What exactly is it that causes a stock’s price to rise or fall? Economists will tell you that it’s the market forces attempting to find the equilibrium point between supply and demand. So the next logical question then would be; what causes supply and demand to become unbalanced? The answer to that question is news. In other words, information that may change the investment community’s opinion about a company’s ability to generate profits in the future.
About four years ago, I was with a pretty large group touring the Think or Swim headquarters in Chicago Illinois. We were all assembled in a theater where the head technician for the trading team for Think or Swim was going to make a presentation. We expected that we were going to hear how technical analysis was the most important aspect of our due diligence. We were wrong. At the very beginning of his speech, the speaker asked us “How many of you believe that technical analysis can predict future price movement of an equity?” About half the room raised their hands, another quarter of the room really weren’t sure how to answer the question, and perhaps 25% of the room believed that statement to be false. The speaker was quick to respond, “You’re wrong, what moves an equities price is news.”
It has always been my belief that the investment community (which is dominated by large institutional traders), buys and sells based on valuations. Whether they use some very sophisticated methodology to establish what they believe to be the value of the equity, or a more simplistic approach like price-earnings ratios and growth rates, ultimately they make the decision to acquire or dispose of an equity based on expectations of value. Once they have established their idea of what the equity should be worth (based on current fundamentals) they will continue their actions (either buying or selling) until one of two things happens: the equity reaches their target value, or a piece of news occurs that changes their expectation of value.
So how do we as retail investors stay on top of the news? For me it’s a process that begins with the reading of a very important section of a company’s 10-Q or 10-K. Both of these documents are filed with the Securities and Exchange Commission (www.sec.gov). Now I’m not a masochist, and I’m not suggesting that you read the entire 10-K or 10-Q, but there is one section that’s really important. If you read nothing else out of the 10-K or 10-Q, you do need to read “Management’s discussion and analysis of financial condition and results of operations”. Even though it is written by the management of the company, and therefore may paint a bit of a rosier outlook than is justified, it presents a lot of information that alerts investors as to what might affect the company’s ability to generate profits going forward. Since this is the root of change in an equities price, we, as investors, need to know what we are watching for. On any given day there will be lots of news about a particular company. However, it may not directly impact the company’s fundamentals. We need to know what the management of the company has identified as opportunities and challenges. In that way we become sensitive to those areas and can disregard most other news simply as noise. Once this step has been completed monitoring the news for important information becomes a much simpler process.
My daily due diligence is simple, straightforward, and efficient. I’ll first take a quick glance at Yahoo finance for any major news (www.finance.yahoo.com). Then I will open my trading platform and look for news that might pertain to each of my equities on my watch list. If I find a piece of news that I think might affect the investment community’s opinion about the company’s ability to generate profits going forward, I’ll look for other sources to confirm. I have found that both Reuters (www.reuters.com), and Bloomberg (www.bloomberg.com) are excellent sources of news. I’ll also look to Baron (shttp://online.barrons.com/home-page) and the Wall Street Journal (http://online.wsj.com/home-page).
Once I have the news and feel relatively confident in its validity, then I will consider whether this information is going to improve profits for the company or act as a detriment to their earnings. In that way, I can refine my expectation about the direction of the equities price and make any necessary adjustments to my positions or, based on this new information initiate new positions.
Our due diligence consist of technical, sentimental, and fundamental analysis. Fundamental analysis really boils down to understanding what affects a company’s ability to generate profits. Once the investor or is aware of the metrics and forces that affect earnings for their company, then the process of monitoring the news becomes much more efficient. By using a logical approach that involves the review of management’s discussion and analysis of financial condition and results of operations, and then being aware of those issues that can affect the company’s profits, the investor is in a much better position to develop realistic expectations of how the equities price may trend.