Rule 5 – Check the Fundamentals - BWLD

When purchasing a stock I always think WHEN, WHAT and HOW. We have covered WHEN to buy since it is when we see a stock break out of a high level channel then go quiet (low volume very little movement). We have the HOW to buy, basically we have a pilot purchase of a small amount of stock that wont keep us awake at night. With a 10% stop sell we would lose very little if the stock falls. You don’t need all your picks to win. Even if you pick just a few winners and all other stocks fall, you can still be ahead of the game as you build bigger positions on your winners. Now we need to cover the WHAT to buy.


We don’t just buy the breakout we need to ensure they are making lots of money. Check the stock fundamentals, at the very least you want to see qtr over qtr earnings gains of 30% or more. The bigger that number the better, try to find stocks that are having earnings gains of 100% or more over the same qtr a year earlier. If you can’t find the big earnings gains then at least try and keep it to 30% or more. If a company is not making money then there is no reason for long term stock price increases.

Now the reader will point out stocks that have doubled with no earnings and point out stocks that have gone down with fantastic earnings (doesn’t this drive you crazy)? This is because the market is a forward looking mechanism, price is really determined not by what is being reported today but what is likely to happen in the future. You may ask well how can we possibly know that and I say that’s why you look at volume. Massive up volume suggests that maybe earnings are going to improve, maybe somebody knows something. So now you say we can forget about earnings then, well the answer is you cannot. As an investor you have to put as many factors in your favor as possible. You want the great volume and the great earnings. Remember a company that is doing well with consistent great earnings is likely to continue that way at least for a while, just look at Apple.

Look at the history of great companies like Wal-Mart, Intel, Cisco, and Oracle to name just a few. In the days when they were climbing fast and having stock splits every year they also had great growth in their earnings. Those companies today struggle to get the stellar earnings growth year after year that they once did even though they are still great companies with great products. When a company is making lots of money its tough to keep increasing those earnings by 50% year after year. Those companies go from being growth stocks to eventually becoming large cap income stocks. If you were to plot earnings versus stock price over a 10 or 15 year period using each quarterly earnings you would see a very close correlation between earnings growth and stock price. Notice I say earnings “growth” because having the same earnings as last year is just flat so you can expect the stock price to also be flat. A company can report a great profit but it doesn’t help if it’s not beating the same qtr a year ago by a large amount.



Before I leave this topic I want to point out that a company can report great earnings yet the stock plummets and visa versa. Two things could be at work with this situation. Maybe the stock has just climbed much too fast and has got way ahead of itself or maybe something somewhere is suggesting tough times lay ahead. Remember it is all about the future not what is happening now. A stock price is set by what will happen, not what is happening (or has happened since an earnings report is about the past anyway). Finally a stock price is also affected by what the general market is doing. When the major indexes are going down you can be sure that 90% of stocks will also follow it down but maybe the great companies will fall less. You can usually expect 90% or more of companies to follow the general market. This suggests you do not want to be buying stocks in a falling market but more about that another day. One word of warning you should not buy if the earnings report is imminent. That is gambling, who knows what the results might be. Better to wait so you can build up a profit as a buffer before the next earnings report.

The following stocks are NOT recommendations to buy. Add them to your watch list and do your research first or consult your advisor. I you conclude they are a buy then wait for the pull back when the stock goes quiet.

BWLD - $46.15

This stock has just broke out on at least triple the volume. Latest quarter shows 46% qtr over qtr earnings growth with great growth in previous quarters. This would look interesting if a pull back occurs on low volume. Earnings due Feb 11th.