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12 Jan 2017

Stock Selection

This really is focused on those of you who want to purchase individual stocks. I wants to share with you the methods I have tried personally over the years to select stocks which i have discovered to become consistently profitable in actual trading. I like 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 regular using the fundamental analysis presented then
2.    Confirm the stock is definitely an uptrend as indicated by the 50-Day Exponential Moving Average Line (EMA) being above the 100-Day EMA

This two-step process increases the odds the stock you decide on will be profitable. It offers an indication to sell a stock that has not performed not surprisingly if it�s 50-Day EMA drops below its 100-Day EMA. It is also a useful method for selecting stocks for covered call writing, a different type of strategy.

Fundamental Analysis

Fundamental analysis is the study of monetary data for example earnings, dividends and funds flow, which influence the pricing of securities. I use fundamental analysis to assist select securities for future price appreciation. Over the years I have tried personally many methods for measuring a company�s growth rate so that they can predict its stock�s future price performance. I used methods for example earnings growth and return on equity. I have found these methods aren't always reliable or predictive.

Earning Growth
For instance, corporate net earnings are subject to vague bookkeeping practices such as 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 results in more aggressive accounting interpretations. Some corporations take special �one time� write-offs on their own balance sheet for things like failed mergers or acquisitions, restructuring, unprofitable divisions, failed product development, etc. Many times these write-offs are not reflected like a drag on earnings growth but instead appear as a footnote on the financial report. These �one time� write-offs occur with more frequency than you may expect. Many companies that from the Dow Jones Industrial Average took such write-offs.

Return on Equity
One other 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 much more successful?
Coca-Cola (KO) having a Return on Equity of 46% or
Merrill Lynch (MER) having a Return on Equity of 18%

The reply 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 really over valued that its stockholder�s equity is just comparable to about 5% of the total market value from the company. The stockholder equity is so small that nearly any amount of net gain will create a favorable ROE.
Merrill Lynch however, has stockholder�s equity equal to 42% of the market price of the company and needs a greater net income figure to make a comparable ROE. My point is that ROE doesn't compare apples to apples therefore is not a good relative indicator in comparing company performance.


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