Fundamental analysis is something many online traders tend to relegate to the back burner. This makes sense for those trading a short-term timeframe; chart patterns and moving average violations are much more telling than the underlying business dynamics, which take time to impact a stock's price.
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Longer-term traders, however, can wield some basic fundamental analysis as a powerful tool for trade selection. The key to understanding this approach is taking the mystery out of the numbers. For those trding online who are used to deciphering chart patterns, a list of dry figures or a balance sheet doesn't lend much immediate information.
The bread and butter of the fundamental trading approach is to find stocks with attractive valuations. In a nutshell, a good valuation means that a company's projected business outlook hasn't yet been priced in by the stock market. The basic idea is that over time, money will naturally gravitate towards stocks that offer the best bargains. It's a common-sense idea that applies well to online trading. However, it can be easily overshadowed by other factors that attract a trader's attention: broader market dynamics, geo-political events, and so on.
The Price/Earnings ratio is one of the basic ways that valuation can be gauged. Generally speaking, a lower P/E suggests a more attractive valuation for online trading. Oftentimes you'll see a company's P/E compared against the benchmark S&P 500 average, which tends to hover in the 20-25 range.
A more useful approach is to compare a stock's P/E to its primary competitors and the average for the overall industry. Utility stocks, for instance, often trade at relatively low valuations, while tech stocks clock in at higher levels. To use a real-life online trading example, in Setpember 2006 shares of Ameren (AEE), a diversified utility, have a P/E of 22. That's roughly in-line with the broader market. But when compared to the overall utility sector, it doesn't look quite so attractive; the 2006 average for the industry is 19.
Periodic business updates can provide another window into a company's fundamental performance. For retailers, this includes the monthly same-store sales data. Stock analysts will venture guesses as to the results, just like they do with earnings.
When holding a retail stock, it's always a good idea to be aware of any upcoming same-store sales announcements. These can often have a strong impact on the equity's price, depending on how the actual results compare with the consensus estimate. Companies also frequently offer regular mid-quarter updates. Anyone interested in trading online, regardless of their chosen timeframe should be aware of these events because of the potential impact on a stock's price.
