This section covers basic approaches used to determine which stocks/industry/markets to buy, when to buy them, and when to sell them. It corresponds to the Implementation stage of the Portfolio Management. The approaches are often classified into fundamental, technical analysis or a combination of the two. At the conclusion of this unit, students should be able to:
-Use fundamental analysis approaches to identify buy and sell signals
-Utilize the CANSLIM approach to identify stocks to buy
-Utilize stock screens to identify potential stocks to buy or sell/short sellThis unit section is divided into several parts.
• The first presents definitions and briefly discusses issues that are of interest to the typical participant in the stock market.
• The second section includes a discussion of fundamental analysis,
• The third concentrates on technical analysis.
• The fourth section presents specific examples of approaches.
• This is followed by a section on stock search and tools available to perform searches.
I. Introduction and Definitions
Fundamental and Technical Analysis are approaches to determine:
(1) Which stocks to own and
(2) When to buy and
(3) When to sell these stocks
It is important to underscore the necessity of making a decision on when to sell a stock prior to buying it. Many of the losses in the stock market are due to the fact that a stock is owned even when the conditions that formed the investor’s decision to buy have changed.
Fundamental analysis is based on the premise that the price of a stock is the net present value of all future dividends. This value is estimated by an investor based on variables such as sales, growth rate, quality of management, expected growth of the industry and its potentials. Technical analysis is an approach based on the premise that certain market data such as price movements, volume, and open interest can help predict future trends (future, often short term, prices of a stock).
Some argue that the efficient market hypothesis makes it futile to attempt to search for stocks regardless of the approach used (technical or fundamental). The efficient market hypothesis (EMH) is an idea partly developed in the 1960s by Eugene Fama, and it states that it is impossible to beat the market because prices already incorporate and reflect all relevant information. As such, under the efficient market hypothesis, any time one buys and sells securities, one is engaging in a game of chance, not skill. If markets are efficient and current prices always reflect all information, then there is no way one will ever be able to buy a stock at a bargain price. This is a highly controversial and often disputed hypothesis, and is covered elsewhere in this course.
While supporters of EMH believe it is pointless to search for undervalued stocks or try to predict trends in the market through any technique (fundamental or technical analysis), others believe that it is possible to outperform the market . For example, value investors and technical analysts believe that it is possible to outperform the market, and many real life examples favor this belief. As such a new approach in finance, behavioral finance, evolved. The main argument used by the supporters of the new approach is that many investors base their expectations on past prices, past earnings, track records, and other indicators. Since stock prices are largely based on investor expectation, it only makes sense to believe that past prices do influence future prices. .
The terms investors, traders, day-traders and swing-traders are not used in the first few paragraphs of this write-up on purpose. All four terms refer to people who attempt to make money in the stock market. Though there is no “agreed upon” definition, the terms often stand for the following:
• Investors are individuals who use fundamental analysis,
• Traders are individuals who use technical analysis.
• Day-traders: Day trading refers to the practice of buying and selling financial instruments within the same trading day such that all positions are usually closed before the market close for the trading day. Traders that participate in day trading are called active traders or day traders. That is a typical day-trader buys at the beginning of the day and sells at the end of the day, thus ending each day with no money in the stock market. Finally, individuals who may leave their money in the market for few days are called swing-traders. This section is not concerned with the techniques and practices of day and swing traders.
The terms investors and traders evolved to indicate different activities (fundamental versus technical analysts) and a legal differentiation has developed for tax considerations . The differences are based on two dimensions: duration (length) of a stock ownership and number of transactions. Fundamental analysts determine which stocks to buy based on the difference between their evaluation of the stock value and the market value (i.e., price of a stock). This process often results in a long term ownership since it may take the market a long time to reach the same evaluation that an investor has. As such investors have both a long term dimension and a limited number of transactions, while traders often mean short term and a large number of transactions.
Fundamentalists often discuss trading in a disapproving tone insinuating negative connotations. This section assumes no such notions.
Other terms are often found in investment literature. These include Bear market and Bull market and their derivatives Bearish and Bullish. A Bear market is used to state that the market is declining while a Bull Market is an advancing market. Long and Short; Long (or long position) means owning a stock, and Short (or short position) means selling a stock (i.e., opposite of long) that you do not own.
No discussion of investments maybe complete without the study of how psychology play are role in investment decisions. Investors are people that share all the positive and negative attributes of human decision making. Investors often develop what is described in psychological terms as Cognitive Dissonance . A psychological phenomenon that refers to the discomfort felt at a discrepancy between what you already know or believe, and new information or interpretation. Cognitive dissonance manifests itself when an investor decides on acquiring a stock with the expectation that it will go up, and then the stock starts to go down. The investor often insists that this slide in the stock price is due to circumstances that do not contradict the analysis, and refuse to sell the stock and in some cases continue to acquire additional shares.
In order to avoid many of the shortfalls of human decision making, it highly recommended that an investor must decide on when to sell the stock prior to buying any shares of the stock.
II. Fundamental Approach
Definition and Introduction
The fundamental approach is based on the academic hypothesis that the price of a stock is the net present value of all future dividends. This value, often called intrinsic value, is estimated by the investor based on the company’s fundamentals, i.e., variables such as sales, growth rate, management, industry and potentials. The intrinsic value is compared to the current share price. Companies that are undervalued should be acquired, and those that are overvalued should be sold.
Fundamental analysts study everything from the overall economy and industry conditions, to the financial condition and management of companies . The method uses revenues, earnings, future growth, return on equity, profit margins, and other data to determine a company’s underlying value and potential for future growth. A good source of information on the fundamentals approach is at
http://www.investopedia.com/university/fundamentalanalysis/
Two common approaches in fundamental analysis are: Value and growth. Value investing identifies undervalued stocks. Warren Buffett is one of the legendary names that use this approach. The Growth approach identifies companies that are on the verge of growing at a rate that exceeds that of others. Peter Lynch is another legendary name that is associated with growth.
Value Investing is used by Warren Buffet and his followers, it is a disciplined approach to investing. The objective is to identify companies that are selling below their intrinsic value, are run by “good” managers, and have “good products”.
Investors should choose stocks of companies that have value. Questions to answer when assessing a company’s value:
Is this a good business run by smart people?
What is the company worth?
How attractive is the price for this company, and what should I pay for it?
How realistic is the most effective catalyst?
What is my margin of safety at my purchase price?
The Growth approach is very similar to value investing and it advocated by Peter Lynch.
You have to choose carefully the companies where you are going to invest. You should develop the story of the company:
What is the size of the company?
What stage of growth is the company at?
Is it a simple business?
Is it engaged into the production of something solid and relatively safe?
Is it a spin-off?
Institutions don’t own it and analysts don’t follow it.
It’s got a niche
It has no major competition
Its product is something people will keep buying forever like razors
Insiders are buyers
The company is buying backs shares
The remainder of this section outlines a fundamental analysis approach. However, an excellent source of information for fundamental analysis is “Guide to stock picking strategies” found at the investopedia web site.
Approaches and Examples
Fundamental analysis is the study of the company health and well being. Several financial ratios allow us to achieve this objective. A few of the financial ratios that are often considered are:
• P/E ratio
• P/E/ relative ratio
• Projected EPS (Earnings per share)
• EPS growth over 3 years
• Return on Equity
• Company Growth ratio
• Debt/Equity Ratio
• Insider Trading
• Cash Flow Growth over 3 years
Each of the ratios (or measures) on the list may assume one of three categories; Good, Neutral and Bad. Good means that the company is exceeding expectations (as represent by industry average or market average). P/E (Price/Earnings ratio) is a good example. P/E ratio is the price a stock over its earnings. A typical ratio for an S&P 500 stock is between 10 and 23. However, specific industries may have lower or higher P/E ratios (these numbers change over time). Internet companies at one point exhibited a much higher P/E ratio (90 and even more). P/E ratio in new industries (e.g., gene related companies) is very different than P/E ratio in well established industries (e.g., utilities companies). Some suggest that a good ratio should be slightly better than that of the industry, but not exceedingly high. For example a good P/E ratio in the automobile industry may be 14, but a P/E ratio of 50 may mean that the share price does not have a great deal of room to increase. At the same time a low P/E ratio (e.g., 4) may signal that investors believe that the company is performing poorly.
In addition to the various ratios, there are other fundamentals that must be considered. These include the changes in Wall Street profit estimates for the company. Zacks report studies the estimates and compares them to last quarter, to last fiscal year and to the next 5 years. Estimate should show an increase that is better than the industry and with an annual growth of 20% or more. CANSLIM (discussed later) suggests 25% increase. In addition to the Zacks, the Market Guide reports past performance. It includes ratios such as Return of Equity, Growth rates, Revenue Growth, and EPS Growth. Value Line Investment Survey is another example of a source that relies on fundamental analysis to rank stocks of about 1,700 companies and about 93 industries. In most cases sophisticated fundamental analysts rely on complicated econometric models to help them in ranking stocks and industries.
Many sites including Yahoo Finance and MSN show these ratios and assist investors in assessing the companies. This is often carried out through the use of filters (software tools that search stocks and list those that meet specific criteria). In addition to these free sites, there are paid sites (e.g., QUICKEN and Morningstar, a company known for their evaluation of mutual funds but has an extensive web site), and dedicated software packages.
III. Technical Analysis
Definition and Introduction
Fundamental analysis is an attractive approach for those who believe in economic rationality, however, research suggests that economic rationality is not always a human trait. An investment approach that does not share the same theoretical foundation of fundamental analysis is technical analysis.
Technical analysts believe that future performance can be studied based on the statistical analysis of historical performance of stocks and markets. That is a stock price is the result of the behavior of the investors. Investors in a specific stock (company or in an industry) often behave is similar manner, and as such a specific stock is expected to behave in a specific pattern. Technical analysts often study charts and graphs that represent the historical performance of the stock, which explains why they are often called chartists, and why fundamental analysts relate to them in the same manner that astronomers view astrologists.
Approach and Examples
Technical analysts study stock charts. Charts show several stock characteristics including stock prices and volume of sales. For example figure 1 shows IBM stock prices for the year 2006. Along with the price line, the chart shows the volume (number of shares that were sold each day) at the bottom as a vertical line.
Technical analysis uses indicators that identify potential movement of the stock, i.e., buy and sell signals. For example, figure 2 shows IBM with its price line and 50 day moving average (the average stock price for the previous 50 days). Whenever the stock price crosses the moving average line in upward direction, it is a buy signal and whenever the line crosses the 50 moving average while going down, it is a sell signal.
INTL BUSINESS MACH (NYSE)
Figure 1: IBM Stock chart for 2006
Figure 2: IBM stock chart with 50 day moving average shown in red
Many of these indicators use statistical analysis and variables such as moving averages, variance and standard deviation. They are, as such, implementation of statistical tools in predicting price movements. Indicators are often based on mathematical formulae using the price and volume movement of the stock. Examples of such indicators are MACD and Stochastic. MACD (Moving Average Convergence Divergence) is calculated by subtracting a 26-day moving average from 12-day moving average. The result oscillates around 0. A positive number is a bullish signal, while a negative number is a bearish signal. Stochastic compares a security closing price relative to its price range over a period of time. It is calculated using the following formula =
Stochastic, for any time period, varies from 0 to 100. When the value crosses 75% in an downward direction, it is a sell signal. While when it crosses 25% in an upward direction, it is a buy signal.
Figure 3 shows IBM with Moving Average, MACD and Stochastic as well as buy and sell signals shown as green and red vertical arrows.
Figure 3 IBM Stock with Moving Average, MACD, Stochastic and Buy/Sell signals
Indicators are classified into leading and lagging indicators. Leading indicators attempt to predict future price movements, while lagging indicators help identify trends. They may also be classified into lines (MACD or 50 day moving average) or bands (such as stochastic). Crossing a line (in either direction) represents an action signal (i.e., buy or sell). For example, in figure 3, the MACD line is crossed in a downward direction during the month of Feb. This is a sell signal and is identified using a red arrow on the chart. Similarly, during the month of March the MACD line is crossed in an upward direction. This is a buy signal and is identified using the green arrow. The same is true with the bands as shown in the stochastic portion of the graph.
In addition to stock indicators, there are industry and market indicators that predict the movement of an industry or the overall market. For example table 1 shows the movement of money into or out of industries for a 12-week period. Red squares indicates that investors are moving money out of the industry (selling the stocks), a green square means that investors are moving money into the industry, while an orange square means that there are no major movements in either direction.
Market indicators are grouped in three categories; monetary, sentiment and momentum . Monetary indicators are similar to interest rates and money supply. Sentiment indicators include put/call ratio and other option related measures. Finally, momentum indicators study the current performance of the stock. Examples include the number of stocks that made new highs and new lows.
In addition to indicators, technical analysts utilize price charts. Support, resistance, head and shoulder, and cup and handle are common names used to describe specific meaningful patterns. Support level is a minimum price that a stock may reach before bouncing back. Stocks that cross below the support level are expected to decline to the next support level. A resistance level is a price where a stock often has difficulty crossing in an upward direction. If a stock crosses a resistance level it is expected to continue to a new resistance level. The old resistance level is often considered the new support.
• Cup and Handle – This is a pattern on a bar chart that can be as short as 7 weeks and as long as 65 weeks. The cup is in the shape of a U. The handle has a slight downward drift. The right hand side of the pattern has low trading volume. As the stock comes up to test the old highs, the stock will incur selling pressure by the people who bought at or near the old high. This selling pressure will make the stock price trade sideways with a tendency towards a downtrend for 4 days to 4 weeks, then it takes off.
It looks like a pot with handle. Traders have made a lot of money using this pattern, which is one of the easier to detect.
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Patient outcomes of care provided by NP’s as compared to care provided by physicians alone
Use recent literature to discuss patient outcomes of care provided by NP’s as compared to care provided by physicians alone
Academic Level : Bachelor
At least 2 outside scholarly reference is required (the course textbook
may not be used as a reference).
• Word count met • Provides a clear and concise response to the assigned/selected topic. • All main points are well-developed; directly related to the topic. • Supporting examples are concrete and detailed. • Writing is fluid and free from spelling and grammatical errors. • References (if required) are precisely listed in APA format. • In-text citations are used correctly for all quotations and paraphrasing.
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Illegal Immigration
Let’s talk about immigration and how immigration related to some of the things we will discuss in this class for example race, religion, and social class. Lately, we have been hearing a lot about “illegality° what it means to be legal. I want you to think back to the week we talked about language and connect it to this week. Also, in this week’s discussion, I want you to read your book, go through the slides and share your thoughts, feelings and be sure to share any statements that stood out to you as you read this week’s topic.
