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Fundamental or Technical Stock Analysis?

There is a significant distinction between a fundamental investor and a technical investor.

Stock Market Video

Fundamental or Technical Stock Analysis?

Never Hope More Than You Work

In Case You Missed It

In this week’s Stock Market Video, I talk about the correction in the market caused by the dust-up in Cyprus, and how little that really means to the actual trend of the market. There may be a correction waiting out there for us, but there’s no way to tell, so it’s best to just go with the evidence we have now, and that tells us that the market uptrend is continuing. I took a closer look at the leading stocks in the leading Consumer Cyclicals industry, which is Leisure Services–Movies and Related. Stocks discussed: Netflix (NFLX), Lions Gate Entertainment (LGF), Imax Corp. (IMAX) and Coinstar (CSTR). Click below to watch the video!

Netflix (NFLX), Lions Gate Entertainment (LGF), Imax Corp. (IMAX) and Coinstar (CSTR), Cabot Heritage Corporation, Paul Goodwin


Fundamental or Technical Stock Analysis? The Perils of Purity

In the world of equity investing, there is a significant distinction between a fundamental investor and a technical investor.

The fundamental investor wants to figure out the intrinsic worth of a stock by looking at data like revenues, earnings, cash flow, projected growth, return on equity, profit margins and lots of other factors. Fundamental investors want to know everything there is to know about a company’s operations, management, markets, competitors and prospects. But the biggest emphasis is on financial performance. If you see a stock investor spending hours on the quarterly and annual financial reports, you’re probably looking at a fundamental investor.

Ultimately what a fundamental investor wants to determine is a value for the company, sometimes called the liquidation value. Once the investor knows what a company’s assets would be worth—even if the company went belly up—it’s a relatively easy matter to buy only when the stock is trading at the greatest discount to that intrinsic value. Then all the investor has to do is wait for the stock’s price to increase to that value and sell it.

There are differing opinions about which fundamentals produce the best results. Some people look only at price-to-earnings ratios. Others tout the usefulness of price-to-book, price-to-sales or price-to-discounted-cash-flow, or myriad other approaches. But the basic approach is always the same: calculate the intrinsic value, find the bargain and wait for the appreciation.

Pure fundamental investors—often called value investors—are often willing to wait years for their stocks to come around. Disciplined subscribers to Cabot Benjamin Graham Value Letter are in this camp. And once the stock becomes fully valued, they’ll sell, no matter how strongly the stock is advancing at the time.

At the other end of the spectrum is the technical investor. Technical analysts evaluate stocks by looking at their price and volume patterns to try to find strong stocks, identify trends and patterns, and determine buy and sell points. For more information on Cabot Benjamin Graham Value Letter, click here.

The technical analyst’s primary tool is a chart that shows a stock’s price, trading volume, moving averages and other information over a specified period of time. Seasoned analysts learn to recognize patterns in these charts that indicate rising or falling support for a stock. The information gleaned from this kind of analysis usually leads to much shorter holding periods and more active trading. The purest practitioners of technical analysis may not even know what products are made or sold by the stocks that they follow. The only thing that matters is the chart and its patterns.

Some technical analysts look for stocks that have strong positive momentum and are outperforming the broader market (or are in base-building periods with minimal selling pressure) with supportive trading volume. Technical analysts generally do not establish sell or target prices when they buy, preferring to monitor performance closely while letting stocks rise as high as possible. Stocks favored by technical analysts are typically growth stocks, and these stocks’ high P/E and other ratios are a major distinguishing feature. As with fundamental analysis, there are different schools of thought about what technical indicators to look at and the statistical methods used to find promising patterns.

But why, you may be asking, is this message called The Perils of Purity? Because we think that following either of these investing styles exclusively can be risky for your total portfolio.

Pure fundamental analysts, while keeping risk low, can miss out on the huge profits to be made during bull markets. By giving so much weight to valuation, these investors can also leave money lying on the table by selling at predetermined levels when stocks have strong upward momentum.

And pure technical analysts, by ignoring fundamentals, can build portfolios of very expensive stocks with such high volatility and risk that following them can be a full time job.

While Cabot offers newsletters that span the spectrum from value to growth to aggressive growth, we advise our subscribers to maintain a diversified portfolio of stocks. And subscribers to our growth letters (Cabot Market Letter, Cabot Top Ten Report and Cabot China & Emerging Markets Report) know that we always take fundamental factors into account, even in our most aggressive recommendations. We see no point in excluding any information that can increase the success rate of our featured stocks.

So the way to avoid the Perils of Purity is to keep exploring (as we do) every kind of information available and every method of analysis. Like all skilled workers, we want to have as many tools at our disposal as possible. We think you should too.

And if the idea of being able to look at a number of different investment styles (and talk with the experts who subscribe to them) appeals to you, you really should consider attending the first Cabot Investors Conference that will be held in Salem, Massachusetts, on August 14 through 16. All of Cabot’s editors will be there, ready to answer those hard questions you’ve been dying to ask. Find more details on first Cabot Investors Conference here!

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Here’s this week’s Contrary Opinion Button. Remember, you can always view all of the buttons by clicking here.

Cabot Heritage Corporation Button

Never Hope More Than You Work

Tim’s Comment: The full quote, by Rita Mae Brown, is “Creativity comes from trust. Trust your instincts. And never hope more than you work.” She was speaking about writing in particular, and the first two parts of her quotation do apply more to writing than investing. But the final thought is perfect for investors who are often guilty of hoping when they should be facing reality. In fact, it’s reminiscent of the saying, “Hope is not a strategy.”

Paul’s Comment: I’ve always liked the old proverb that asserts that, “Hope is a good breakfast, but a sorry supper.” But since there wouldn’t be any small investors in the stock market if hope weren’t in the equation, the important thing is to give your hopes as firm a foundation as you can, and that’s where work comes in, in the form of due diligence. After all, as Louis Pasteur used to say, “Fortune favors the prepared mind.” In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, here are links below to each issue.

Cabot Wealth Advisory 3/18/13—Trouble in Cyprus

Tim Lutts of Cabot Stock of the Month uses this issue to reprint an update from Cabot Options Trader’s editor Jacob Mintz, which points out that uniformly positive sentiment often leads to unexpected reverses. Tim also looks back at defunct automaker Studebaker and gives the tenth of his Ten Stocks to Hold Forever, which is his own pick: Tesla Motors (TSLA).

Cabot Wealth Advisory 3/19/13—Finding the Next Big Leading Stock

Mike Cintolo, editor of Cabot Market Letter, writes about the 10 to 20 stocks that typically make the biggest gains; they’re the stocks that trade on big volume, have lots of institutional support and run for a long time. Stock discussed: Chicago Bridge & Iron (CBI).

Cabot Wealth Advisory 3/21/13—Tips on Investing in Small-Cap Stocks

Cabot Small-Cap Confidential editor Thomas Garrity answers some questions from subscribers that illuminate the investing process that has been producing a series of big winners.

Have a great weekend,

Paul Goodwin
Editor of Cabot Wealth Advisory
and Cabot China & Emerging Markets Report

Cabot Editor