It looks as if 2010 is starting on strong footing. As I have been saying for some time now, this first quarter looks like an opportunity. The big, bad wolf lurking in the woods is oil, though. Will it derail the economic recovery? Hard to say at the moment, but keep an eye on it. In any case, right now the path is clear for bagging some of the opportunity out there.
Following this thinking, I would like to answer a question I received from Ben, an opportunist looking to trade a company or two that is undervalued but fundamentally sound. The only problem Ben has is that he doesn’t know how to track down these companies.
In order to find a fundamentally strong but undervalued company, the first thing you have to understand is the big economic picture. Are the markets moving in the right direction? Where is the money flowing? Which sector is getting the most attention? Which industry is coming out of the recession with guns blazing? Which sectors or industries will most benefit as the economy moves into full recovery? If you know the answers to these questions, you will know where to begin your hunt.
Now, once you understand the big picture, you need a set of skills to find a particular company. You need to know how to read the financial information and the information related to trading. You need to understand and interpret such terms as PE, Profit Margin (ttm), Qrtly Revenue Growth (yoy), Total Cash (mrq), Total debt (mrq), Operating Cash Flow (ttm), and Levered Free Cash Flow (ttm). This sampling of financial information points you in the correct direction.
Along with understanding and interpreting financial information, one needs to understand how a company is trading. Sometimes, a fundamentally sound company is, well, only just a fundamentally sound company. For whatever reason, it is not trading. It could be the financials contain something you have missed or it could be that the company is simply “off the radar,” meaning it has yet to interest the “big” money. Understanding trading information, such as Beta, 52-week High and Low, moving averages, Average Volume (3-month and 10-day), Shares Outstanding, Float, Shares Short, and Short% of Float.
I look at all the information, but I like companies that have good balance sheets with positive sequential quarterly growth (Year-over-year quarterly growth is important usually, but in this market, one has to consider where we were last year at this time.), lots of operational cash flow, and lots of cash on hand. As to the trading information, volume is the first thing I look at. Weak volume means little trading, which can mean extreme volatility. Volatility without volume is like flipping a coin. In an instant, the price could be up 5% or down 5%. What trend? As well, the short ratio, the 52-week high/low, and shares outstanding all factor into my analysis.
In today’s highly-technical trading world, fundamental analysis is given short shrift. Don’t let this throw you off the track. Predicting movement with repeated patterns is one thing; getting down on the ground and following prints in the earth is another. Both work, but following footprints is, in my opinion, a better way to track down opportunity in fundamentally sound but undervalued companies.
Trade in the day; invest in your life
