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Research and Evaluation
4.1 INVESTMENT PRINCIPLES
Objectives
The BetterInvesting Way of Investing
BetterInvesting was founded as the National Association of Investors
Corporation (NAIC) in the 1950s.
BetterInvesting’s four basic principles of investing are:
1. Invest on a regular basis over a long period of time.
2. Reinvest all earnings (dividends, interest, capital gains).
3. Invest in good quality companies with proven track records of
growth (with few exceptions).
4. Diversify your portfolio to reduce overall risk.
Invest Regularly Over a Long Time
Advantages:
1. Provides a way for someone who may not have a lot of money to
form an investment habit and begin building a portfolio. (Group of
Investments). The earlier you start, the more time works for you!
2. Takes advantage of Dollar Cost Averaging.
Dollar Cost Averaging means investing roughly equal amounts of
money at regular intervals. By spreading your purchases out this
way over time, you get more shares when the price of stock
fluctuates downward. As a result, you will buy a lot of your shares
at a price lower than the average price.
Dollar Cost Averaging Example
Reinvest All Earnings
By reinvesting all earnings, your investment takes advantage of
compounding.
Capital Gains from the sale of stock
Dividends from stocks you hold
Interest earned on any investment
Remember, it is the power of compounding over a long period of
time that produces superior performance.
Rule of 72!
Invest in Quality Growth Companies
A growth company is perceived to have excellent prospects for
above-average future growth in revenues and earnings – and thus, in
the price of its common stock.
They are usually defined as companies that are growing faster than
the growth rate of the overall U.S. economy.
They should have established, continuous growth records for sales
and earnings per share (EPS) for at least 5 years (preferably 10).
Continuous growth reflects strong management.
Diversify your Investments
By investing in different companies representing different
industries, you reduce the risk of your overall portfolio.
This strategy is known as diversification.
In addition to diversifying by industry grouping, you can diversify
by company size based on sales volume.
Small Companies: Sales under $500 million.
Medium Companies: Sales between $500 million and $5 billion.
Large Companies: Sales over $5 billion.
Advantages of a Large Sales Volume Company
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Business is more stable.
Stock price tends to be more stable
Stock price should hold up better in a weak market.
Management should be able to control growth more
efficiently through types of products sold.
• The company may have a worldwide market.
• Such companies should be purchased on dips in prices.
• Dividends may be larger as a percentage of earnings.
Disadvantages of a Large Sales Volume Company
• Growth rate in sales and EPS is normally less than 10%.
• Sales have to increase by a much larger dollar amount
to achieve the same percent of increase as a smaller
company.
• Dividends will be small if there is a real potential for
growth.
Advantages of a Small Sales Volume Company
• Sales and earnings growth rates can be higher than
those of larger companies – hopefully between 15%25%.
• Yearly high and low prices tend to be farther apart due
to greater price fluctuations.
Disadvantages of a Small Sales Volume Company
• Small companies are more likely to experience falling stock
prices in a weak market, especially when the country’s economy
is slow.
• May have more problems obtaining experienced and effective
management.
• Smaller companies are frequently younger and their survival
rate is lower.
Research and Evaluation
4.2 MARKET FUNDAMENTALS
Objectives
Technical Analysis is the study of the stock price.
Technicals include: Charts with graphical representations of price,
last trade, change, volume, 52 week high/low, etc.
Fundamental Analysis is the analysis of the company itself…its
operations and its position in its industry.
Fundamentals include: Earnings, Dividends, Sales, Revenues, Profit
Margins, etc.
The purpose of fundamental analysis is to assess the financial history
and current conditions of a company’s income, expenditure of money
and measure how efficiently they manage their business.
Tools of Fundamental Analysis
1. The Basics – What line of business is the company in? How does it earn
profits? Is it cyclical, seasonal? Defensive?
2. Identifying Industry Leaders – How large are total revenues of the
industry? What is the company’s Market Share?
Market Share – The percentage of the industry’s goods and services
controlled by one firm. The larger the market share, the less likely the
company’s profits will be squeezed by competition.
3. Insider Holdings – Knowing if company insiders are buying or selling their
company’s stock has proven helpful to investors in decision making. The
Securities and Exchange Commission (SEC) defines corporate Insiders as
officers, directors and major shareholders who own more than 10% of a
company’s shares.
4. Management Interviews – Listen to interviews with top management. The
internet is tearing down old barriers.
5. Analyst Coverage – An Analyst is a financial professional who study companies, write
research reports, and make specific recommendations based on their conclusions. After
studying the company, the analyst will issue a specific recommendation on the company.
Common terms used when analysts make recommendations:
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Strong Buy - Strongly recommended buy
Buy – Recommended buy
Attractive – Sees the stock as a good value
Accumulate – Recommends the investor make periodic purchases over coming
months
Market Outperform – Expects stock to perform better than the market (S&P 500)
Market Perform – Expects stock to perform similar to the market
Hold – No strong feelings either way
Avoid – Recommends not adding any shares
Sell – Negative on stock and expects price to fall
Strong Sell – Very negative on stock and expects price to fall
6. Revenue or Sales – The top line of the company’s Income Statement.
Ideally, a company will be increasing revenues by at least 20% annually
(varies based on a number of factors). As a basic rule of thumb you’re
looking for companies that are outperforming their fellow competitors.
7. Earnings Per Share (EPS) – The primary tool to determine a company’s
profitability. (Net Income divided by shares outstanding).
8. Price to Earnings (P/E) – Sometimes used to gauge whether a stock is
overvalued or undervalued. Most helpful when compared to industry
averages and the overall market. (Price per share divided by earnings per
share).
9. Volatility – a measure of the amount by which a stock price is
expected to change.
10. Beta – A stock’s volatility is measured against the overall market. If a
stock is more volatile than the DJIA, it will have a Beta greater than 1.