Harry Domash's Winning Investing


Brush Up On the Basics

Your mail tells me that sometimes my columns assume a familiarity with terms and concepts that many beginning investors don’t have. With that in mind, I’m going to use this column to explain a few basic stock market concepts. But, don’t tune out if you think you know this stuff. I’ve included enough of my own arguable opinions to make it interesting for you too.

Price Charts
A price chart graphically illustrates a stock’s price action over a selected timeframe, one-year, for instance. Some investors, called technical analysts or chartists, feel it’s a waste of time examining financial statements, dissecting analysts’ forecasts or pondering a firm’s prospects vis-à-vis the competition. Instead, they believe that a stock’s price chart tells them everything they need to know about a stock.

Chartists say stock prices move in trends. That is, a stock that has already been moving up in price (uptrend) will continue its winning ways, while one going the other way (downtrend) will continue to disappoint its shareholders.

As simplistic as that idea sounds, in my experience, it’s true more often than not. While understanding a firm’s fundamental outlook is crucial, I believe that it’s also important to look at the charts.

Fortunately, you don’t have to be a charting expert to do the analysis. Start on Yahoo (finance.yahoo.com) by clicking on “Basic Chart” after getting a price quote. By default, Yahoo displays a one-year chart, which is ideal for spotting which way a stock is trending.

The analysis is easy. If the stock is in an uptrend, the price will be higher on the right side than in middle or left side of the chart. Conversely, the right side will be lower than the middle or the left side if it’s in a downtrend.

If you don’t see a trend, the stock is probably in a consolidation pattern (no-trend).

Even if a firm’s fundamental outlook looks rosy, avoid stocks that are consolidating or trending down. Instead, check the stock’s chart once a week or so, and wait for an uptrend.

Valuation Ratios
Valuation ratios help you to understand how the market views a company. Most market players are “growth” investors, meaning that they prefer stocks with strong future sales and earnings growth expectations. High valuation ratios signal that a firm is “in-favor,” with growth investors.

By contrast, low valuations tell you that a stock is “out-of-favor” with the growth crowd. “Value investors” search through these stocks looking for those with the best prospects of recovering from the problems that caused growth investors to shun them.

All valuation ratios compare a company’s recent share price to a fundamental factor.

The price to earnings, or P/E, is the most widely followed ratio. It compares the recent share price to 12-month’s earnings, expressed on a per share basis. For instance, the P/E would be 10 if it earned $5 per share and recently traded at $50 per share. Growth stocks usually trade at P/Es above 20, and P/Es below 15 identify value-priced stocks. Stocks with P/Es between 15 and 20 could be either growth or value, depending on the circumstances.

Price/sales (P/S), which compares the recent share price to 12 month’s sales per share, is another popular valuation ratio. Some investors prefer P/S instead of P/E because sales generally don’t fluctuate as much from quarter to quarter as earnings. Also, you can still calculate P/S, but not P/E, when a company reports a loss (negative earnings). P/S ratios of 4 and above usually identify growth-priced stocks while ratios below 2 signal value stocks.

You can see the valuation ratios on many investing sites. On Reuters Investor (www.investor.reuters.com), get a price quote, then select Ratios

Financial Strength 
All it takes is a rumor that a company might fail to send its share price into the dumpster. That’s why it’s important to include financial strength in your analysis when you size up a candidate.

The good news is that you don’t have to don green eyeshades and dig into financial statements to make that assessment. Checking one financial strength gauge will do the trick.

The debt/equity (D/E) ratio compares a firm’s long-term debt to its shareholders equity or book value (assets minus liabilities). A firm with no long-term debt would have a zero D/E, and the higher that debt, the higher the ratio. Generally companies with ratios above 1 are considered high debt and those with ratios below 0.5 are low-debt.

However, the definition of low and high varies with industry. Software companies typically carry no long-term debt while banks and utilities often carry high D/E ratios. So you can do a better job of evaluating debt by comparing a company’s D/E ratio to its industry.

You can do that on MSN Money (moneycentral.msn.com) by getting a price quote, selecting “Financial Results,” then “Key Ratios,” and finally, “Financial Condition.” To reduce your risk of picking a financially troubled firm, avoid stocks with D/E ratios above their industry average.

That’s all I have room for today. Let me know of any other basic terms I’ve used that require explanation. If I get enough questions, I devote another column to the topic.
published 3/5/06


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