In this seven-part series, I have introduced five important concepts as to why stocks move. We discussed macroeconomic conditions last week, the role bonds and the Federal Reserve play on shaping equity prices, how ETFs and sector gravity can lead stocks despite individual company differences, index futures and how hasty buyers and sellers can quickly overwhelm the market, and finally a return to basic microeconomics with supply and demand analysis of stocks.
Once you have analyzed these forces in detail, then you can look at an individual company’s fundamentals to determine whether this firm is a solid one to invest in and if is the right time to purchase this stock. Fundamental analysis is highly regarded among many investors as the only way to invest. Fundamental analysis means taking time to analyze an individual company’s annual report, quarterly earnings reports, conference calls, and financial statements. After conducting fundamental analysis, you should be able to describe why you are purchasing this company’s stock and the basis for doing so.
The biggest key to fundamental analysis in this tepid growth environment is identifying companies with the ability to deliver strong growth numbers. When analyzing the growth rate of a company, pay careful attention to the revenue and earnings actual results versus what was estimated for the firm. Beats that are higher than expected will traditionally elevate a stock way higher than misses or just matching analyst consensus predictions. Pay attention to analyst opinions but do not take their word as the holy gospel. Understanding what analyst are predicting a company to do are a key indicator of which direction a stock is headed. If analysts are consistently upgrading the firm’s stock and changing its price target to a higher region, then this stock price is likely to increase over the next few months to year. Likewise, downgrades have the opposite effect on a stock’s price.
When looking at growth rates for companies, understand which firms are cyclical dependent versus secular. Cyclical companies rely mainly on economic forces to propel their prospects. Cyclical companies include General Electric, Cummins, Deere, Caterpillar, and CSX. Since many of these companies mentioned in the previous sentence are solely cyclical and conduct a lot of international business, investors in these firms will need to pay special attention to world events. Secular growth are trends in society that are likely to last for the long-term and do not rely solely on economic forces to propel them forward. With the rise of the selfie age and constant need for taking pictures, facial beauty products are an example of secular growth as more individuals seek beautification of their faces and teeth. This trend is likely to outlast any economic boom or downturn. Due to this, secular growth companies have expensive price/earnings ratios and investors pay a heftier price in purchasing shares of these firms.
Lastly, do not focus entirely on revenue. Yes, revenue is a key category of fundamental analysis and companies that do miss on revenue expectations will see their stock price fall. However, earnings are just as, if not more important than earnings in the grand scheme of things. Earnings indicate net profit, also known as the “bottom line”. When a company earnings nice profits quarterly, more money can be retained in the company for future projects or can be dished out as dividends to investors. In fact, investors expect dividends to increase annually so improving profits are important for investors.
Not only is revenues and earnings important for investors, but when listening or reading a conference call look for what company executives say about future guidance. If the future guidance indicates positive results in the future, then this stock is likely to continue its increase in value. If guidance is cut as the company future is expected to falter on weak revenues, then that stock is likely to fall in price. Outlook is very, very important and investors should pay close attention to what companies say in their conference calls after quarterly results. Always aim for companies that beat estimates and raise guidance. These stocks will consistently outperform the market.
