Valuist readers are likely aware that I advocate for a broadly diversified portfolio of low-cost ETFs and mutual funds, especially for core retirement investing. Over time, it becomes increasingly difficult to outperform the return of a low-fee index fund containing just the U.S. total stock market. However, that’s not to say that the only good portfolio is one comprised of VTSAX or the like. There are many good reasons to add positions that don’t correlate to the total market in the U.S. or the world.
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For instance, I hold small positions in both small cap value and emerging markets, via ETFs. These funds align with my risk-tolerance so I don’t mind taking the chance that they won’t outpace the total market’s return in the long run. By holding them I might be able to supplement the return of my core holdings without a lot of additional effort. However, when diverging from the total market return, do so cautiously. The more angles you consider, the better your chances of making sound investment decisions.
The following list are factors to consider when investing in non-core retirement holdings. It is not inclusive though, none of these factors are particularly useful on their own. Rather, this list is meant to serve as an introduction to stock analysis. When considered together, these factors help investors confirm the strength or weakness of a stock, ETF or mutual fund, as well as its expected, but never actual, performance.
The First 15 Things to Look at When Analyzing an investment in Mutual Funds, ETFs and Stocks
1. The 52 Week Range
The 52 week range shows the lowest and highest price that a stock/ETF/mutual fund has traded at during the previous 52 weeks. This range gives investors a sense of recent price history and whether there has been a dramatic change in value over the last year.
Having at least 1 million shares exchanged daily will help ensure that shares can be sold when necessary. Having too few buyers and sellers may lock investors into a position beyond their horizon or risk tolerance.
3. Institutional Ownership
This is a nuanced topic but important to be aware of. Having 50% or more of stock owned by large institutions may benefit individual investors, as these large investors are often considered the, “smart money.” That is, they have teams of analysts guiding investment decisions. Typically once a large institutional investor enters they attempt to drive more value/sales, which may in turn increase stock price.
The performance of a public company or fund is public information. Knowing the return on equity, return on assets and return on capital are good starting points. Also important is to have an understanding of the people behind a company by evaluating the management’s performance records.
5. Long-term debt-to-equity ratio
A “healthy” debt-to-income ratio is dependent on several variables, perhaps most significantly, the industry that you are analyzing. A healthy long-term debt ratio is often a sign of stability.
6. Growth statistics
Where was the stock/fund 10 years ago? How does its growth compare to the competition? Are profits seasonal; what are the other factors of supply and demand for this industry? Knowing how an asset’s value is increasing over time could signal the direction it is heading.
7. Trend lines
Because it assumed that prices trend, on a stock chart trend lines provide a big-picture view of where a fund or stock has traded at historically. Investors can use trend lines to attempt to identify a trend, or movement to determine entry and exit points for a position.
8. Relative Strength Index
The RSI measures a stock or asset’s strengths and weaknesses by comparing daily upward movements of price to daily downward movements. It combines the average gain with the average loss, within a set period of time. A ratio of these values is calculated to result in a figure between 0% and 100%. RSI readings over 50% generally indicate prices are rising over time and readings below 50% may indicate a declining price trend.
9. Support and resistance
Simply put, “support” is the price-range in which investors are willing to buy an asset, and resistance is the point where prices struggle to increase in value, due to lack of demand. Understanding support and resistance can help determine when to enter and exit positions. They also may foreshadow how far a stock is likely to increase or decrease in value.
10. Moving Averages
Moving averages help investors understand price trends over a specific time frame. Moving averages can also signal support and resistance levels. The Simple Moving Average (SMA) weighs all data equally, thus providing average price data, whereas the Exponential Moving Average (EMA) gives more weight to recent prices, thus providing a truer reflection of current value.
11. MACD (moving average convergence divergence)
MACD is a momentum indicator, reflecting the relationship between two exponential moving averages, one calculated on a short-term trend and one on a longer-term trend. Comparing these data sets can inform investors as to whether the more recent, average price, aligns with the larger trend, triggering buy or sell signals. This is used more by active traders than long-term investors but it is good to have an awareness of MACD if you are considering individual stock investments.
12. Put/Call Ratio
When you buy an options contract, it provides you the right (the ability, not the obligation) to buy stock (with a call option), or sell stock (through a put option) at a predetermined price, before a predetermined date. When investor sentiment about a company is negative there are typically more puts than calls issued. A significant trend in one direction or the other can be illuminating as to how investors feel about an asset, which in turn, may signal how they will invest.
13. Volatility Index
The volatility indicator (VIX)is another measurement of investor sentiment, but not immediate market movement. The VIX, or “fear” index, is based on price fluctuations in S&P 500 index options. Because of the predictive nature of options trades, the VIX is supposed to reflect how confident investors are investing in the market. The VIX generally rises when volatility is high and falls when volatility is low but it is not a flawless measurement. There have been many periods where the VIX remained high and stocks did not suffer but rather soared. Taken along with other factors, however, VIX can be a powerful tool to confirm trends.
14. Price-To-Earnings Ratio
The Price-to-earning (P/E) ratio is one of the most widely adopted stock analysis calculations. It is a more-or-less objective measurement of value, calculated by dividing the stock/fund’s current price-per-share by the reported “earning-per-share.” P/E can be calculated using future projected earnings, or 12 months of trailing earnings. A high P/E ratio might suggest that the stock/fund is over-valued. Or, it might mean that investors expect higher future growth rates. The P/E can also give insight into how a stock/fund’s valuation compares to its benchmark or industry.
15. Economic Reports
Economic reports contain a wealth of data that may help investors determine the relative health of an industry, or the market-at-large. When considering investing in sector-specific stocks or funds, economic data can be telling. Reports are available for a wide range of topics, perhaps most importantly on manufacturing, housing, inflation and job growth.
However, the strength of the economy and the performance of the stock market are not always correlated. As I write this, the U.S. economy is suffering high unemployment rates and profit loss due to the COVID 19 pandemic but the stock market is performing remarkably well. As with all of the factors outlined above, when considered alone they are not helpful measurements and may even cause investors to form false assumptions about the strength or weakness of the market. When taken together though, understanding the data behind stock analysis may make a huge difference in returns, even if individual stocks only comprise a small portion of your total equities portfolio.