Stock Investment Methods

Stock Investment Methods

Fundamental analysis

Technical analysis

Being whipsawed

Momentum investing

What's Peter Lynch's secret?

Fundamental analysis

Looks at value indicators like

• Price-earnings ratio
• Price-book ratio
• Price-sales ratio

Also tries to determine price through discounted cash flow using estimates for

• Expected growth in company
• Required rate of return

Also may attempt to value factors like

• Corporate management
• Industry prospects
• Government regulation

Technical analysis

In purest form technical analysis ignores all fundamental information and only focuses on what the chart says

Two schools

Chartists

• Look for patterns like "double tops" and "head and shoulders"
• Often don't use any numerical analysis at all

Technicians

• Use numerical analysis to determine things like moving averages and stochastics

Many technical analysts use both methods

Being whipsawed

Technical analysts often give buy and sell signals when a trendline or a moving average is crossed

Many of these signals are only short-lived, and so you're constantly buying and selling

This whipsaw will cost you money due to commissions

Momentum investing

Perhaps better called "band wagon" investing

Attempts to buy stocks that are rising and sell those that are falling

Momentum stocks by definition are subject to ramping

The main problem with momentum investing is that the stocks are often thinly traded

You won't be able to get out when the stock begins a sharp fall

What's Peter Lynch's secret?

Lynch had a great record running Fidelity's giant Magellan fund

Magellan is the country's largest mutual fund

Lynch had his best returns in the late 1970s when Magellan was very small (under $100 million) and not open to the public for investment

Lynch also invested in a risky manner

Had a very large holding in Chrysler when Chrysler was near bankruptcy

In the 1987 market crash when the average mutual fund dropped 16 percent Magellan dropped 32 percent

You can almost always beat the market by taking on more risk