As the markets keep on calling into question every single portion of your investments, even well-informed investors never stop doubting themselves!
You wonder, did I make the right decisions when I bought these stocks?
To answer yourself in any rational fashion, you need to be able to judge whether circumstances, not just psychology, have changed for your holdings.
In times like these, strong fundamental analysis becomes the most important key to your convictions. May be you have read about a company that intrigues you, or one of your friends is excited about a particular stock. Perhaps you keep seeing a stock on various "buy" lists and wonder what makes it so appealing.
Before you decide to buy a stock, you face two key research tasks:
1. Fundamental Analysis: Examining the company issuing the stock.
2. Technical Analysis: Evaluating the stock itself.
Both forms of analysis are sometimes needed. You don't want to buy a stock that looks attractively priced, only to find out that the company is on the skids.
To further clarify the difference between fundamental analysis and technical analysis, think of the market as an open-air bazaar with stocks as items for sale.
A technical analyst would get into the shopping frenzy with eyes seeking the crowd. He would ignore the goods on sale altogether. When the technical analyst notices a group gathering in front of the booth selling, say, shirts, he would scramble over to buy as much inventory as possible, betting that the ensuing demand would push prices higher.
He doesn't even care what a silk shirt is as long as some greater fool at the back of the line is willing to buy it for more than the technical analyst paid.
Researching a Company
Fundamental analysis simply means conducting basic research on a company. When analyzing a company, you may want to choose companies that have the following qualities:
- A competitive advantage (such as key patents, a dominant share of the market or the fastest growth of new customers in a growing industry).
- A record of consistent earnings growth or a strong indication of future growth.
- A healthy balance sheet (low debt, strong cash flow).
- Substantial ownership by management and, perhaps, recent insider buying.
- Strong minority stakes by outside investors.
- Substantial and growing competition and low barriers to entry.
- A shortfall in earnings, or a possible future impediment to growth, such as new regulations or tax changes.
- A weak balance sheet (high debt, declining cash flow).
- Low ownership by management and/or insider selling.
- Recent resignations of key officers.
Crowd psychology can be a powerful yet fickle force in the markets. As a smart investor, you've got to stay constantly alert for when the herd reverses direction.
Fundamental analysis definitely takes time, effort and hard work, but if properly done it will most certainly allow you to identify strong companies.