When choosing a stock to buy, the long term price trend is a good place to start. This is because companies that are well run and grow earnings year after year will likewise have stock prices that continually grow. Remember that we are looking to find stocks that will grow reliably over the next several years. Ideally we would want to buy a stock that doubles reliably every few years or so. We aren’t interested necessarily in something that will shoot up right now, but a stock in a company that will faithfully grow, and this growth will be reflected in the stock price sooner or later. Note that the “sooner or later” qualification is due to the fact that the price the market is willing to give for a stock at any one time is fickle and can be much higher or lower than the perceived “fair value.” These fluctuations, however, will tend to be centered around the fair price, so if the fair price of the stock is growing over time, because the company is growing as are profits, then the market price will also tend to follow this trend over the long-term.
The first thing I tend to look at, which is an obvious but an often over-looked trait, is the price of the stock itself. As said above, the market price will tend to follow the fair value, just as a paper boat floating downstream in a turbulent river will tend to move at the average velocity of the stream, although there may be many changes in velocity if observed for only a short period of time. If a company is increasing share holder value, making the company’s stock more valuable, this will be reflected in the price of the stock eventually.
When looking for candidates, I will flip though several stocks looking at the 5-10 year price history (High-Low-Open-Close charts or candlesticks, preferably) and look for those that I could set a ruler on and draw a relatively flat line. This can be done in a chart book (Dailygraphs, for example), in a publication like Valueline, or, less easily, on the web at Yahoo or another site. The issue with doing this online is that you often need to provide the symbol for the company, so you can’t easily flip through a set of price graphs, and you obviously won’t look at the charts of companies of which you have not heard.
Also, I try to avoid companies that are increasing very rapidly in price. While these companies are the lifeblood of the momentum investor, which is also a perfectly valid investment method, these companies tend to fizzle out and fall back down to earth, producing a bell-shaped curve (see Krispy Kreme for an example). In a later post I’ll go into the two main investment philosophies, momentum and value, and provide some tricks for those wanting to do momentum investing.
An example of a company with this type of price trend is Aflac (AFL). While there are some deviations, over the period growth is relatively steady, so the people running the company obviously know how to grow the business. As long as they don’t change what they do, and the business climate is such that what they have done will continue to work, and the company has not grown as big as it can following that business model, then I would expect this trend to continue.
Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.