Is A Stock With Strong Fundamentals A Good Buy?

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In my previous article, I shared about the things to look out for in a good broker. Now that you have found a suitable broker, the next step is to discover which stock to buy.

There are 2 broad methods for investing – one that is based on fundamental analysis (FA), the other on technical analysis (TA). Which method should you use? Let’s explore.

I’m certain that we are aware that McDonald’s is in the fast-food industry. Studying its fundamentals require looking at the relationship between its earnings and stock’s performance. Below is a screenshot of McDonald’s chart.

McDonald’s stock chart 2016 – present

There are many factors that may affect a stock’s price: earnings, scandals, stock splits, innovations that save costs etc. Personally, I would like to see good earnings reinforced by good stocks performance to affirm that this company is indeed valued by investors/traders who are buying in.

The column “stock price percentage change“ refers to how the stock performed after last quarter’s earnings are announced compared to before the announcement.

If Column H2 is 10.96%, it means after earnings for the 4th quarter (Oct to Dec) are announced ($1.82), and trailing twelve months (ttm) earnings per share is $7.54, prices increased by 10.96% from 177.65 to 197.12.

In short, this table shows us if there are any relationship between the ttm earnings and stock performance.

Common sense tells us if the ttm is higher than the previous quarter, the stock price performance going forward should rise. The issue? This does not happen all the time.

Take for example Mar 2018 to Jun 2018. Ttm (Mar 2018) increased vs but McDonald’s stock price still went down. Under the ‘stock price percentage change’ column, we can see that McDonald’s earnings are improving with its stock prices, in general.

This is why we need TA to help us time our entry. Knowing that McDonald’s is a good stock, we can use TA to time our entry with the confidence that prices would generally head in the upwards direction.

How much to risk?

This study not only tells me how much I can earn per quarter but before thinking of the profits, traders need to think of how much risk they can stomach. From the data and chart for the past few years, prices could move -7% against you in a quarter. This tells me that perhaps I should be willing to lose this much if I am wrong in my analysis. Cutting losses is part of the trading business.

Conclusion

Is a stock with strong fundamentals a good buy? Yes and No.

Yes, because we see that the stock price generally goes up as the business continues to be more profitable than the previous years.

No, because this is just one example and technical analysis would be a great help when it comes to answering the question of WHEN to buy.

If you are serious about learning more about trading, test this out with other stocks and you may find some potential trades/investments.

Cheers
MH
Swim Trading Resident Columnist