I’ve been blessed to experience wonderful friendships across my life. What a privilege to teach accounting to people in college over the years! I feel I’ve already made new friends via the website-enabled interaction that surrounds my book, “Choose Stocks Wisely.” Tonight, I will briefly share a very recent interesting question I received.
A reader of my book wrote the following:
“Sir, I am extremely happy with the purchase of my book. I am 21 years old currently serving in the military and spending my free time learning about investing and the stock market. I was concentrating on technical analysis but now with the addition of the balance sheet to confirm the financial health of the company I feel more confident with the risks the stock market holds. My question; Is your balance sheet formula only intended for use with the stock screener step (occurring) prior to testing for liquidity and solvency. Or will it be just as effective if I concentrate on charts and use the liquidity and solvency tests (parts A and B of the Scorecard) to confirm what the charts are reading (saying). Thanks again for the great book; it will be a powerful addition to my tool kit and I’m looking forward to hearing from you!”
Let me acknowledge what a respectful note this is and how much it is appreciated. While the question posed is specific, it serves to reflect the bigger picture with regard to the multitude of stock investing approaches which exist.
My response to the reader:
“First, thanks for reading my book…..and I applaud you for serving in the military, friend. You have my respect.
You ask an excellent question. You know, my expertise is not with charting, but I know people who are good at that and feel most comfortable with doing what they know. For me, my comfort zone is with fundamental (financial) analysis. So, migrating to focus on technicals would be difficult for me since my inclination toward fundamentals is formulated already.
I would say if you have gained expertise with technical analysis (TA), then you may not want to abandon that (altogether). Yet, complimenting that TA with checking out the health of the balance sheet makes all the sense in the world. Parts A and B (of the Scorecard) taken together, in my mind, formulate the most important facet of my book’s theme. Why would I consider investing in a company that is not adequately liquid to pay its daily operating costs and not solidly solvent?
I hope I’m answering your question…..let me know if I’m not addressing it. I’m hearing you say you are comfortable with technical analysis and wonder if blending the liquidity and solvency Scorecard checks will help reduce some risk with your investing. You are wondering if you would be deriving benefit from the liquidity and solvency checks without having done the preliminary screening. I would say you are absolutely improving your analysis. In my view, you would go from strictly depending on a trading picture (pattern) to having some added knowledge about the health of the underlying company.”
I appreciate my readers and hope this discussion is helpful to someone. While a plethora of investment approaches are available, there’s no substitute for the balance sheet in risk assessment, regardless of the investment approach used. Liquidity and solvency assessment is enabled with the balance sheet and is important whether an investor uses a screener or a whether a particular pricing method (formula) is used.
For myself, I want to mitigate my risk by seeking quality and I want to mitigate it further by paying a low price for that quality. That said, what price should I be willing to pay if I can’t assess quality or if quality is absent? From my viewpoint, price becomes irrelevant if quality is missing. Paying anything where quality is missing is paying too much. Quality precedes price with investing in stocks, I believe.
My friend wanted to know whether the Scorecard could still be useful with checking for quality (Parts A and B of Scorecard) in a situation where he is used to reading charts (technical analysis) to pick buying points rather than using a balance sheet buying formula like mine (fundamental analysis….see Parts C and D of Scorecard). My answer is that assessing quality is the most critical part of risk analysis when buying stocks. It can only benefit whatever approach one chooses when it comes to investing in stocks.
Hello Paul and Reader,
I use both. I start with Paul’s spreadsheet, make sure that the company under examination is liquid, solvent, and note what I call the True Book Value from Paul’s Balance Sheet method. Then, I look at the stock chart. Looking at the stock chart aids me in my entry timing.
Regards,
Marc
I would like to second Marc’s comment. In addition, it seems important to distinguish between “investing: and “trading” and between being a “risk taker” and a “gambler”. The difference is being able to hopefully quantify the risks when making an investment. Most people are more successful at one or the other, based upon my experience. I am definitely not a gambler and would make a lousy trader, for example. However, I am a risk taker and I work hard to understand and quantify the risks. The only thing one can control when investing is his or her exposure to risk.
As Paul suggests, one should explore various approaches and find one or more that suits him or her best. Personally, I put quality above everything else. My efforts are devoted to studying and performing valuations of quality companies. As Mr. Buffett says, “it is better to buy a wonderful business at a fair price….” Attractive entry prices don’t develop very frequently so it pays to do your homework in advance and be attentive.
Regards,
David