Grad Call Summary 6-12-08

Hello All,

In the Grad call we discussed some of the basics of fundamental analysis. Fundamental analysis is a very subjective topic. There are many ways to analyze a stock and often times, different stocks require a different type of analysis. The subjectiveness is what turns many people away from a fundamental approach.

As mentioned in the call, my bias is towards technical analysis, but there is an element of fundamental analysis that I use to increase the effectiveness of my technical trading. The key to fundamental analysis is understanding what you are really looking for and finding. Fundamentals are used to answer the question WHY. Not WHEN…just WHY. It is great for establishing a long-term bias for stock direction.

In the market, there are several types of investors. Value investors and Growth investors. When I look at fundamental analysis, I attempt to combine the best of both worlds. (growth and value) Lets take a look at them below.

Value: When filling up a tank of gas; given the option of paying $3 a gallon or $6 a gallon for the same thing, a rational individual would choose the $3 a gallon gas. Stocks in the market all have different prices which tends to disguise the value of the company. To get a clearer picture of the true value, investors compare the stock price to the company’s earnings. The comparision is refferred to as the P/E ratio. Generally speaking a high P/E ration is $6 gas and a low P/E ratio is $3 gas. Current market average for a P/E is about 22.

Growth: If an individuals shows up for their job and receives a 100% increase in pay, what happens to their morale, loyalty, and motivation to work? The same type of increase in company earnings keeps shareholders happy and attracts others to invest in the company. Growth is what drove Microsoft’s higher and higher in the 90’s. It is the reason why PCX and WLT are continually driven to new highs. Growth is a magnet that attracts buyers and pushes stocks higher.

So what is a good P/E or a good growth rate in earnings? All kinds of numbers are thrown out there, but I prefer a principled approach. My fundamental analysis lives by the following line.

If the Growth rate is greater than the P/E, the stock tends to rise in the long term…and vice versa.

To many it is overly simplified, but great success can come by trading high growth, good valued stocks as institutional investors step in and buy for these same reasons. My favorite place to find these stocks is on www.barchart.com. I like to look at the top 100 as many of these stocks are growing very rapidly. There is a tendency to want to buy these at any time, but by buying on pullbacks, phenomenal profits can be achieved.

Happy Trading,

Jeff