Hey friends. My (Part I) post on the subject matter was several weeks ago. Today’s post concludes this discussion.
Hindsight is, of course, 20/20. A stock chart reflects what’s in the rear view mirror. To the degree past prevalent behavioral patterns toward stock buying and selling are repeated in the future, a stock chart may indeed provide some predictability of future stock prices. As discussed last time, my personal focus for investment decisions is to use available fundamental data coupled with management commentary toward a company’s fundamental outlook in order to define true value of a business and, from that, extract a true (fair) value per share of ownership — that is, a per share stock price. After doing the needed fundamental analysis, a stock chart can provide additional color toward, for example, setting the exact prices when buy or sell limit orders are placed.
In my view, the stock market cannot be consistently “timed.” No fundamental or technical approach can time unexpected “news” from a company — or even the market’s wild mood swings.
Good businesses should be undervalued when bought and held until let’s say “not undervalued” as opposed to saying until “fully” valued. Defining “fully” valued is more abstract than defining undervalued as fully valued encompasses a present value assignment to a future stream of earnings. Of course, the future is uncertain; thus “fully” is impossible to define beyond a good ballpark attempt. This “fundamental” analysis does not guarantee positive outcomes but is structured intuitively for rational success. I think even a person completely bent on the superiority of technical analysis (trading) might concur that fundamental analysis would be a less stressful approach since it doesn’t demand the same level of constant monitoring of stock price movements as does following chart patterns to determine buying and selling decisions.
See you next time.
It would seem that most value stocks decrease in price significantly prior to them being undervalued based on the balance sheet and future earnings potential. I have seen many technical traders buy stocks just because they are making new highs and forming “patterns.” Do you think that many technical traders fail to buy undervalued companies because they interpret recent price upswings as a signal to buy? If most undervalued stocks have been dropping significantly, does that mean they are off the radar for technical traders, which could be a major cause for their inability to buy value and realize good returns?
Ian, most technical traders I know will tell you they don’t pay much attention to company fundamentals and almost strictly make trading decisions based on recent price activity. That is, the basis for “technical” decision-making is analysis of recent stock price behavior relative to various technical indicators. However, for an investor, stock price alone tells you very little. Only by relating various fundamental characteristics of the company itself can you analyze the underlying company fundamental value. For example, every company is going to have its own number of shares outstanding. If two oil companies (call them company A and company B) both trade for $25/share, they may have radically different market valuations. Company A might have 10 million shares outstanding while company B has 100 million shares outstanding. Thus, company A is being valued by the stock market at $250 million while company B is being valued at $2.5 billion. By relating the stock price to the balance sheet composition, we can learn a lot. It’s really not possible to generalize with regard to your specific questions. For instance, if a fundamentally sound company is “out of favor,” technical traders may be profiting on the “short” side — that is, selling into the wave down and exacerbating the situation by “shorting” (borrowing shares to sell, betting on the price to continue downward, then buying back or “covering” the shares borrowed to derive a profit.) Again, there are too many possible scenarios to generalize. Every company is unique and has to be analyzed in its own context.
Paul –
Interesting point, you raise.
Every stock that crashes, I evaluate the stock in terms of its price-exponential moving average, using the average of the last 52 weeks. Almost always, PEMA signaled danger.
Just this week Bed Bath & Beyond made news. The price action signaled danger four years ago when the stock was in the mid-$60s. Today’s price: under $11.
Dutch investment manager Robeco says price action is one of the most persistent sources of alpha, based on a study of four asset classes since 1800.
Also, I copy and past charts of Wall Street’s extreme losers into a Word document, and almost always the PEMA warned to get out or lighten up before the waterfall.
A last point – Although I am a fundamental-value investor, I have learned to use price action to hold a stock longer, for maximum profits. I have sold many stocks after making a double because they seemed expensive, only to watch them climb much higher in price.
Hewitt,
It is very good to hear from you and I hope my response finds you doing well! Your comment is very insightful and helpful. Thank you.
I’d like to assure readers of my blog see your comment(s) about PEMA as a red flag and how stock price action impacts holding decisions. If it’s okay, I’ll include your remarks as a quote in the next blog post.
It seems there’s always another layer to the onion of investing to peel back — always something yet to factor in; another way to use information. Again, your comment is much appreciated.
It’s so clear that investor sentiment plays such a role in “what” valuation market participants will eventually assign to a business. I’m surely no artist in this arena and appreciative of what can be gleaned from an intuitive look into that sentiment. Your comment really adds something today!
Paul
This thought isn’t completely related to technical analysis but rather price performance coupled with fundamentals. Paul, I know every stock is unique and a case by case scenario, but what’s are your thoughts about rebalancing a portfolio according to the price performance of individual stocks. For example, if I own 5 stocks that are below their adjusted floor price in a strong industry with good future earnings growth, two of the stocks have risen in price significantly, while the others have had small profits and losses, would selling the strong performers and using those profits to buy the underperforming stocks be sensible? This is assuming that the balance sheet is still quality and the earnings and industry prospects are decent. Since the decision to sell is rather difficult and based on future earnings, I thought this may be a solution to enter and exit stocks closer to their respective highs/lows.
Thanks,
Ian
Yes, it’s intuitively sensible, Ian. Rebalancing is an ongoing activity. Ranking the strongest prospects is important. Two companies of equal deep value based on assessment of the latest balance sheet equity composition but of unequal performance outlook would not be equally ranked. It would make sense to weight the one with the stronger outlook higher and invest a larger percentage of capital into that company. As a company’s performance translates into higher stock price, it makes sense to take some profit and reallocate to ones that intuitively have better upside and (now) lower risk. Much judgment is certainly involved in rebalancing. But capital rationing is part of investing. Indeed, the economic notion of translating scarce resources into maximum potential (results) comes into play. Thus, taking some profit in strong performers and using that capital to acquire undervalued companies with yet-to-be rewarded solid performance catalysts is sensible in my view. I’ve been doing it for years. But the relevance of “uniqueness” is still applicable because what is “sensible” in theory becomes more difficult in practice as judgment of qualitative factors about one business vs. another is reality and part of the rebalancing process. And there’s no substitute for experience and practice in developing that judgment.
What you are seeking to understand is commendable. Not only are companies unique (management aversion to risk is different, for example, and this impacts virtually everything that happens with that business) but individual investing strategies are unique too since individuals respond to risk and change with regard to investments differently. So, finding that niche strategy that works for you is key. It should be fundamental (in my view) at is source and I wrote my book about this in a “how to” form that rested primarily on the concept of balance sheet equity composition. But its day to day application will be honed via practice to become your personal strategy. Again, working through the logical aspects of risk and return is commendable. Why? Because the application format (strategy) that ultimately fits for “you” will come out of the fundamental understanding behind your practice.
Thanks for all of the superb responses Paul! 🙂