Why You Should Not Grow Complacent
Any trader that does any amount of fundamental analysis
will look at earnings. While EPS ratings are a quick and easy way to see how
your company compares with others, it doesn’t tell the whole story. You should
also look at revenues. Revenue growth is especially important in the current
economy, and can help you to distinguish those companies that are rapidly
growing their business from those that are simply increasing earnings through
cutting costs.
The basic premise behind growth
investing is that those companies that grow earnings the fastest will also see
their stock price grow the fastest. The purpose of fundamental analysis is to
help determine which companies are best positioned to rapidly grow their
earnings over the next several months/quarters/years. The simplest way to do
that is to look at how fast a company has grown earnings in the past and project
that forward. Â
As of this morning, S&P 500 companies had reported about a 12% earnings gain on
average. This was accomplished with about 9% sales growth.
What we see in today’s economy is relatively high unemployment, a difficult job
market, and yet corporate earnings on the rise. While these might seem to
contradict each other, what is happening is that many companies have improved
their bottom lines through cutting costs. Some of the primary ways in which
companies cut costs are through layoffs, attrition, or hiring freezes. All of
these cost-cutting techniques lend to the difficult job market.
Growth companies, those companies that have the best chance of rapidly
increasing their earnings over the next several years, are not cutting costs in
these ways. They are growing earnings by growing their revenues. More demand
means more people will be needed to meet that demand. Research and development
costs may also be increasing, as they look to continue that growth and stay
ahead of the competition.
When comparing two companies with similar earnings rankings or growth rates, be
sure to take a look at revenues, as well. If one has significantly stronger
revenue growth, then that company normally has the better chance at sustaining
its earnings growth. Cost-cutting is a short-term solution. You can only cut
costs so much before you are out of business. True growth must be accompanied by
increasing revenues.
With regards to the market, it is acting very well lately. Whether you’re
looking for day, swing, or intermediate term trading opportunities, there seem
to be a larger number of them on the long side that are working currently than
in a very long time. The red flag I mentioned last time still exists,
though. There is still a lot of bullishness and complacency in the market
right. So while I would continue to focus on the long side of the market, don’t
get complacent. The worst time get complacent is when everyone else is. Also,
don’t completely abandon trying to identify short opportunities. As
Gary Kaltbaum says, strength is most easily spotted in a bad market, and
weakness is most easily spotted in a good market. I would only take
intermediate-term shorts that are obvious and provide ideal setups.
Best of luck with your trading,
Rob Hanna