Outside the Box: Locating Strong Stocks in a Bearish Environment
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December 3, 2008
Even in a bearish market and a weak economic environment there are still some well tested fundamental analysis methods that can help pinpoint strong stocks. These stocks not only hold their own while other stocks are declining but in many cases they actually advance significantly.
One of the first fundamental attributes to focus in on is Return on Equity. Return on Equity essentially tells us how financially efficient the company has been. This measurement tells us how much profit a company makes relative to what it owns. Basically the Return on Equity is a report card for a company’s management. It tells us how prudent they’ve been with their shareholders’ money. A Return on Equity number above 15 percent is good, and anything above 25 percent is stellar.
The next factor to analyze is cash flow. A sign of a strong company is a robust cash flow and from an accounting perspective it is difficult to manipulate. It demonstrates that a company is earning more than they spend. The basic definition of cash flow is earnings plus depreciation. What cash flow tells us is how much cash is coming into the company from its business compared with the amount of cash going to fund its operations. The problem is that some companies generate a lot of cash, but they require even more to keep things going. By looking at cash flow, we can see how healthy a company really is.
Another important fundamental factor is operating margin. The larger the margins the larger the profits. Expanding operating margins shows that the company has pricing power in its market and its growing earnings faster than its sales. That is very important especially in the current economic environment. Usually a company can grow its margins because it has a dominant niche in its market.
Finally, a key fundamental factor to look at is whether or not the company is beating estimates because it demonstrates that their stock is outperforming other stocks. In addition, it really is a huge plus if a company indicates that future earnings are going to be better than expected. Locating earnings revisions is a great way to uncover value stocks before the crowd does.
These fundamental factors discussed in this article can help the investor locate future stock market winners, especially in a difficult market. Make sure to take a look at them before committing any funds to a new stock position.
Happy Trading.
Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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