As famed value investor Benjamin Graham once mused, it’s better to buy an investment after a decline than after it has risen. One of the goals when buying low is to avoid catching a falling knife. To the extent possible, if you are about to buy a stock after it has had a substantial decline, you should abort the mission if you believe there are factors present which could cause it to fall even more.
This raises the question: How do you know if a security’s price is close to its bottom? Prudent analysis will help. But even with the most sophisticated tools available today, there’s no guarantee that you’ll get in at just the right moment. That said, when scanning the wonderful world of investments, you might consider dividing your due diligence into three categories. This includes fundamental analysis, technical analysis, and a third that I’ll call ‘other’ that includes looking at recent news of a company, the level of (legal) insider trading and so forth.
In this post, we’ll briefly touch on each with the hope that you will find something to help you in your business.
Fundamental analysis consists of a company’s finances, quality of management and business ratios which can provide insight in to the health of a business. Is the company profitable? Is its earnings consistent and have there been any positive or negative surprises? Does the company have a lot of debt relative to others in their industry? The list is extensive and some of the information is more predictive. Is the current price above or below its fair market value? Determining intrinsic value is a common technique which may help. Some investors prefer stocks with a low valuation ratios (P/E, P/S, P/B, etc.). However, this will vary by industry and even when there is a low P/E, it’s not unusual for it to remain low for quite a while before the stock’s price rises. In my opinion, fundamental analysis is essential, but it only provides a partial picture.