Fundamental Analysis
Our Fundamental Analysis Theory is based, in large measure, on analyzing the rate of change of each company’s business operations. We look for signs of increasing or decreasing economic health. We have found that certain economic conditions within a company provide a basis for evaluating whether that company is in an upward or downward growth pattern.
This theory is very trend oriented. If we can determine an upward trend in fundamentals, then history shows us that it is likely the company’s fundamentals are improving rather than weakening or stagnant.
The following is a general overview of our approach to the fundamental analysis of each stock:
- Quarterly Earnings
We believe that the rate of growth of quarterly earnings growth is one of the single most important indicators of a stock's potential to make a significant movement in price. With that in mind, we study the historical earnings reports of each stock, looking for increasing trends, and the percentage increase in those trends.
- Year-over-Year Growth in Earnings
Additionally, the annual increase in earnings (or lack thereof) provides further insight into the pricing growth potential of a stock. Therefore we look at multiple year-over-year earnings reports to see if a trend has developed and the rate of increase or decrease in that trend.
- Profitability
We like to see either expanding pre-tax profits on a year-over-year basis or, at the very least, expanding return-on-equity. The stronger these numbers, the higher the rating from a fundamental perspective.
- Demand for Shares
The price of a stock, ultimately, is determined on the ratio of the demand for the outstanding shares and the availability of those shares. When demand for a stock outpaces supply, the price usually goes up, sometimes, dramatically. Therefore, we look for companies that have a relatively small number of shares outstanding, while still being large enough to be actively traded. We generally do not trade in a stock that has an average daily volume of less than 80,000 to 100,000 shares. We look for a correlation between rising stock price and volume. We look for strong demand supporting an increasing price in the stock.
- Best-in-Class
We believe that a stock’s pricing performance is significantly influenced by how that stock measures up against its peer companies within that stock’s sector and industry. If we expect a stock to be moving up in price, we expect it to be performing at or near the top of its sector and industry, based on key fundamentals of return-on-equity, annual earnings growth, profit margins and relative price strength.
- Institutional Demand
Large institutions play a major role in tightening or loosening the supply and demand of stock shares. When institutions begin to accumulate shares in a company, we expect that stock’s price to begin an upward movement. Likewise, when institutions begin to sell large blocks of shares, we expect the price to move lower. Therefore, we track the percentage ownership of each stock by institutions and monitor the average daily volume of shares traded to derive leading indicators of pricing trends.
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