As the stock market drives towards brand new highs I would like to remind you all of a popular quote from Warren Buffet.
“Be fearful when others are greedy and greedy when others are fearful”
I believe we are about to see a herd of average joe investors rush into the stock market as we hit fresh new highs. This is very unfortunate because I believe mom and pop investors will get slaughtered by the time it’s all said and done. Your next door neighbor and coworker will feel like stock market geniuses as the market climbs higher and higher. When you see them walking a couple months from now you will notice a new found “swag” they now carry when they walk. I’m here to beg you not to get caught up in the hype. Sure I believe the stock market is going to roar higher than we could ever imagine, but when you disregard sound financial principles you get KILLED in the markets.
Ask yourself a simple question. If you know the value of a business, is it safer/easier to make money when it’s trading near its 52 week highs or near its 52 week lows?
I for one find it much safer and easier to turn a profit when I purchase a company near its 52 week low than it’s 52 week high. Why? Because as the stock price grows, more and more profit is taken off the table.
I consistently screen for stocks that recently hit their 52 week lows. This has proven to be a gold mine over the years when coupled with fundamental and technical analysis. Please let me be clear, nobody said gold mining was easy, it’s hard work but definitely rewarding when you strike gold. Here are the steps I take when screening 52 week lows in the stock market.
1. Scan 52 Week Lows Daily
Stockcharts.com does a lot of the heavy lifting for me as they already have a list of predefined scans. I simply click on the 52 week low scan and sort them by the closing price. I never pay attention to a stock that is trading under $8, typically these stocks are thinly traded and do not have options available.
2. Value Each Stock
There are two quick down and dirty ways to assess stocks on a fundamental basis: Free Cash Flow (Operating Company) & Tangible Book Value (Asset Based Company). I have previously shown how to value stocks. Additionally I try to quickly assess if this business is dying or just stumbled on hard times.
3. Create a Watchlist
Once I have established a value for a stock (business) I compare that price to what the current price is for that company.
- If the stock price is severely above the actual valuation of the company I simple throw it in the trash and move on.
- If the stock is within 25% of the actual valuation I place it on my Watchlist.
4. Monitor Watchlist
Patience and discipline is key with this watchlist. I monitor it daily and over the course of several weeks and/or months I use technical analysis to gauge great entry points or potential trades.
Whew! I know some of you may have found that boring, I know I personally hate instruction and would rather see a hands on example. So let’s take a look at how I screened 52 week lows to find a gold nugget a couple months back.
Western Union (WU) got absolutely HAMMERED on Oct 31, 2012 after it announced earnings after the market close the day before. Take a look!
Once I identified Western Union at a new 52 week low, I quickly determined at $12.61 WU trades at 7 times free cash flow and pays an annual dividend of 4%. I also quickly identified that the company continually buys back its own stock and has steady cash flow.
I placed Western Union on my watchlist and initiated a trade a couple days later. Let’s see how Western Union is performing today.
As you can see Western Union rebounded very well from their 52 week low. To date it is up 16% from its crash.
I believe investing in stocks is very simple. A sound education in fundamental and technical analysis is a huge advantage as it helps you sift through the marketing and mainstream media hype of the stock market. Simply identify a business, value it properly, and wait patiently to acquire it at the price you are willing to pay. It really is that simple.
Do you use fundamental and technical analysis to identify new positions for your portfolio?