Questions on the Stock Market

Question:
I have a few questions about short term trading, where the speculator holds the stock anywhere from several days to a month. Currently, I am using what I call an "optimist" strategy. I search on Yahoo Finance for companies that register a considerable drop because of lackluster earnings reports, failed drug trials, unfavorable news, etc. Generally, the price drops anywhere from 15-30%.

Of these companies, I try to pinpoint whether the value has dropped too far and should bounce back, whether by looking at the key statistics or by looking at previous all time lows. The first time I used this strategy, I netted about 27% in 3 weeks. However, currently, it has been going nowhere. Is this a good strategy? Are there any improvements that can be made to augment it so that it is more reliable?

Answer:
Regarding your first question, it is a good strategy to observe if stocks that have been hammered are going to bounce back right away. However, you cannot employ this strategy effectively if the company isn't a quality company to begin with. This means the company needs to have an established track record of getting through tough times. If no history has been established then it would be difficult to get value investors and others to jump in at the new low price. A history of over 30 years is ideal.

To improve your observations on this strategy, I would concentrate on the companies that are the top 100 of the Nasdaq and S&P 500 indexes. The reason for this is because almost all mutual funds have to buy the top 100 of the respective index. Do not bother with companies 101 and lower. Only the top 100 from each. This will make your observations easier.

Question:
My second question is trend analysis. Is it good to, essentially, follow the lemmings? I'm going to use Google as an example. In the past 2-3 months Google's stock price has been increasing like clockwork at a rate of about $50/month because of stellar earnings and profit reports. However, I am worried that Google is rising too quickly and will eventually burst. Would it be advisable to jump in and ride the wave, even though the stock price may become unstable?

Answer:
Regarding your second question, I don't think you need to follow the lemmings especially when you know you're following lemmings. Few people are able to identify lemmings when they see or hear them. If you have that ability, then always avoid taking the path of lemmings.

I looked up GOOG and found that it is up only 131% from the low. Contrast this with the 20+ companies that are part of my Dividend Achievers list which range from 138% to 414% above their respective low. Remember, these companies are considered the most conservative and have had a history of paying their shareholders for the time that they hold the stock, something that GOOG doesn't do at all.

GOOG is popular now but it will be a "has been" before you know it. Everyone, I mean everyone, has a target on Google and want to take over their market share. However, ask yourself this, "how many college students are trying to take out Nordstrom's department store?" Nobody. Despite this fact, Nordstrom's stock has increased 414% since November 21, 2008.

Question:
I have been trying to find markets with a lot of short term volatility, with large jumps or falls within a period of weeks. What markets would exhibit these characteristics.

Answer:
In answer to your last question, the market with the most short term volatility is the stock market. It's just a matter of which stocks to observe. Personally, I would be satisfied if I could get 3% in 3 months. As long as that 3% is on 50% of my portfolio and CDs (certificates of deposit) are yielding less than 6% annually.

Thanks for the questions and keep them coming.

Technical or Fundamental: Which is Better?

Question: Do you value fundamental analysis over technical analysis, or vice versa? Also, could you explain your reason why?


Answer: My view is that both are important to know. I like to see that a stock is technically at a new low (within 20% of a 1 year low.) Afterwards, I verify that the company can continue to operate as a business using fundamental analysis.

Basically, the technicals provide the symptoms of the patient while the technicals determine of the subject is going to live through the underlying condition. If everything checks out then you determine how much of your capital you'd like to commit. Personally, I like to commit a minimum of 20% of investment capital...otherwise it just isn't worth it.

I practice many kinds of technical analysis but my specialization is in Dow Theory. Dow Theory happens to be the basis of all modern American technical analysis and therefore provides a greater level of insight.

Although I use fundamental analysis, I have to admit that I am a skeptic of fundamental analysis for many reasons. The main reason is the fact that all financial data can be manipulated. Therefore, I focus on the one thing that has never been manipulated and that is dividend payments. In all the history of manipulation of financial information, the dividend payment is the only thing that has never been revised or taken back after it has already been paid out. Either the dividend has been paid or it hasn't. This is not the same for other types of company data that is reported.

If a company claims to pay a dividend but somehow doesn't, then I ignore that company. This is the reason why I focus on companies that have a history of dividend increases. These companies have established their reputation as being trustworthy. In the world of finance, trust is everything.

Now, don't get me wrong I still run all the numbers for fundamental analysis. It's just that I don't get too excited about how good the results might be. Additionally, with fundamental data I always assume the worst case scenario just in case.

I hope my response is helpful and leads you to examine the aspects of both technical and fundamental analysis further.

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Monsanto (MON) is within striking distance

According to Google Finance, "Monsanto Company along with its subsidiaries, is a worldwide provider of agricultural products for farmers. The Company’s seeds, biotechnology trait products, and herbicides provide farmers with solutions to produce foods for consumers and feed for animals. The Company operates in two segments: Seeds and Genomics, and Agricultural Productivity."

Although Monsanto (MON) isn't a Dividend Achiever or a member of the Nasdaq 100, the company has a solid history and provides investors with an exceptional opportunity.

MON is currently trading within 5.85% of the the 52-week low. What is significant about the low that MON is approaching is that it is close to the November 2008 low. This is a critical support level for the stock which could indicate that a major reversal is ahead.

According to Dow Theory, MON is projected to decline to the following levels:

• $52.17
• $37.08
• $21.99
• $6.90

Each of the downside targets, based on Dow Theory, should provide some kind of support level. Interestingly, MON's 50% level, based on the decline from the prior peak and the July 2002 low, is at $67.90. This means that either the stock declines much further or the stock rebounds from here.

According to Value Investment Survey dated August 2009, MON typically reverts to a level of 17 times cashflow. Full year 2008 cash flow was $4.50 per share. This equals a price of $76.50 that the shares should revert to at some point in the future. Value Line seems to believe that, for 2009, MON should achieve cash flow of $5.55 per share which implies a mean price of $94.35. I would opt for the lower price just to play it safe. In the period from 1981 to 1996, Value Line had a smaller mean price to cash flow (13x). This means that as time has gone on since 81' to 96' MON has managed to improve their price to cash flow figures.

With MON trading at 11% below the historical mean value, as well as being within 6% of the low, this is a good opportunity to get your research in as the share price declines. Focus on the downside risk and good luck. Touc.

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Investment Observation: Aqua America (WTR)

Today's investment observation is AquaAmerica (WTR). According to Yahoo!Finance's water utilities review, WTR is ranked as the second largest water utility based on market capitalization.

The most important point about this investment observation is that WTR has fallen to a brand new low during market hours on Friday October 30th. This low may soon match the 2-year low of around $14.50 set in mid-October 2008. This is fascinating because the actual lowest point after the market peak of 2006 at $30 is no longer on our last 52-week radar. However, we will watch to see if the ultimate low of $14.50 is reached.

According to Value Line Investment Survey, WTR normally trades around 1.6 times the per share dividend divided by the "interest rate" (1.6x $0.51/interest rate). Valueline doesn't tell us by which interest rate we should apply to the company, so I have decided to apply the 30, 20, and 10 year U.S. Treasury rate. The following are the mean prices that WTR would trade at for each interest rate:

• 30 year rate- $19.29
• 20 year rate- $19.47
• 10 year rate- $23.93

Based on the 30 year rate, WTR is selling 19.91% below the historical mean value. I chose the $19.29 value since it was the most conservative figure.

However, according to Investment Quality Trends, WTR is considered undervalued when it is selling for $12.27 or less. This indicates that WTR is not currently undervalued but could easily get to the $12.50 range if market conditions continue on the downside. Additionally, WTR has a large debt low and a high dividend payout ratio of 74%. This means that the stock could only "afford" a decline in earnings of 25% before the company has to borrow or issue more share to service the dividend.

According to Dow Theory, the following are the most important downside targets to watch for:

• $14
• $11.25 (fair value)
  
• $9
• $6.50

These targets are supposed to act as support levels. Support levels are points which the stock falls to but should not go below. If the stock goes below one support level then we should expect the stock to decline to the next target level.

One support level that is significant is the $15 level. This happens to be the most obvious level that the stock needs to hold above. Falling below $15 could indicate the negative nature of the markets.

Although this is a water utility and water is critical to life, investors need to understand that companies in this industry aren't a "sure thing." The biggest reason for this is that when, and if, water becomes scarce, government regulators will step in to take over (nationalize) what should otherwise be sold at the most profitable price (thereby curbing wasteful consumption.) There is literally an upside cap on profitability to a company like this due to the critical importance of the resource being sold.

Take your time to consider this Dividend Achiever for the good and the bad attributes. Your careful analysis of this company might compel you to purchase the stock. It is my hope that the stock falls further before your next acquisition. Touc.

Please revisit Dividend Inc. for editing and revisions to this post.

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