Considerations on stocks

Raul Tortima - 11/11/2019

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Given the tiresome discussion of the best method to evaluate the purchase - or sale - of a stock, the truth is that both fundamental and technical analysis can provide interesting tools, depending on the goal sought.

The graphs and their various analytical perspectives can help in price beaconing, under a shorter-term view. Obviously, any investor buys an asset for its appreciation, but the investor focused on price - trader - is often guided only by the difference between the purchase value and the potential sale value, which forces to establish exit parameters in case of frustration of expectations (stop loss). This type of approach does have its place in investment management, but with a quite different functioning and result when compared to the fundamental model of management.

There is a certain modus operandi in using such methodologies, combining them as if they were symbiotically complementary. Using support and resistance concepts to hit bottom and top can work well when applied in a short window of time. When looking at a horizon of years or decades of appreciation, one or more difference of cents in buying or selling adds very little value to the result of the trade. Not that price is irrelevant in the setting up of long-term positions - although some advocate in this sense - but the evaluation criteria for purchase becomes others, such as qualitative, accounting criteria, the intrinsic valuation of the asset and any comparison with its pairs. Likewise, obtaining short gains via day-trade from a position originally purchased for the long run degenerates a previously modeled strategy with a distinct purpose.

The idea among some long-term investors that there is no perfect timing for purchase lies in the concept that time and successive new buys dilute possible bad prices executed over the time. Although it may hold some truth, a good portion of investors takes this concept to an extreme, investing in the same asset at lower and lower prices in order to reduce the average purchase cost. Successive investment in the same stock is not a problem, on the contrary, as long as the motivation is based on some solid criteria, that the company will generate consistent returns in the future, not simply the need to reduce the average purchase value.

The consistent returns of a given company, extracted from the positive evolution of the market price and the payment of dividends over many years, may be corroborated by relatively simple valuation parameters. Recurring profits and cash generation are easy to check in any financial statement and should be placed in long-term perspective, since circumstantial increases in CAPEX (investments made), or some acquisition of a competitor - both with a view to accelerating growth - can mask a healthy and controlled evolution of a company's operation. At the same time, the indebtedness level and its ability to paid, always analyzed within a strategic context through which the company passes are relevant indicators as well. From the qualitative point of view, although it is often neglected, corporate governance is a powerful instrument for assessing the level of institutional maturity, translated by the way the company operates in the market, through transparency of the presented numbers, consistency in the treatment of minority shareholders and by management free of external interference.

Obviously, the numbers of revenue, EBITDA, net income and indebtedness should be viewed in relative terms, through growth indicators and comparisons with direct peers. Absolute debt growth will have more or less impact depending on the proportional increase in profit or EBITDA generated in the period. A decrease in the net margin, when coupled with direct competitors, may present a less negative image as it might suggest. When put in perspective of the current situation and when possible in the comparison to its peers - maturity, market leadership, rigidity or operational flexibility - the indicators provide a powerful picture to infer true value in the investment in the company's stock.

One of the most dangerous assumptions in equity investing lies in limiting the analysis to the qualitative scope. The fact that the company is a leader in its market, loved by consumers and has no governmental interference is no guarantee of success, just as companies in socially debatable sectors are not synonymous to failure. Another common misconception among investors is the pursuit of high dividend stocks, based only on the dividend yield, since it leaves aside the company's real payment capacity and the impact of this payment on the designed market strategy.

If the company has a high payout (payment of dividends in relation to its annual profit), but is a mature company, with not much competition or with tight and rigid operation, the impact is completely different from another that is still dependent on large investments to cope with its growth. If the company can obtain a good return on its operation, there is no reason to promote distribution, adding the fact that taxes on dividends crates a negative effect on compound interest inherent to the investment made.