|Simple (and complex) investment strategies
|Page | 1 | 2 | 3 | 4 | 5 | 6 |
Filtering down to the industry level, one would look at how the economy is affecting businesses -- for good or bad. For instance, at this point in time, "World financials are very doubtful and they're in bankruptcy," says Penman.
"Whereas another company like Procter and Gamble would be more concerned with the effect of the financial situation flowing into the real economy -- the consumer economy -- and what the effect would be there," he says.
Lots of other things affect industries as well: consumer sentiment, technology, the weather, politics, government regulation, competition and labor conditions -- to name a few.
Shifting down yet another level to companies within a sector or industry, investors should "look where the industry is going and note the firm's market share of the industry. Because ultimately among the drivers of fundamental value are future sales and future revenues that come in," Penman says.
To investigate individual companies, investors can turn to the annual or quarterly financial statements, called the 10-K and 10-Q reports, respectively, filed with the Securities Exchange Commission.
The annual 10-K report reveals a company's accounting as reflected in the balance sheet, income statement and cash flow statement.
It also offers the perspective of senior management, who explain events of the past year and also predict what might happen going forward.
"The management analysis will give you an interpretation of the reason for what's in the report, what the business is like now, and give you some indication of the future -- sometimes they do it too optimistically and sometimes they do it too conservatively because of the fear of litigation and so on," says Penman.
"It's always a place to start. You can add to that impression by looking at more general industry and firm-specific information outside the firm," he says.
To really get a good picture of a company, one should look not just at the last year's earnings reports, but at a five or 10-year history of the company's performance.
"Can they grow sales? What's the profitability of their sales? What earnings do they make from sales? What are their margins? And then it's a question of how much assets they employ to develop those sales. Obviously more assets mean more investment and lower return on investment," says Penman.
Whereas an indexing strategy might subscribe to the efficient markets hypothesis, and fundamental analysis involves a close look at a company's financials in the context of its industry and the overall economy, technical analysis falls more under the theories of behavioral finance, which factors the human element into market behavior.
Technical analysts use charts to study historical stock prices and trading volume data to gauge investor sentiment as a guide to the prospects of a particular security.