Utilising a technical approach to fundamental investing

(iStock)
(iStock)

When I was learning to trade in the 1990s, I tried to put together a technical trading system. But I was all over the place. I would try one technical indicator and then abandon it shortly thereafter for another, and after a year or more of this I had managed to make exactly zero progress. I was frustrated and wondered whether I should just give up.

Then a trader friend gave me some advice that got me back on track in no time. He said that I should just pick my favourite two or three indicators or oscillators and use them together. Using the basic default settings and trigger levels, I now had a system; all I had to do was sit back and wait for a stock to confirm and then enter the trade.

I did exactly that and it worked, albeit the key lesson for me was that this method of trading required a lot of waiting. I wanted multiple triggers every day, but I ended up only getting a few triggers every month. But the quality of those triggers, and hence my profits, was far superior to the messy method I had been using to try and trade.

This strategy still applies to trading, but recently I have been applying this to a long-term investment approach. You need to decide on the fundamental metrics that matter to you and which levels you consider to be an acceptable number. Then, put them all together and wait.

My online stockbroker offers a search facility that makes it easy to scan across the entire market to see which, if any, stock meets my criteria.

A particularly useful feature of this search function is that it also enables me to search on a three-year average and this increases the outputs. I like that function as I can filter them out later. The result is a decent list of stocks that have what I count as strong fundamentals across sectors for me to start digging further.

This method is typically called the bottom-up approach, as it is agnostic as to which sectors will end up confirming your requirements. Many investors, myself included, usually work from a top-down approach, whereby we’ll focus on a specific sector that we consider to be a great place to invest and then dig around the available listed stocks to decide which is the best in that sector to buy for the long haul.

The bottom-up approach has its benefits as it gets me to look at stocks I would normally never consider. Now sure, I may still walk away, but it does enlarge my potential investment universe.

The question is then which fundamental data points should be included?

I have stuck with the old-fashioned, tried and tested ones. They’ve survived decades of investor usage. I prefer return-on-equity and would look for a figure of at least above 16%. Debt is always important, so a debt-to-equity ratio is included, and here I’d look fora figure below 50%. Cash is always king, and the easiest measure of cash is a dividend; here I would look for consistent dividend payments that also increase every year.

Another important ratio to consider would be the quick ratio. There is no fast rule about which ratios to use, so any one you really like is worth including as you build your own system.

A last point is that as this bottom- up approach is industry agnostic, you can’t include industry specific measures in your initial search. For example, with banks, the cost-to-income and impairment ratios are important, while with miners it is head grade and mineral reserves. You’ll have to dive into those numbers after the initial search that sets up your universe of stocks.

This article originally appeared in the 4 June edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

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