Everyone wants a winner, but picking a share is as much an art as a science. A dose of luck helps, too. Almost every punter has his favourite technique to spot a share that will rise in price. Ignoring the 'hot tips', most of these techniques fall into two basic camps - fundamental analysis or technical analysis.
Those in the first camp look at the fundamentals behind a share, like the business that the company is in, its financial health and the state of the economy, and then project the company's performance and its share price.
Technical analysts or chartists, however, believe that past price movements in themselves are at least as good an indication of future prices as individual analysis of a company. They note price movements on graph paper and look for familiar patterns that tend to repeat themselves. An extreme exponent of technical analysis might claim that the pattern on the chart alone indicates the next move in the price: it is not even necessary to know the name of the company before making a forecast.
Both camps will probably start with a bird's eye view of the stock market. Listed shares are divided into six broad categories -industrial & commercial, finance, hotels, properties, plantations, mining - and loans.
Ask yourself which of these have the best prospects. Once you decide on a sector, narrow down your choice to a handful of 'possibles'. It is at this stage that fundamentalists reach for the Annual Reports and technicians for price charts, but there is nothing to stop you from doing both. Quite often they produce the same forecast. And there is not necessarily a disagreement between the two views, which can be used to complement one another.
Fundamental Analysis
Fundamentalists usually adopt what is generally known as the top-down approach. They start with a broad picture, then through a process of elimination arrive at a certain sector and finally a company. Taking a simple example, a fundamentalist may start with the broad outlook of the world economy, and ask himself questions like:
- Which country has the brightest economic outlook?
- Is the country politically stable?
- What about the political outlook of its neighbours?
- Which sector of the economy looks brightest?
- Are there any changes - legal, political, economical, technological, moral, etc. - on the horizon that may affect that sector?
- Which company or companies in that sector have the best chance of excelling?
At this stage, the fundamentalist will be reaching for the companies' Annual Reports. Company accounts and Annual Reports are essential reading for fundamentalists.
In analyzing stocks, comparison is the name of the game. One set of indicators does not tell you much, so you must compare it against the indicators of similar companies in the same sector. Then, decide which has better value for money.
It may pay to take a closer look at each company's Annual Reports at this stage. Ask yourself questions like: is the company still growing, is it burdened by too much debt, is it earning enough to pay off its loans and bank interest yet have profit left over?
Other tell-tale signs of whether things are as healthy as they seem are the stock of goods. If the stock of goods or inventories -usually measured by the amount of goods available for sale over a time period, like 'three months' stock' - is building up faster than sales it means something is wrong. The company could be losing its market or its goods may be uncompetitive or outmoded.
Share analysts also make use of several financial ratios - like current ratio or ratio of debt to equity - as quick tests.
Are Fundamentalists Out of Date?
Critics of this method point out that all the figures fundamentalists set store by are out of date.
Consider this: Companies which close their books with the end of the calendar yeair announce their results usually about three months later, around March. These are sketchy figures at best and the details will only be filled in around June when the Annual Reports make their appearance. By the time you get your hands on the precious Annual Reports, six months have already passed and the company is due to report its interim results. The economic climate could have changed drastically over the period.
Forecasting, say the critics of fundamental analysis, should be based on up-to-the-minute figures which mirror the current state of affairs. And what more up-to-date figures are there than today's share price?
Technical Analysis
Technical analysis or charting was discovered quite by accident about a hundred years ago in Wall Street - the financial heart of New York. Investors noted price movements on squares of graph paper to save themselves the tedium of copying columns of figures and later found that certain patterns kept cropping up. And these patterns were followed by certain price movements.
Of course, this was not 100 per cent accurate, but the repetition was enough to qualify price movement charts as a forecasting tool and technical analysis or charting was born.