Stock Market Analysis Video
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Last week, I wrote about a famous investing quote that helped form the basis for Cabot’s market timing indicators. Keeping with last week’s theme of investor education, I want to clear up some terms that we use frequently when writing about investing. I pulled them from the survey responses you kindly provided us with last month, so I know they’re on your mind.
ADRs–Cabot China & Emerging Markets Report recommends stocks that trade on U.S. exchanges as American Depositary Receipts (ADRs), which are dollar-denominated stock equivalents. This avoids any currency risk and gives investors the protection of knowing that the listed companies have met U.S. accounting and reporting requirements.
BRIC–The BRIC countries are Brazil, Russia, India and China, and we often refer to the acronym when writing about the emerging markets.
Gaps–Gaps occur when a stock begins a new trading day at a price that’s significantly above or below the previous day’s closing price. In effect, there is no trading at prices between the closing price and the opening price. This appears as a “gap” on a price chart. Generally speaking, gaps up are considered positive and gaps down are considered negative. However, in many (but not all) cases, price gaps get filled. So if a stock gaps up, you might expect that at some time in the future (from minutes to months later) the stock will drift back down into the gap. Conversely, if a stock gaps down, it’s likely to bounce back up to fill or partially fill the gap. Gaps typically offer support or resistance. If a stock gaps down, the gap will offer resistance if it attempts to recover. A gap up will provide support when the stock corrects.
Options–An option gives you the right to buy or sell shares of a stock if it reaches a specified price by a set date. Cabot does not yet provide specific advice on options. But because we set buy and sell prices for the stocks we recommend, Cabot stocks work well for options traders.
Price/earnings ratio–If you divide a company’s stock price by its earnings per share, you’ll come up with a price/earnings ratio, or PE. This simple number reflects how well-thought-of the stock is by investors. A single-digit PE is considered to be low, while a number over 20 is considered to be high. If stocks were commodities, like bananas, a low price/earnings ratio would represent a bargain, a good value. But stocks are not commodities. A high PE usually signals that investors believe a company will experience fast earnings growth in the future and/or that its profit margins are higher.
Relative Performance–Momentum analysis of a stock’s relative performance (RP) is one of our favorite ways to measure a stock’s health. RP measures how a stock is performing relative to a specific market or index. A stock that holds its value during a declining market often soars once the market turns higher. In a strong bull market, most stocks will rise, even the stocks of weak companies. But you should concentrate your efforts on the best companies with the strongest stocks, the market’s leaders. The way to find them is by analyzing RP lines. Specifically, RP is calculated by dividing the Friday closing price of a stock by the Friday close of an index. (We use the broad Wilshire 5000.) The weekly changes are then plotted on a line graph, using a log scale. When an RP line is moving upward, the stock is outperforming the market. When it’s moving downward, the stock is underperforming the market. A flat RP line indicates the stock’s performance is equal to the market’s performance.
Short Selling–Short selling is the practice of borrowing shares of a stock so you can sell it (short), planning to buy it back later at a lower price … returning the shares and keeping the difference in price as your profit. Essentially, you’re betting that the price will fall. At Cabot, we seldom recommend the practice, for a couple of good reasons. First is the long-term trend of the market, which has been generally upward over the decades, even centuries. When you invest (long) in a stock, you’re investing in synch with the long-term trend. But when you go short, you’re betting that the stock you’re shorting will move contrary to that long-term, upward market trend. And you’re betting that you’re clever enough to time both your entry and exit points to catch this move. It’s tricky. Equally important is the fact that the potential profits of a short-seller are limited. If the stock’s price falls to zero, the best you can do is double your money. Contrast that with the potential of a fast-growing company that could triple your money, or more, in a year or two. Conversely, on the long side the worst you can do is lose all the money you invested in that stock, while if you’re short, your potential losses are unlimited!
SNaC-SnaC, or Story, Numbers, Chart, is Paul Goodwin’s unique way of determining whether a stock is a good buy. Story includes the basic market proposition of a company, including its products, its target consumers, its potential for huge sales growth, its barriers to entry, its competition, its intellectual property, its management and all the other stuff that you can put into words.
But a good story isn’t enough. A stock also must have good numbers, which are a factual record of a company’s (and thus, management’s) success. Paul looks for stocks that have been growing revenues and earnings for a number of quarters, ideally with earnings (profits) rising faster than revenues (sales). Paul likes to see the rate of growth for both categories accelerating. It’s also nice to have an increasing number of institutional investors and an after-tax profit margin that’s high and rising. And finally, Paul wants a stock that’s liquid–trading at 400,000 shares a day or more–so Cabot subscribers can trade without being worried that the stock will get deep-sixed by one money manager who wants out.
Charts are where the rubber meets the road in growth stock investing. Some highly technical investors don’t even care what a company’s product is or how much money it’s been making. They think they can tell everything they need just from a stock’s chart. Paul isn’t that narrowly focused, but he knows that a stock with a rising price and good volume support must be doing something right.
The list could go on forever, but that’s a basic rundown of terms we write about frequently. And as always, send me an email with any other questions, comments or suggestions. More definitions and educational information can be also found on our Web site, http://www.cabot.net.
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Now on to Cabot’s weekly Stock Market Analysis Video with Cabot China & Emerging Markets Report Editor Paul Goodwin.
This week, Paul discusses S&P 500’s good, but not great, week, which he thinks is a good illustration of how markets actually work. Paul thinks we are in a highly reactive market where people are worried, but optimistic about the economy looking out six months or so. Our market timing indicators reflect this, as they are all positive.
Paul also discusses the Halter USX China Index, which forms the basis of the Cabot China-Timer, as well as some emerging markets stocks, including Turkcell (TKC) and Sociedad Quimica Y Minera (SQM).
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In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, I have links below to each issue.
Cabot Wealth Advisory 3/29/10 – The Most Serene Rich Man in the World
On Monday, Timothy Lutts wrote a follow-up to his previous week’s column on the NCAA, featuring a readers’ letter. Tim also discussed the Templeton Prize, which was recently awarded to genetic researcher Francisco Ayala. Tim finished by writing about a few travel stocks. Featured stocks: Priceline (PCLN) and UAL Corp. (UAUA).
Cabot Wealth Advisory 4/1/10 – A Dividend-Producing Income Stock
On Thursday, we heard from guest columnist Chloe Lutts, who is the editor of Dick Davis Digest and Dick Davis Income Digest. Chloe wrote about the history of the New York City subway system and recommended a dividend-producing income stock. Featured stocks: Bombardier Class B Shares (BBD-B.TO).
Until next time,
Editor of Cabot Wealth Advisory
P.S. Follow me on Twitter and ask me more investing terms: http://twitter.com/IconoInvestor And become a fan of Cabot on Facebook to see photos of our beautiful, historic building: http://www.facebook.com/pages/Cabot-Heritage-Corporation/412563550595