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Scroll to the bottom of this Guidepost for an easy way
to ask for clarification on questions as they arise!

Greetings, fellow Pro-fundity team members -
2-01-02 Background music:

  1. We were asked why one of last week’s main picks looked to be near the top of its roll… (FMKT, Freemarkets, Inc.). Why would we include such a pattern among those that should be near-term buys? Excellent question, one we should address this week with all that goes into the pick selection. You may thrill to the answer.

  2. First, review the chart last Friday for FMKT, one of the 10 main picks (chart taken from TC-2000):


  3. The price chart shows a definite up-turn just prior to the 1/25/01 close. In fact, the four closing prices for the week (a four day trading week with the MLK holiday) were:
    1/22/02 - $18.30
    1/23/02 - $22.10
    1/24/02 - $23.50
    1/25/02 - $23.14
    That’s a 27% increase in four days!

  4. Let’s look at the reasons for including this security as a near-term buy. First, on the technical-analysis side, the following chart (taken from the Yahoo-Finance site outlined in last week’s Guidepost):


  5. 1st Point: In this chart we’ve included two TA indicators, Stochastics and Wilder’s Relative Strength Index. Both indicators show the overbought/oversold character of the price chart to be just coming off the bottom. That is, the bottom of the oscillation reflects the psychology of an over-sold condition. Sellers have dried up, with supply/demand pushing the price higher as buyers pick up the slack. The top of this emotional cycle finds the buyers weakening in the face of higher prices, and the cycle turns down. For this chart, these indicators are just beginning their movement higher. This suggests the price is not ready decrease.

  6. 2nd Point: The same chart as before is examined with weekly time-bars, rather than daily. It is always helpful to view the current condition on more than one time frame. This is very important in viewing charts, getting out of the forest to look at the trees, as it were. The same two indicators are included, confirming the price chart is not at the psychological high, but moving in a “range-rider” fashion on a respectable trend since May of 2001, the past 8 months.


  7. The next time-frame shows the price action the past five trading days, with an intra-day focal-angle. We see the dramatic volume increases that accounted for most of this 27% price-hike. This punches up the importance of volume activity in large price moves. But the nature of the price pattern on Thursday and Friday does not indicate a decrease is necessarily in the offing.


  8. Another popular oscillator is the MACD (moving average convergence/divergence). The next chart shows its pattern during this time-frame. It is suggested in trending markets (sideways, without marked trends up or down) a “buy” signal occurs when the red line crossed up through the green line. That occurred on Friday the 25th.


  9. The ”Bollinger band” is an envelope trend-measuring technique blended with a statistical concept. The envelope, providing support/resistance lines bounding a channel in which the price fluctuates, is not fixed in its width, but varies with the volatility of the price. In the chart below, notice how the price (blue line) bounces off the top and bottom of the Bollinger bands. We cover this principle in our book, “Provident Investing.” But for this discussion of FMKT, notice where the price bar is on the end of the chart, 1/25/02. It could go either way, but it is not at the top of the band, suggesting an eminent drop.


  10. Not one of these indicators will make the price do anything. That is, we have no guarantees moving forward. What we do have is some consensus between indicators, more than one message of the same flavor. We have hints, nothing more, with technical indicators. However, the odds ride with those who gather and find the most hints. But we rely not only on TA, let’s consider the “quality” of the company being considered.

  11. On the Yahoo-Finance site we found the following links when conducting research on a ticker. Clicking on the “Performance” link takes us to the next page.


  12. This page contains important information about FMKT, but the important point is the link just under the highlighted Performance Report, Earnings Estimates.


  • Clicking on this link brings the following estimates of earnings for the company. Point: Earnings are the life blood of successful market activity. It is the earnings and the increases of those earnings quarter-to-quarter that will do more for the financial well-being of a company than any other thing! This is the bottom-line Quality metric for a company’s value. So how does FMKT stack up? Note, there are 15 or 16 estimates. There are that many analysts assigned to study the fortunes of this company. These are the professionals who get paid big bucks to understand what makes a company tick. They know company executives, company business models, market competitive advantages/weaknesses and much more than you or I will ever approach. In today’s open information marketplace, we can piggy-back on their efforts. Take a look at the next picture. We see the average opinion of these analysts (Mean Est.), with the earnings per share increasing from $0.03 per share first quarter this year, to $0.05 per share the next quarter. On a larger scale, we see earnings for 2002 at $0.24 per share more than doubling to $0.56 per share in 2003. That is a positive picture. Notice also the LT (long term) growth rate is over 46%. Another quality measure.



  • These are internal quality measures. We next consider what the market sees in the company by reviewing how it compares to its peers. Investor’s Business Daily (IBD) financial newspaper includes a proprietary “Smart Select” rating system which compares a ticker against all other listed issues. Three important measures we consider are Earnings Per Share, Relative Strength, and Group Relative Strength. Rather than list the earnings per share, the relative position of the company is shown compared to all others, from 1 to 100. If a company is rated 70, that means is has performed better than 70% of all other listed stocks in that category. The relative strength measures how a stock is performing against itself, that is relative to past price performance. The Group Relative Strength compares the industry group the stock is in to all other industry groups. We feel this is one of the most important measures of where a stock is going. Our book speaks of sector rotation, where some sectors are in favor while others are laggards. This “favor” moves from one sector (industry group) to another. Mediocre companies in hot sectors perform much better than when their sector is lagging. The rising tide lifts all ships, as it were. Wouldn’t it be better to target companies in hot sectors? On that Friday of the FMKT pick, its IDB ratings were EPS = 74, RS = 93, GRS = 93. We found that external quality measure quite positive.

  • We cover in our book the importance of news on the fortunes of a company, particularly short-term. Each week in our search for companies to post, the last thing we do is study the financial news. In our early investing efforts we were blind-sided too often by obscure news issues popping up late Friday, like an analysts downgrade or a missed earnings surprise. What was a good pick yesterday becomes today’s bad news. The market reacts emotionally to any shade of uncertainty. This has little affect on the long-term investor since this emotion is quite fickle and short-lived. However it is critical for short-term trading, particularly with rolling stocks. So what did FMKT look like on Friday the 25th? The following frame is the news link on Yahoo-Finance for FMKT. The most recent news was posted on the previous Tuesday, the first day of that trading week.


  • There is nothing profound in any of the previous news items. Much of the news that is posted is promotional. That is, the item about FreeMarkets beating Q4 estimates was issued by Free Markets! Other forward-looking items appear as well, without much influence on market action. So what kind of news does make a difference? We watch for two important issues. First, any Upgrade by a financial house means the analysts (remember, the guys with the best information about a company’s fortunes) see something positive in the companies future. A Downgrade has the opposite reaction. An upgrade is GOOD news, a downgrade BAD. The second news issue we consider worthy are announcements of coverage initiation. That means an institution considers a company worthy to receive the focus and scrutiny of analyst coverage. That is GOOD news. Ten days before the pick, the following news appeared:


  • The coverage initiated by Bear Stearns is positive news. This is the most recent news we consider worthy. However, if we go back another 12 days, the following BAD news item was posted.


  • As we mentioned earlier, the news is fickle and short-lived. The announcement of coverage by Bear Stearns on the 15th is more important than the downgrade by Raymond James on the 3rd. As we use news as a screening device, old news is just that, old. How old is old? The market reacts quickly, often discounting news ahead of time. That is, an interest rate cut by Greenspan has been factored into the market even before he makes the official announcement. When an analyst downgrades a company, the market often knows the reason for the downgrade before the downgrade and has priced the company accordingly. This is far more true of large-cap, well established companies. That is, large cap stocks are more “efficient” than the smaller guys. With many of the smaller issues we deal with in rolling stocks and short-term trades, news plays a bigger role. We use a two-week rule-of-thumb dealing with the news. A positive news item within one week gets a rating of 8 to 10, within two weeks a 6 to 7. No news gets a 5. On the negative side it’s the same, within one week a 0 to 2, within two weeks 3 to 4.

  • The ingredients for pick-selection include technical performance, internal quality, external quality, and the news. Our choices for the weekly offerings are not arbitrary tickers taken from come computer screen. We go through several levels of assessment, narrowing the list from thousands to a few hundred. These are then studied individually, assessing the likelihood of a near-term price increase, accompanied by the positive support outlined in this guidepost. So how did FMKT do?


  • It went sideways, losing $0.18 on the week. We still feel strongly about its near-term future. But we shall see. Anyway, that is why we included FMKT last week. There are TC-2000 proprietary technical indicators we use in addition. These will be covered in a separate TC-Tutorial soon. Stay tuned.






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