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A Few Notes on Fire Your Stock Analyst!

| | Posted in: Fundamental Valuation, Investing Expertise

In his 2009 book Fire Your Stock Analyst!: Analyzing Stocks On Your Own (2nd Edition), author Harry Domash “describes practical step-by-step strategies for finding, researching, and evaluating investment candidates…one for growth stocks, and the other for value investors. …The methods described make use of information readily available to anyone connected to the Internet, but in new ways…” The target audience of the book encompasses “investors willing to put in the time and effort it takes to find and research profitable stock investments.” The culminations of the book (Chapter 18) are separate value stock and growth stock “analysis scorecards.” Some notable points from the book are:

From Chapter 2, “Evaluating Risk” (Page 23): “Be wary of investing in overvalued markets or in downtrending markets or sectors. There are thousands to choose from, so disqualify stocks with risk in the areas of product allocation, litigation, earnings restatement, sector outlook, financial health, and creative accounting.”

From Chapter 3, “Screening” (Page 27): “Portfolio123 offers, arguably, the most powerful free web screener available. It may take you some time to learn how to use it, but it’s worth the effort.”

From Chapter 4, “Analyst Tool #1: Analyze Analysts’ Data” (Page 70): “You probably won’t make money following analysts’ buy/sell advice per se. But there’s plenty of moneymaking information imbedded in their ratings and forecasts, if you know what to look for.”

From Chapter 5, “Analyst Tool #2: Valuation” (Page 80): “Market analysts all too often ignore the earnings growth expectations built into the current price when they tell us to buy their favorite stocks. But you can check the reasonableness of their recommendations yourself. Simply look up the current AAA corporate bond rate on the web and then find the growth rate implied by a stock’s P/E…”

From Chapter 6, “Analyst Tool #3: Establish Target Prices” (Page 90): “Even with the inherent errors, calculating target prices gives you insight into a stock’s upside potential that will help you make better choices.”

From Chapter 7, “Analyst Tool #4: Industry Analysis” (Page 102): “Growth investors will do best…by pinpointing the eventual winner in a still-fragmented emerging industry. Focusing on just four factors – sales (revenue), sales growth, operating margin, and SG&A compared to sales – will help you pick the winners.”

From Chapter 8, “Analyst Tool #5: Business Plan Analysis” (Page 104): “…you need to consider a company’s competitive advantages, or barriers to entry, in your analysis. …Without sufficient barriers to entry, a company’s long-term success is problematic, because it will be easy for new competitors to enter the fray.”

From Chapter 9, “Analyst Tool #6: Evaluate Management Quality” (Page 122): “Reviewing key officers’ resumes…the firm’s accounting cleanliness…earnings growth stability and key officers’ shareholdings gives you…perspective on management quality.”

From Chapter 10, “Analyst Tool #7: Analyze Financial Fitness” (Page 153): “You can simplify the task by sticking with low-debt firms showing positive cash flow and positive working capital. You can get a quick read on a high-debt firm’s financial health by checking its bond ratings, but the detailed Fiscal Fitness Exam is the best way to detect a potential financial basket case.”

From Chapter 11, “Analyst Tool #8: Profitability and Growth Analysis” (Page 190): “Sales growth, operating margins, profitability ratios, and cash flows all figure into the profitability equation. …They help you determine a company’s absolute profitability, and they help you pinpoint the most profitable players in a market sector.”

From Chapter 12, “Analyst Tool #9: Detect Red Flags” (Page 213): “Red Flags: slowing sales growth; accounts receivables increasing faster than sales; inventory levels increasing faster than sales; reported net income increased by pension plan income. Yellow Flags: capital expenditure lagging depreciation write-offs; temporarily low income tax rates.”

From Chapter 13, “Analyst Tool #10: Ownership Considerations” (Page 221): “…growth investors should be cautious about investing in stocks with less than 40 percent institutional ownership, because it’s likely that the smart money is avoiding the stock. Use caution for stocks with very high insider ownership, because that signals that big shareholders may be waiting for the opportune time to reduce their holdings.”

From Chapter 14, “Analyst Tool #11: Price Charts” (Page 230): “…avoid stocks in strong downtrends. Growth stocks should be in an uptrend when you buy, and value stocks should be close to their 200-day moving average…”

From Chapter 15, “Quick Prequalify” (Page 233): “You should be able to eliminate most bad ideas in less than five minutes… You’ll probably end up eliminating 15 out of every 20 candidates if they originated from tips from TV pundits, magazines, friends…”

From Chapter 16, “The Value Investing Process” (Page 273): “Value investing is about picking stocks left for dead by the growth crowd. If you’ve picked the right stocks, sell when they are trading within your target sell range. If something goes wrong, sell as soon as you realize that the recovery you expected won’t happen. Don’t procrastinate.”

From Chapter 17, “The Growth Investing Process” (Page 317): “…almost all growth stocks eventually fall short of expectations, triggering a 25 to 50 percent sell-off before you can react. Successful growth investors must learn to recognize the danger signals and sell before the news hits the street.”

Some cautions regarding context and expectations for the investing tools and strategies described in the book are:

  • The book only loosely ties recommended tools and strategies to a limited body of formal research, making it difficult to judge their efficacy and reliability.
  • The book does not offer expectations or benchmarks regarding returns achievable by correct application of the tools and strategies recommended at either a trade or a portfolio level. There is a mention of backtesting capabilities associated with stock screening tools, but such easy backtesting invites incorporation of data snooping bias into results via intensive testing of alternatives.
  • The book focuses entirely on equities and, given the tools and data requirements, mostly U.S. equities. Investors must look elsewhere for discussion of other asset classes (such as international equities, bonds and commodities) and portfolio-level allocations across asset classes.

In summary, relatively inexperienced investors should find Fire Your Stock Analyst! a useful guide for analyzing U.S. stocks. However, the book presents no benchmarks for investing performance and does not support diversification across asset classes.

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