Rules-Based Investing

by Scott O'Neill

A key task for investors who own individual stocks is to regularly monitor them. Such analysis requires specifically looking for those items that could give you reason to either continue favoring a stock or sell it.

A proper monitoring process focuses on the items that reveal whether a company’s underlying trends are positive or negative. Most of these can be reviewed on a weekly and quarterly basis. There is no need to pay attention to intraday price movements unless significant breaking news has been released and you are looking to buy or sell.

The weekly indicators I pay attention to in my portfolio are valuation, earnings estimates and relative strength. I keep an eye on current price-earnings and price-to-book ratios to make sure neither becomes excessive. Earnings estimate revisions reveal whether analysts are more upbeat or downbeat about a company’s prospects; I track the one-month change in profit projections for this year and the next. Relative strength shows how a stock has performed relative to an underlying index. I keep an eye on how a stock’s relative strength index (RSI) compares to its industry and sector peers. Comparative underperformance can be a tip-off that something is wrong, or at least that there is a perception that something has gone astray.

On a quarterly basis, I review a company’s earnings release, its conference call transcript and related filings with the Securities and Exchange Commission (SEC), including the 10-Q and the 10-K. I pay particular attention to whether the company generated free cash flow; how sales, margins and earnings compare to the prior year’s figures; and how the balance sheet has evolved. I also want to know what management says about current and expected business conditions. Finally, I want to ensure that the dividend is paid, and raised, as expected.

I do look at my stocks at a daily basis, but I mostly the scan the headlines. The reason is that the majority of the commentary published is a press release, a non-material event, or simply people posting their opinions as opposed to news that warrants paying attention to and monitoring. This is particularly the case for widely held stocks. For example, we hold Apple (AAPL) in our Stock Superstars Report portfolio and the amount of headline noise surrounding the stock is high.

I also intentionally go to the source whenever possible. An example would be Tuesday’s headlines about Warren Buffett being diagnosed with prostate cancer. After hearing the news, my first stop was Berkshire Hathaway’s website to read Warren’s letter to shareholders. (I hold BRK.B in my portfolio and was very cognizant of the management succession risks when I bought the stock.)

All of this is not nearly as time-consuming as it sounds. I have a report set up in our Stock Investor Pro stock screening program that allows me to review the weekly quantitative data in far less time than it takes to finish a bowl of cereal. The daily review of news takes just a few minutes, unless there is something worth reading. The quarterly analysis does take more time, but it’s a small price to pay to make sure I am properly managing my stocks.

If this does sound like too much work, then I would encourage you to reconsider whether you want to own individual stocks. Not everyone has the time or interest to research and analyze individual stocks—and there is nothing wrong with that. A mutual fund or an exchange-traded fund still gives you exposure to stocks, but requires less time to analyze. One key to successful investing that isn’t stressed enough is the importance of knowing what your limitations are and staying within in them.


 

Scott O'Neil is president of MarketSmith, Incorporated and a portfolio manager with the O'Neil companies. W. Scott O’Neil is president of MarketSmith, Incorporated and a portfolio manager with the O’Neil companies. His 25 years of industry experience include a range of leadership roles at Investor’s Business Daily, where he also served as publisher.