The market has behaved badly, there’s no doubt about it – but now is not the time to forget about stocks. The best use of the downturn is to start creating a watchlist of future candidates to buy in time for the upturn.
Some of the techniques outlined below require the use of stock data such as stock screening software. James Dunn featured stock screening software some time back. If you are interested in learning more about screening for top stocks, you can read it here.
1. Search for stocks trading on heavy volume
When fund managers and private investors start buying up, you want to get in on the action too. One of the best ways of locating heavy buying and selling activity is via a stock’s volume (the number of shares traded daily). Since fund managers tend to target large cap stocks with higher liquidity, you might want to seek out large cap stocks that are trading on increasing volume.
Remember, there’s no point choosing a high-volume stock whose earnings are shrinking. A healthy stock should post solid earnings results even in a downturn.
2. Seek out stocks that hold up during the downturn
Resilient stocks during downturns are often good candidates for when the upturn begins. James Dunn recently profiled stocks that are defying the downturn. If you haven’t read it, click here.
Resilient stocks don’t plunge by 90 per cent during downturns. Just like the rest of the market, they will fall – but losses will be more moderate.
But when the market takes a turn for the better, these stocks often lead the charge.
In search of budding leaders, check out the top gainers and losers (stocks that have posted the biggest gains and losses over the week). You might want to sort these stocks by sector. This task will help you nail down the stocks posting the biggest gains over the trading day, or week, and from which sector.
3. Don’t just stick with familiar-name stocks
Stocks that are most likely to soar during an upturn are those that will benefit from the sale of new products, the opening of new markets, the prowess of new management or advantageous industry conditions. Search through news, press releases and company reports for information that may propel the share price higher.
Many stocks post terrific gains in the decade after their initial public offering; but many of these stocks are relatively unknown and don’t appear on the radar of punters.
Don’t just stick with familiar names or stocks that are profiled in the media regularly. You are just as likely to find winning returns in the list of relatively unknown stocks that are doing great things – but quietly.
4. Locate the best time to buy
It’s helpful to know what the rest of the market is doing; are they buying up or offloading stocks?
One way to gauge the strength of the market is by examining the balance between the number of rising and falling stocks. In a downtrend, there will be more declining than advancing stocks – and the reverse will be true at the start of the uptrend. Some time back we examined the advance/decline line as a measure of the strengh of the market. You can read this story here.
It's handy to be familiar with the top stocks that rose or fell on big volume on given days. Take note of any company news, earnings announcements, or other performance information that may help explain any sudden price movements.
5. Compare a stock’s fundamentals to its industry peers
When giving a stock the once over it’s important to compare the company to its peers in the same industry. Comparing a company’s underlying fundamentals to other random stocks or the entire market is pretty pointless as a top-performing engineering company will look very different to a well-oiled software company.
Handy measures for comparison are a company’s after tax profit margin, sales growth and return on equity.
6. Growth in Earnings per Share (EPS) is key
It’s always worth screening stocks for growth in its earnings per share (EPS) over the past five years, and compare this figure to its peers. After all, if a company’s earnings per share increases year on year, it’s highly likely that it’s share price will follow suit.
Also check to see how much a company’s EPS has fluctuated from year to year (over the past three to five years). A company that generates consistent and stable earnings year on year is a more attractive candidate than a company with inconsistent earnings growth.
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