and providing specific criteria information for each company.  How much easier can it get?

Although the screens provided by brokerage houses are very comprehensive, there are also some basic stock screening programs available on line.  These are provided at no charge.  If you wanted to experiment constructing your own screen, you could go to  To set up your own stock screener, use the "Add Criteria" button on this screening site.

Next week, we will discuss what to do after you have your screen list of possible investment candidates.

Comments are always welcome.

Monday, August 29, 2011

Stock Screens (1)


The computer has changed the landscape of stock analysis.  Instead of the drudgery of searching through reams of printed information to find stocks with desired financial strengths and ratios,  an investor can access and create computerized stock screens to identify companies which meet his or her requirements.  Most, if not all, brokerage companies with an on-line presence provide their customers with this time saving tool at no charge.  Individual investors can create their own screen, setting it up with his or her desired financial characteristics and save it for future reference.

If, for example, the investor wants a list of companies traded on the New York Stock Exchange (NYSE)  with market capitalization of two billion dollars or more; annual earnings growth of not less than 15%;  paying a dividend of not less than 2% per annum, and trading at a price earnings ratio of not more than 15, then he or she enters these requirements and the screen will find those publicly traded companies which meet them.  Value, growth and contrarian investors can adjust the screening requirements to fit their particular investment strategies and press the "enter" button for the results.  In seconds, a list of investment candidates appears on the screen.

In setting up the screen, the investor can establish the stock exchanges to be searched: the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), the NASDAQ, and the over the counter market (OTC) or all of them.  If the investor were to choose all of them, the universe of stocks to be screened would include over 7,000 companies.  The level of market capitalization (stock price multiplied by number of traded shares) can be established.  The investor can limit the screen to companies in a particular industry.  The screen can search for companies paying a dividend with a specific yield or trading at a certain price limit.

A screen can be programmed to search for companies with preset analysts' ratings.  The investor can set the screen to look for companies with histories (up to five years) of desired revenue and earnings growth rates or with analysts' revenue and earnings estimates going forward.  If the investor wants to focus on price, various standards can be established, including the price performance of a company when compared to its industry or to the S&P 500 index.

Valuation ratios can be established, such as price/earnings, price/book or price/sales.  Of particular importance to investors looking for dividends would be the dividend payout ratio.  This ratio measures what percentage of a company's earnings are paid out annually to shareholders in dividends.  The lower the ratio, the better the chances that the company should not have to reduce or suspend its dividend payments in the future.The screen can be set for various tests of financial strength such as ratios for debt to equity, return on equity, quick and current ratios and cash flow per share, to name just a few.

There are also various settings for technical measures of a company, but these would, typically, be of little interest to a fundamental investment strategist.  In the next blog, we will run a test screen with some metrics and see what happens.

Comments are always welcome.