After we have completed the planning process, determined income and growth requirements, organized distributions, quantified attitudes toward risk, and settled on an appropriate investment model, we then have to select investments and buy them. We use two types of analysis in making our buy and sell decisions: fundamental analysis and technical analysis. The fundamental analysis focuses on a company’s income statement, balance sheet and cash flows, and identifies the investments we would like to own. The technical analysis focuses on price movements and identifies the point at which we will buy or sell an investment.
To illustrate the process, here are four very different, recent examples: Roper Industries (ROP), British Steel (BST), Cadence Design (CDN), and Identix (IDX).
ROP – We first identified ROP back in May ’98 from one of our research services, Marketscope. After our analysis, we concluded that ROP was engaged in a highly profitable business, had great cash flow, a superb balance sheet, valuable patent protection, a large market and weak competition. Their revenue growth rate was in the 20%+ range for many years, margins were high (50%) and profitability was continuing to grow (all part of our fundamental analysis). However, the stock was too expensive at that time. In June, the stock began to decline from a high of $34 and P/E of close to 30, and by October it was selling for $15. It declined because 20% of its annual sales are to the large Russian utility company, Gazprom, and investors feared that ROP’s profitability would be negatively impacted by the Russian situation. After talking with their treasurer, we discovered that ROP/Gazprom had obtained bank guarantees (LOC’s-Letters of Credit), which would ensure payments to ROP by Gazprom.
Based on these facts, chart patterns, and positive cash flow into the stock (technical analysis), we purchased $500,000 of ROP on 9/22/98 at about $17/shr. for our clients. We recently sold ROP at $34, after determining that the stock was fully valued. Our clients’ profit on ROP will pay their investment management fees for 1-2 years.
BST – Searching for income producing investments in our Value Line service, we noted that BST was trading down in price, which put the dividend at about 11% of its market price (11% yield). Our analysis concluded that the strength of the British pound was adversely affecting their sales and profits, and hence the price of their stock. We further noted the strength of their balance sheet (only 13% debt), strong cash flows, and that their profits were plenty sufficient to cover their dividend payment. Our assessment was that the British pound would eventually decline (perhaps due to the new euro currency), thereby enabling the company to increase sales, and the stock price would rise. In the meantime, we would continue to collect 11% income on our investment to help our clients fund their retirement. We still own the stock, and it has appreciated from a low of $15 to $26 after a buyout offer. It is still yielding almost 9%. We are comfortable with our decision to hold BST until it is bought out.
CDN – Research by Standard and Poor’s indicated that CDN was a great buy, with all of the features we look for in a stock. We bought it in our more aggressive accounts on 3/30/99 for about $26/shr., and as late as 4/5/99 analysts were issuing buy ratings when the stock was selling at $27/shr.
On 4/21/99, CDN announced their earnings, which were very good, but issued a warning about temporarily slowing growth in their markets. On that date, the stock fell $9. CDN is now selling at 13 9/16, and we are watching the charts for indications of strength, so that we can “average down” (i.e., buy more in accounts that own it, lowering the average price per share) on the stock.
We believe that CDN has a great future.
IDX – Our Special Situations service recently identified IDX as “especially recommended.” I first saw the stock years ago, when one of our new clients came in with it, and have been tracking it ever since. After reading the analyst’s report, I was excited about this stock, and recently put together a buy list to purchase $500,000 of IDX for our clients. IDX is in the biometrics identification business, which uses fingerprints and other human features to provide access authorization to PC’s, ATM’s, door locks, etc. IDX is a leader in a vast market.
Fundamentals looked good, but research on our Bloomberg news service indicated that large amounts of insider selling has been taking place in recent weeks. Among those selling was the current IDX President, who had sold all of his shares in the last few days at $11/shr. We canceled our plans to buy the stock, and it is now selling at $9. We avoided a potential problem, but we will continue to track IDX for a while.
We hope this article has provided some insight on our investment decision discipline, and the steps we need to go through to make intelligent investment decisions.