Stock price charts and quotes are readily displayed across all forms of media which can result in investors being overly fixated with share price movements. Also, the visual aspects of stock price charts can lead novice investors into the following misconceptions:

• If a stock traded at $10 one year ago and is now a bargain at $4
• A stock with a low share price (say $1) is cheap whereas a high share price ($70) is expensive

To help novice investors start thinking like savvy investors we suggest a simple brain storming exercise. The brainstorming exercise is to compile a list questions you would ask to the owner of a small business you are interested in buying.

The following non-exhaustive list contains some of the most common questions (in no particular order):

• How much income is being generated through sales?
• What expenses are associated with generating this income?
  Advertising, rent, salaries, etc.
• Are sales and expenses increasing / decreasing?
• How much debt (liabilities) does the company have?
  Accounts payable, bank loans, etc.
• How much assets does the company have?
  Property, equipment, value of inventory, etc.

For a quick first pass on whether the small business of interest may be a good investment you could compare the asking price to the total company assets minus any debt. Then compare the profit (sales minus expenses) and possible growth based on sales and expenses forecasts.

Notably absent from the list is what the previous owner bought the business for, the previous owner before them, the previous owner again, and so on. These questions would allow a graph of price versus time to be created similar to a stock price chart. The key point to be made is that the fundamental valuation of the business based on actual financial measures is the critical factor. Additionally, the details of previous purchases are inconclusive as they more than likely occurred in different economic conditions.

Buying a Stock is Buying a Share of a Business…

Therefore similar questions to those highlighted in the brainstorming example should be considered when buying a stock, which forms the basis of a fundamental stock analysis approach. Each publicly listed company must release their audited financial results so start using fundamental analysis criteria in your stock selection process!

Stop being fixated on share price alone. A company’s share price only becomes useful when taking the underlying fundamentals into account.

Start using First Class Trader’s fundamental analysis software to identify value investment opportunities!

OBV Calculation

OBV Usage

OBV is based on the idea that volume precedes price. A rising OBV can indicate the presence of smart money flowing into (or out of) a security which may initiate a trend with ensuing investors. A plot of 3M’s stock price and OBV over the 18 month period to June 2010 is shown in Figure 1.

The numerical value of OBV is not important or comparative between stocks. The main focus is the OBV trend and its relationship with stock price.

Figure 1: On Balance Volume (OBV) Example – MMM

The OBV trend can indicate whether buying pressure is increasing or decreasing. If volume starts decreasing on days of stock price increases the OBV will tend to flatten out. This indicates that buying pressure is weakening along with the upward price trend and a reversal may be on the way.

Figure 1 Note: A strong upward trend was established in 3M’s OBV in March 2009 through to September 2009 with the stock price rising from $40 to $75. From September 2009 onwards the buying pressure was weakening as can be seen from a flattening out of the OBV signal until a trend reversal was confirmed in mid May 2009.

The OBV signal can also be used to identify divergence with the stock price trend to indicate that a trend reversal may soon occur.

OBV Limitations

One limitation of the OBV indicator is that it doesn’t take into account the magnitude of price change. E.g. the OBV would be the same if a stock price went up 10% or 0.1%. However, the OBV would be quite different if the 0.1% increase ended in a 0.1% stock price decrease.

Chart images were generated using First Class Trader’s stock analysis software.

Using the First Class Trader Stock Search tool allows you to easily navigate through and obtain a list of companies from one of the indices listed below (NASDAQ, NYSE, ASX, etc). Adding a list of companies to the fundamental analysis Research Filter will highlight companies in the strongest financial positions through to the weakest by performing stock market analysis and investment research for you.

Fundamental Analysis Data

Click here to see Version 2′s new features and bug fixes

The major new feature is:

Financial Health Algorithm and Ranking

The financial health of each company can now be ranked on a scale of 0-100. The rankings are based on each company’s current and historical financial results. Up to 30 financial performance indicators are included in the financial health algorithm to give an overall assessment of the operations and business performance of each company.

Financial Health Ranking Screenshot

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Download a Free Trial

Click on the Download button below to obtain a trial version of the First Class Trader stock analysis software and be up and running in just 60 seconds.

Just follow the installation wizard and use the password “firstclasstrader.com“, without the “quotes”, to activate your software.

There are two main methods of determining buy/sell signals using the RSI indicator:

• RSI Crossover Levels
• RSI Divergence

Relative Strength Index (RSI) Crossover Levels

Using the RSI to determine overbought and oversold conditions can be achieved when the signal rises or falls below predefined levels. These predefined levels are referred to as crossover levels and typical settings include 70/30 and 80/20. These levels are related to the RSI scale of 0 to 100 and for example with the 80/20 settings, overbought signals are generated when the RSI signal falls below 80 and oversold conditions when rising above 20. Additionally, overbought signifies that a price down-turn may be approaching and conversely a price up-turn after oversold conditions are met.

Using RSI crossover levels for buy/sell signals can be seen graphically in Figure 1, for Microsoft (MSFT) during the 6 months from February 2009. As can be seen there are two buy signals generated when crossing over the oversold level of 20. Two sell signals are also generated over the period when crossing the overbought level of 80.

Figure 1: RSI 80/20 Crossover Levels Example – MSFT

Figure 1 Note: The RSI signal used in the example of Figure 1 has a period of 14 (default settings). Using a low period will generate more buy/sell signals however they may not all be accurate. A higher degree of confidence can be achieved basing buy/sell signals off a longer period RSI.

Relative Strength Index (RSI) Divergence

Divergence is where two signals are trending in opposite directions. A divergence with the stock price and RSI signal can indicate that a stock price reversal may soon occur. RSI Divergence is best illustrated in the example shown in Figure 2 for IBM during the 8 month period from September 2008.

Divergences occurring after a cross over into overbought / oversold conditions are much more reliable that when the RSI is at an intermediate level.

Figure 2: RSI Divergence Example – IBM

Around November 2008 the stock price was in a downward trend setting new lows however the RSI signal during that period was setting higher lows causing a divergence. The mid November price break-out confirmed the improving momentum which saw the stock price continue on an upward trend.

The two months from April 2009 saw a steady trend upwards in the stock price however the RSI was setting new lower highs causing a divergence. The stock price reversal came mid June 2009.

Investing Tip: Look for a confirmation of expected future price trends from one or more indicators before investing.

All charts have been generated using the First Class Trader stock market analysis software.

Version 1.2 of the First Class Trader User Guide has been released and can be downloaded now.

Revision History

Stock Screener / Stock Screening

A Stock Screener is a way of selecting stocks that meet a “strict set of criteria that he or she requires prior to investing in a company” (quote from Investopedia’s definition). For reference, an example of a free Stock Screener is the Yahoo! Stock Screener.

The main problem with using a Stock Screener is knowing what financial criteria to use and at what levels to set the screening limits.

Stock Screening Financial Criteria

The amount of different combinations makes it overwhelming for experienced investors. If your selected criteria is not thorough enough you may invest in companies that are performing well in some aspects but going backwards in others, which may eventually lead to their downturn. If your stock screening criteria is too comprehensive you will end up missing growth opportunities whilst waiting for the market to become under-valued.

Also, stocks may be identified by your Stock Screening criteria at inopportune times such as companies meeting growth criteria at the peak of their economic cycle or identifying under-valued investment prospects in an industry on a downward path.

Stock Screening Criteria Levels

Typical screening levels for each set of financial criteria are not well defined, especially for companies in different Industries whose financial structures can differ greatly. For instance, screening for companies with a low Price to Earnings (P/E) ratio will likely exclude most of the Technology sector. Including a high Return on Assets (ROA) percentage in a stock screener may focus on companies with little assets like consulting firms.

Based on the stock screening levels chosen you may miss out on lucrative investment opportunities if your filtering criteria is too strict or, alternatively, end up speculating from a large list of screened stocks.

First Class Trader’s Research Filter

The Research Filter will statistically rank each company against 30 financial performance indicators. Each financial performance indicator highlights a different aspect of financial health and when combined enable an overall financial assessment to be made.

Stock Screening with the Research Filter

The Research Filter was designed based on a comparative Fundamental Analysis approach but can be used to perform Stock Screening. Once you have added a list of stocks to the Research Filter all you have to do is sort a column with the financial criteria of interest and then remove all the companies that do not meet your chosen criteria levels. When applying for example P/E<15 you may be eliminating hundreds of possible investment opportunities (which is the point of a stock screener to narrow down your focus) however what about all the companies at a P/E of 15.1 or even 16? These companies may have an outstanding financial record in all other aspects however they will automatically be filtered out as an investment opportunity based on a single financial ratio. When you move on to the next financial criteria the chances of excluding other potentially lucrative investments based on a single financial ratio is becoming even more likely.

Outperforming Stock Screeners

It stands fair to reason, that if investing in a company based on a single financial ratio is not recommended, then conversely excluding a company based on a single ratio should also be avoided. In summary, stock screening can be a valuable tool however it should be used with care. The Research Filter will not exclude any companies based on a single ratio.

The statistical rankings of each of the 30 financial performance indicators will be used in an algorithm to determine financial health from which each company is ranked on a scale of 0-100.

Fundamental Analysis is used to identify value investment opportunities based on each company’s latest available financial results as well as historical performance. Each company listed on a stock exchange must publicly release their financial results (usually quarterly) which allows for a comparative assessment to be made between companies over a range of fundamental analysis criteria. First Class Trader’s Fundamental Analysis Research Filter then allows you to statistically rank each company’s financial health to find stocks in the strongest financial positions through to the weakest.

The following link contains a screen shot highlighting a number of Fundamental Analysis ratios and growth rates from an income sheet assessment of Australia’s top 20 companies in the All Ordinaries (ASX).

The three major financial statements used in a Fundamental Analysis assessment consist of:

• Income Statement
• Balance Sheet
• Cash Flow Statement

Company financial statements contain an overwhelming amount of information however First Class Trader focuses on the key results of each statement to form a comprehensive yet easy to understand set of fundamental analysis criteria.