• Monday, May 27, 2024
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Stock-picking strategies (2)


Knowing the company management

A vital part of qualitative fundamental analysis is the management of the company. You should ask the following questions concerning the management. “Who are those at the helm of affairs of the company? Who is the chief executive officer? Who is the chief financial officer? Who are the vice presidents? Also, you should ask where these people come from especially their educational and employment backgrounds. Then you need to find out what the management philosophy is and when they took over helm of affairs in the company. Also important is why these people have been selected as managers of the company.

What drives the company?

In addition, you should be interested in knowing how the company makes money, that is, the nature of its business. Knowing how a company’s activities will be profitable is fundamental to determining the worth of an investment. If you aren’t sure how your company will make money, you can’t really be sure that its stock will bring you a return.

Knowing the industry in which the company operates would enable you determine the growth potential of your investment. A mediocre company in a great industry can provide a solid return, while a mediocre company in a poor industry will likely take a bite out of your portfolio. For instance, the Textile Sector suffers from numerous challenges including power; as such an investment in this sector is not expected to generate as much returns compared to investment in a company quoted in the Food/Beverages & Tobacco Sector where demand for these products are continually on the increase.

A company which has a higher market share can take advantage of economies of scale to stifle smaller companies while a valuable brand name also helps a company to stand out from its competitors.

In all of these, you do not need a PhD in Finance to identify a good company. When you see a little known company doing well and expanding, ask around, for you never know the growth potential inherent in the company.

Technical analysis & stock-picking

Technical analysis involves selecting a stock based on analysis from past trends recorded in the stock. Some of these trends may include price, volume, market activity and so on. The rationale for technical analysis is that past performance symbolises future performance, which may not necessarily be true.

Technical analysis is not a long-term strategy, rather it is a strategy adopted by investors who desire to capitalize on fluctuations in trends in order to post short-term profits. Technical analysts are usually very short term investors and are guided by a set of principles which enable them to make their decisions. Some of these decisions include – setting entry and exit prices, stop-loss prices and support and resistance levels.

Technical analysis unlike any other stock-picking strategy – has its own set of concepts, and it relies on a completely different set of criteria than any strategy employing fundamental analysis. However, regardless of its analytical approach, mastering technical analysis requires discipline and know-how, just like any other strategy. You should consider your investment options including your holding period before you make a decision on a stock using technical analysis since it is a purely short-term strategy.

There is however no completely consistent strategy for selecting stocks. Depending on your investment objective, it is necessary to consider all of these strategies in unison and not in isolation. Fundamental analysis should rightly be your starting point while following through with other strategies.

Let me close this discussion with CANSLIM strategy as described by William J O’Neil in the book How to Make Money in Stocks: A Winning System in Good Times or Bad.

What is CANSLIM?

Each letter in CANSLIM stands for common characteristics that are found in the greatest stock market leaders over the past 50 years.

C: Current earnings per share

This figure can be found in the company reports (quarterly). It tells you how much profit the company has made for each share given to its shareholders. As per this strategy, earnings per share should at least increase by 15-18 percent every year.

A: Annual earnings

That is, the net profit made by a company. This should have increased by 15-25 percent or more consistently for the last three years. Annual earnings can be found in the company Annual Report

N: New management/services or products

The company should be under new management (the management should have new strategy), have a new product or have a new service.

S: Shares of common stock outstanding

As far as possible, this figure should remain small. It tells you how many shares a company has issued to investors like you. If this figure is small, the earnings per share discussed above increases. One can get this number after a look at the company’s balance sheet.

L: Leadership

The company should be a leader in its industry, or at least in the top three positions in the sector/ industry/ segment it operates in.

I: Institutional sponsorship

Look at the institutions that are buying this particular stock or holding this stock for a sufficiently longer period. If well performing institutions (Pension Funds, Mutual Funds or other Institutional Investors) are holding your stocks, then your chances of making money are good.