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Finally, Numbers That Matter: Fundamental Analysis for Traders

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March 1, 2013
thinkorswim company analysis tool
Fredrik Broden

Technicians have forever resisted the notion that fundamental analysis matters—you know, poring over those pesky income statements and balance sheets. “It's already built into the charts!” they cry. A trader myself, I tend to agree with my technical brethren. But I also know there may be useful fundamental nuggets that complement my, ahem, charting prowess. And that's why, after 14 years, I'm pleased to announce we've developed the first fundamental gadget for the thinkorswim® platform—the company profile tool.

Be One With The Analyst

If Warren Buffett and Peter Lynch were techno-geeks and had hashed out an idea for a trading tool, it might have been the company profile tool ("tool"), which delivers two key things—valuating and researching companies you already know a little bit about. And why not? After all, Buffet looks for great companies that trade at a fair price. And Lynch believes in researching the companies whose products you already enjoy. The tool not only marries these two concepts but takes it to the next level—allowing you to be your own analyst without pouring over dense financial statements and mountains of data.

Historically, traders haven't cared too much about what a company does. Why bother projecting a five-year growth rate when you may only care about tomorrow, next week, or next month? But truth be told, I don't remember the last time I bought a symbol for a company I didn't know, or at least, didn't know what it made. For me, I feel more comfortable trading something familiar. So, on some level, certain fundamentals do in fact matter. Let's look at how you might benefit from studying them with the help of the tool.

Top Down, Trader Style

Fundamental investors approach markets in two ways—top down, and bottom up. I prefer top down for investments and bottom up for martinis. With top down, you might start with global economics, make your way to industry analysis, then to sector analysis, and finally to a couple of stock picks.

At this point in your research fire up the tool to make a side-by-side comparison of each stock candidate to see which one is favorable. The first question is, what are you looking for? To answer that, grab your analyst hat.

Stock analysts are notorious for building out complex equity models that let them adjust a company's valuation based on pulling certain levers. For instance, sales of widget “X” are up 10%, advertising pricing is decreasing by 1%, and operating margins are increasing by 2% —this is the basket of levers that could impact overall valuation. The tool lets you automatically adjust these “levers” to make your own projections. (See Figure 1.) After all, momentum is everything to a chart reader. You may want to know if there's anything about the company (or companies) you're about to trade that could give you an edge.

FIGURE 1: THE COMPANY PROFILE TOOL.

Studying the business divisions of a company can tell a story about a company you may not have heard. Just type in a symbol, and click a business division in the left bar. Select a forecast measure in the right column and view the data, or slide the levers to see what your forecasts will reveal. For illustrative purposes only.

Hypothetically Speaking ...

For example, imagine it's the start of the new year—new year, new you. We all promise to hit the gym, and with that, you figure millions of wishful thinkers will not only be going for six-pack abs, they'll be shopping for new workout clothes. So, you look for a company that specializes in “performance apparel.” You've narrowed your selection to two companies. Both have diversified businesses, so out of the gate, you're looking for one where there is a higher concentration of revenue in performance apparel. In addition, you're looking for the brand that's squeezing out higher margins in its apparel business. Finally, you're looking for the company that's trading at a discount to its valuation. In about 45 seconds, you should be able to zero in on what you think looks like the better opportunity. How?

Pulling the levers: To use the tool, start from the Trade page of thinkorswim.

1 —Type a stock symbol in the upper left box. If the tool is available for that stock, the “Company Profile” button will appear top right of the page. Click to bring up the tool (Figure 1).

2—On the blue vertical bar in the left of the tool window, click the division of business you'd like to analyze.

3—Notice right column of “Most important forecasts for this division.”

4—Drag estimates of these forecasts (the “levers") based on your own findings. Say you believe that with increased demand for performance apparel, there'll be a near-term sales spike resulting in a greater market share. By moving that lever up slightly, you can see the impact it would have on the valuation estimate.

Finding divergence: When there's a difference between your projections (which you adjusted with the levers), analyst estimates (which you can find on tdameritrade.com), and the current market price, you have found what's called divergence. And divergence is where you can often discover some great directional-trading potential—both to the upside and downside.

Does It Really Matter?

As a trader, you might not care. Because you don't feel qualified to pull levers and pretend to understand fundamentals. I hear you. Yet, there are still plenty of ways fundamentals—along with the tool—can help.

1—Before Betting the Farm. Say you discover an exciting new product. You research the company and everything checks out. The technicals seem to indicate that the time is right for entry so you pull the trigger-only to learn that the product you adore only adds 3% to the company's bottom line. In this scenario, the tool can help you validate or disprove your assumptions. It can help you better understand how much revenue is attributable to the bottom line from the company's combined revenue drivers.

2—Pairs trades. When two companies trend in lock step, they're said to be “correlated.” You'll typically find correlated stocks easiest among a pair of stocks in the same sector. When one of the stocks diverges in price from the other, and correlation breaks up, you might pairs trade by buying one stock and shorting the other, with the hopes that the stocks will again converge and resume normal correlation. (See our “Pairs Trading Special,” thinkMoney, Spring 2012.)

In this case, to help you assess correlation, use the tool to validate the pair itself. In other words, a chart may show that a pairs trade looks great, but the tool could help you understand if there's too much risk in one business over the other. For example, you may have two giant energy companies that appear to be in the same business. But you favor one over the other for technical reasons. By digging deeper into their business divisions, you may find there's a high amount of natural-gas drilling that could either threaten the correlation, or simply tell you it's a lousy pairs trade to start with.

3Finding Soldiers. In longer-term position trades, the tool lets you compare “generals to soldiers.” First-tier companies (generals) that serve as sector proxies tend to have lower volatility and might not offer the ideal opportunity. However, if you're anxious to be in this sector, you might look for the 2nd- and 3rd-tier companies (soldiers) that have room to grow. Do they have similar business units than the generals, and a similar makeup of those units? Are the growth projections of those units what you'd expect? The tool is your secret weapon and can help keep you armed and battle-ready.

Hit the “Books” Gladly

Remember in high school when Cliff Notes were your BFF? With so much great technology in the trading world these days, the idea of market research and informed decisions no longer have to provoke anxiety attacks and extreme dread. Think of the company profile tool as the Cliff Notes of the trading world that can easily turn you into a poor man's fundamentalist. You'll save yourself countless hours wading through beefy analyst reports, and quickly get the insights you need to trade a whole lot of companies whose products and services make you want to profile with joy.