Chuck Hughes – Stock Selection (The Fail Safe Financial Program pgs. 155-158)

This is the excerpt for your very first post.


Stock Selection

This really is focused on people who wish to invest in individual stocks. I wants to share with you the techniques I have used through the years to select stocks that I have discovered to be consistently profitable in actual trading. I prefer to use a mixture of fundamental and technical analysis for selecting stocks. My experience has shown that successful stock selection involves two steps:

1.    Select a stock using the fundamental analysis presented then
2.    Confirm the stock is an uptrend as shown by the 50-Day Exponential Moving Average Line (EMA) being over the 100-Day EMA

This two-step process boosts the odds that the stock you select is going to be profitable. It offers an indication to market a regular that has not performed not surprisingly if it�s 50-Day EMA drops below its 100-Day EMA. It is another useful method for selecting stocks for covered call writing, a different sort of strategy.

Fundamental Analysis

Fundamental analysis may be the study of financial data such as earnings, dividends and cash flow, which influence the pricing of securities. I use fundamental analysis to assist select securities for future price appreciation. Over the years I have used many methods for measuring a company�s rate of growth in an attempt to predict its stock�s future price performance. I used methods for example earnings growth and return on equity. I have found these methods are not always reliable or predictive.

Earning Growth
For example, corporate net earnings are susceptible to vague bookkeeping practices for example depreciation, income, inventory adjustment and reserves. These are all susceptible to interpretation by accountants. Today more than ever, corporations they are under increasing pressure to conquer analyst�s earnings estimates which leads to more aggressive accounting interpretations. Some corporations take special �one time� write-offs on their own balance sheet for such things as failed mergers or acquisitions, restructuring, unprofitable divisions, failed product development, etc. Many times these write-offs are not reflected like a continue earnings growth but instead appear like a footnote on a financial report. These �one time� write-offs occur with more frequency than you might expect. Many companies that from the Dow Jones Industrial Average took such write-offs.

Return on Equity
Another popular indicator, which i’ve found isn’t necessarily predictive of stock price appreciation, is return on equity (ROE). Conventional wisdom correlates a high return on equity with successful corporate management that’s maximizing shareholder value (the larger the ROE the greater).

Recognise the business is more successful?
Coca-Cola (KO) having a Return on Equity of 46% or
Merrill Lynch (MER) having a Return on Equity of 18%

The answer is Merrill Lynch by any measure. But Coca-Cola includes a higher ROE. How is that this possible?

Return on equity is calculated by dividing a company�s net gain by stockholder�s equity. Coca-Cola is so over valued that its stockholder�s equity is just comparable to about 5% from the total market value from the company. The stockholder equity is so small that nearly any amount of net income will create a favorable ROE.
Merrill Lynch on the other hand, has stockholder�s equity equal to 42% from the market value of the company and requires a greater net gain figure to produce a comparable ROE. My point is the fact that ROE doesn’t compare apples to apples so therefore isn’t a good relative indicator in comparing company performance.


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