Dow plunged another 260 points. How do you think I did?
By market close, NASDAQ had plunged 2.41%, the Dow had fallen 1.50%, and the S&P 500 had dropped 1.81%. My portfolio, on the other hand, had climbed .80%. A dramatic breakout? No way. But I will take credit for holding back potentially disastrous losses while also managing to benefit from some dangerous but calculated risks.
It’s been several days since I posted any lesson updates, so before reviewing how I ended up in the green, I’m going to review a few useful pointers I picked up over the weekend.
In my June 23rd post, I outlined some of the basic rules and tactics for analyzing a company’s core financials. I’ll continue that below. To keep it as brief as possible, I’ll post the basic rules and save examples for later:
- Logarithmic-scale graphs should be used to identify key points of “acceleration or deceleration in the percentage rate of quarterly earnings increases.” On a logarithmic-scale graph, a 20% increase is shown as twice as large as a 10% increase. This is different from arithmetically scaled charts in which “a 100% price move from $10 to $20 shows the same space change as a 50% increase from $20 to $30.” How to Make Money in Stocks.
- You should only select “stocks with 25% to 50% and Higher Annual Earnings Growth Rates.” How to Make Money in Stocks (emphasis added).
- You should only select stocks with annual Earnings Per Share that have increased in each of the last three years and that did definitely not have a slump in the second year. A second year slump cannot be overcome by a third-year boost. However, “[i]n a few cases, you might accept one down year in five as long as the following year’s earnings move back to new high ground.” How to Make Money in Stocks.
- Although Return on Equity (ROE) is not as critical a measurement as Earnings Per Share (EPS), it is definitely a metric to follow. “[N]early all the greatest growth stocks of the past 50 years had ROEs of at least 17%. (The really superior growth situations will sport 25% to 50% ROEs.).” How to Make Money in Stocks.
- Annual Cash Flow is another important metric. “To determine cash flow, add back the amount of depreciation the company shows to reflect the amount of cash that is being generated internally. Some growth stocks can also show annual cash flow per share that is at least 20% greater than actual earnings per share.” How to Make Money in Stocks (emphasis added).
- (← no idea why Medium insists on numbering this #1 instead of #6. Technical difficulties. Stick with me here…) Quarterly YoY EPS growth doesn’t necessarily indicate a stable, high-growth company. The stability of that company’s growth is also crucial to the stock’s success. Typically, you want to measure the stability and consistency of earnings growth across the last three years. You can track this metric by “plotting quarterly earnings for the past three or five years and fitting a trend line around the plotted points to determine the degree of deviation from the basic growth trend.” (I’m pretty sure you can also just google it). This measurement is on a scale of one to ninety-nine, with one being the most stable stock and ninety-nine being the most unstable. “Growth stocks with steady earnings tend to have a stability figure below 20 or 25.” Companies ranked over 30 may still be solid investments, but they tend to be larger companies with more cyclical cycles (meaning you have to catch them at the right point in their up-down cycles).
- A bull market usually lasts two to four years before leading to a bear market/recession. Bear markets often last around 10 months.
- A company that has continued profit growth during a bear market usually experiences a compressed stock price, which can spring forward upon arrival of the bull market.
- Young growth companies tend to dominate the market for a couple bull market cycles at a time. After that, the next bull market is usually dominated by larger, cyclical or turnaround companies before switching back to the young growth sector.
- Quarterly YoY EPS growth doesn’t necessarily indicate a stable, growth company. The stability of that growth as also crucial to the stock’s. Typically, you want to measure the stability and consistency of earnings growth across the last three years. You can track this metric by “plotting quarterly earnings for the past three or five years and fitting a trend line around the plotted points to determine the degree of deviation from the basic growth trend.” (I’m pretty sure you can also just google it). This measurement is on a scale of one to ninety-nine, with one being the most stable stock and ninety-nine being the most unstable. “Growth stocks with steady earnings tend to have a stability figure below 20 or 25.” Companies ranked over 30 may still be solid investments, but they tend to be larger companies with more cyclical cycles (meaning you have to catch them at the right point in their up-down cycle).
- Finally, here’s a chart-related pointer I picked up from Investors Business Daily (IBD): charts often consist of dozens or hundreds of tiny bases that appear to make up larger, more noteworthy bases. The question I’ve always had is: how do you know which bases are noteworthy and which are insubstantial? According to IBD, a base does not end until the stock rises at least 20%. So let’s say a stock has risen from 18% and fallen to 5%, thereby establishing its first base. If it rises 13% before falling again, the second drop is not considered a second base. It’s actually still part of the first base, since it never broke out beyond 20% from that first point. So what do you call this type of pattern? It’s a base-on-base, and it can be used to help identify larger trends across several days, weeks, or months.
Okay that’s it on the lessons front! If you have any questions, comments, or anything else to add, please feel free to drop them in the comments. My hope is to use this blog as a personal reference (so I don’t have to constantly rummage through my sources), so I would love to collect as much information as possible. I’d also love to know if you believe I missed important information or misreported anything.
To finish off this incredibly long post, I’m going to walk through how I managed to increase my earnings in the face of a severe downturn in the market.
I only had to invest in three companies to continue my uphill climb:
- American Water Works (AWK). As you know from my last post, I took a massive gamble and invested over $2,000 dollars into AWK to offset most of my Brexit-related losses. This strategy continued to pay off this morning, when the company’s price moderately rose from its starting price of 80.40 to a high of 82.01. I put in a limit sell order, setting the minimum sell price to $79 dollars (to ensure I wouldn’t take a huge loss if it suddenly plummeted before my order went through). My order processed for $80.54, netting me $2,094.04. I originally bought the shares at 79.73 ($2,072.98), leaving me with a small but comfortable profit of $21.06.
- Aqua America Inc. (WTR) — 5 shares ($170.8). Although I couldn’t identify any helpful partners in this one, I invested knowing that (1) utilities were the only stable industry on the rise post-Brexit; (2) WTR’s profit margins were greater than AWK’s (40% to 34% respectively); (3) WTR has shown consistent (though small) and stable YoY quartering earnings/revenue growth. While I didn’t expect to gain much, I also didn’t expect to lose anything. After buying 5 shares for $34.16 each, the stock closed at $34.54 ($0.34 increase per share), totaling a modest $1.9 increase total.
- Twilio Inc. (TWLO) — 5 shares ($134.85). TWLO’s IPO was only a few days ago, so the company had zero history to base an investment on (making it an enormous risk). However, unlike WTR, I based my buy-in on my observation of a “W” trend in the price flux. I put in a buy-order at $26.97, just above the day’s low of $26.30. Looking at the chart to the left, you can see that the low formed a very clear W,w. The price rose to a high of 28.19 before settling at 27.25, netting me $0.28 per share (a modest $1.4 total).
In total, I earned $24.36 for the day. Granted, the bulk came from my successful bet on American Water Works. Nonetheless, the fact that WTR and TWLO rose and didn’t fall during the post-Brexit panic was enough reason for me to celebrate.
Ok, wow, for those who survived this read, thank you! That’s all I’ve got for now. Hope you’re enjoying my posts. Until next time!