FUNDAMENTAL INVESTING

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1 The Trifecta Guide to FUNDAMENTAL INVESTING

2 Trifecta Guide to Fundamental Investing All approaches to investing have various levels of merit. But here at Trifecta Stocks, we strongly believe that for a company s stock to make you some serious cash, it must past a rigorous round of quantitative, fundamental and technical analysis. Only when a stock passes through these three layers of intense scrutiny is it worth investing in. You can learn more about Technical Analysis from Bob Lang in The Trifecta Guide to Technical Analysis. And we rely on TheStreet Quant Ratings algorithm to perform Quantitative Analysis for us. So that leaves the third piece of the puzzle: Fundamental Analysis. Basically, Fundamental Analysis is rigorous investment research of a particular stock or fund. It s looking under the hood, chewing up and spitting out data and numbers to verify that a particular investment is worthy of your hard-earned dollars. Simply put, fundamental analysis is detective work. Fundamentals Expert: Bryan Ashenberg, CFA If you re talking about fundamentals, you must turn to TheStreet s Fundamental Analysis guru, Bryan Ashenberg. With more than 15 years of investment experience, Ashenberg previously provided generalist research coverage at UBS Global Asset Management, was a technology analyst at Columbus Circle Investors, and served as a generalist at Stechler & Company. Today, Ashenberg is a portfolio manager and a top authority on Fundamental Analysis at TheStreet. It s looking at concrete information about a company s veal value. You are judging its corporate health to better understand the risks and rewards, as well as how it measures up to its competitors and alternative investments. To perform your own Fundamental Analysis, you need to dissect a company s financial statements. Balance sheets, income statements, and cash flow analysis are all starting points. And each one helps us determine how a company makes money, how its assets and liabilities look, what its revenues and expenses are, and how much cash the company is generating from its business. In other words, a company s financial statements are the main data points that can be used to determine a company s overall health. Let s take a closer look at them now 1

3 Price-to-Earnings Ratio (P/E) Benjamin Graham, Warren Buffett s mentor, once said that the P/E ratio was one of the easiest ways to determine if a stock was trading on an investment or speculative basis i.e., is the stock s move founded? Jim Cramer is also an advocate for P/E ratios, declaring regularly on Mad Money that he won t buy a company that has a P/E ratio more than two times its growth rate. So what is a P/E ratio and how can you use it to determine a stock s worth? Well, the P/E ratio is a valuation metric that can normalize a stock s value for various companies within and across industries. It gives us an apples-to-apples comparison with other stocks. The P/E ratio let s us know if a stock is overvalued or undervalued relative to its peers and the market. Here s the formula M * E = P Spelling that out The stock s multiple times its earnings estimates equals its price. If you re going pay more (a higher multiple), make sure the company is producing solid earnings that will continue to accelerate through positive earnings revisions (a higher E) and by beating Wall Street s earnings expectations. Take Kansas City Southern (KSU), for example. As you can see in the graph to the right, the company has a higher 40 P/E ratio than the industry average and the S&P At the same time, the company has demonstrated a pattern 30 of positive earnings growth over the past two years. During the last fiscal year, Kansas City Southern earned $3.42 per 25 share versus $3.00 in the prior year and this year, the company is expected to earn $4.10 per share So that s the type of company worth paying more for. 15 But if you re looking for a bargain, follow Jim Cramer s advice 10 5 A bargain is a company that is growing sales and earnings faster than the average S&P 500 company, but sells for a lower multiple than average KSU IND AVG S&P P/E COMPARISON 2

4 A bargain is a company that is growing sales and earnings faster than the average S&P 500 company, but sells for a lower multiple than average. 20 To find this type of bargain, take a look at Rowan Companies (RDC). The graph to the right reveals that RDC has a P/E ratio that s lower than the industry average and the S&P 500. The contract drilling provider is posting solid results, too: Revenues are up year over year, and in the most recent quarter, earnings per share jumped 63% compared to the same quarter a year ago. The company earned $1.64 per share in the last fiscal year versus $1.08 in the prior year. This year the market expects an improvement in earnings to $ RDC would be considered a bargain by Cramer s standards RDC IND AVG P/E COMPARISON S&P Income Statement When looking at a company s income statement, you are literally analyzing how the money it makes flows through the company s expense structure and trickles down into profits. Just like your paycheck each month, net income is take-home pay or for companies, the money they can record as a profit at the end of the day. No one wants to invest in a company that s losing money. So a company s ability to turn a profit is vital. And the easiest way to determine a company s profits is with a simply formula Revenues - Expenses = Profit Writing that out, revenues (the money the company brings in) subtract expenses (anything the company is spending money on) equals profit. 3 3

5 Once you determine a company s profit, take a look at margins. Margins are a percentage of a company s revenues. You should try to understand where the leverage points are in the model to see if the company s gross or operating margins can expand. You want to see margin expansion, because it means earnings growth has the potential to surge. In fact, margin expansion is a powerful force that can help multiply earnings in a very short time. That s because margin expansion means your relative profitability for the same $1 in revenue is increasing. You are pocketing more profits at the end of the day, via volume leverage or other levers. When we see revenue growth with simultaneous margin expansion, that s when a stock can go through the roof as earnings explode. Balance Sheet To better understand what a company s assets and liabilities are, you need to take a closer look at the company s balance sheet. Are they cash rich or cash poor? It s an important question to answer, because you don t want to invest in a company with massive amounts of debt it could be detrimental to your portfolio. So you need to consider a company s cash flow statement and see how they generate their cash. The cash flow statement is broken down into cash flow from operations (cash from sales), investing (expenditures) and financing (selling stock). If the company is not making money from their operations, it will have to raise funds by taking on debt or by issuing new shares that could dilute our stock holdings. The greater amount of stock that is outstanding, the smaller our piece of the profit s pie. To explain this further, consider China Sunergy (CSUN). As you can see in the table to the right, the company s cash flow is rapidly deteriorating, and its debt is growing. BALANCE SHEET Q1 FY13 Q1 FY12 Also worth noting, CSUN had 15 million shares outstanding in the first quarter of 2013 the exact same amount as the first quarter of Given this, one could conclude that financial difficulties may develop in the near future for China Sunergy and it s a stock, fundamentally, you should consider avoiding. Cash & Equiv. ($mil) Total Assets ($mil) Total Debt ($mil) Equity ($mil) China Sunergy (CSUN) 4

6 Conclusion: Put the Fun in Fundamental Analysis Working on a new stock idea is exciting, it gets the heart pumping, but it takes great diligence and effort. Jim Cramer is fond of saying the alternative to the popular adage of Buy and Hold is Buy and Homework. What he means is that investors need to dedicate one hour per stock to research and analysis each week in order to maintain knowledge on their investments and to continue to look for new opportunities. With rigorous Fundamental Analysis, you can vet a particular investment, understand its risks and reward, and discern how it measures up to its competitors and alternative investments. With rigorous Fundamental Analysis, you can reduce your risks and increase your chances of outsized reward. That s why I encourage you to perform your own Fundamental Analysis on each of your stocks each week. Determine each stock s P/E ratio. Take a closer look at income statements. Establish if the company is cash rich or poor by scrutinizing the balance sheet. And even pay close attention to earnings announcements and management s comments on earnings calls. All of which can help you determine if you re investing in solid companies. Or you can just let us do all the heavy lifting for you here at Trifecta Stocks. We want to help you invest in a select group of stocks that have the potential for massive gains, while avoiding stocks that could blow a hole in your portfolio. And to ensure that you are investing in these best in breed stocks, every stock recommended in Trifecta Stocks must pass our three layers of intense scrutiny fundamental, technical and Quantitative Analysis. So you can invest with confidence and sleep a little easier at night. 5

7 REFERENCES