Last week, I shared with you the importance of the postmortem trade analysis. I know it sounded a little strange to you, given that most people think a trade is over when you exit your position and book either a gain or a loss. However, that’s far from the case. Remember that investing is a process, and only by performing this autopsy-like analysis will you understand what went right and why. How can you hope to repeat good behavior and avoid past mistakes if you don’t recognize them?
That’s why this week I want to share with you another part of my in-depth analytical process that helps me watch for signposts along the investing road. These signposts act as confirmation points or warning flags, depending on how things are progressing in the industry, at the company, at one of its competitors or, sometimes, from an unexpected area.
What I’m talking about here is the pre-trade analysis. Compared to the postmortem analysis, the pre-trade analysis entails identifying those key factors that influence a company’s business, recognizing the current and longer-term trends in the those drivers and what potential disruptions lie ahead.
While today we have GPS navigation in many devices, this approach is much like the way many of us used to drive — by watching the road and checking a map for markers, or even asking for directions and looking for signposts along the way. Much like those driving experiences, as you see the markers and signposts, you have a growing confidence that you are on track. If you don’t see those markers, after a while you’re going to wonder where you are and how far off you are.
Think of it this way: if you were to construct a map that sketches out directions for a friend, you would be sure to include the key sites they would see on their way, and these would let them know they were on course or signal them that a change in direction was nearing.
The same is true for investing, except we have to develop our own markers and signposts that tell us whether a position is on track or if we are off course and need to cut said position. To the novice investor, I admit this may sound a little daunting, but the reality is that it’s not impossible to do. All it takes is making sure you understand the company’s business and competitive factors, which is something you should be doing anyway before you buy its shares. I know this because it’s something I do with every stock I recommend in my investment newsletter, PowerTrend Profits, and for every position I invest in for my Thematic Growth Portfolio.
Let me share an example or two with you. If you thought the economy was picking up steam and that boded well for the shipping of goods (products, sub-assemblies and components) from supplier to factory, factory to port, port to customer and their distribution facilities and so on, you would be right. One industry to invest in would be the trucking industry, and upon noticing the average age of the heavy truck fleet — those 18 wheelers you see traveling down interstate 95 on the Eastern seaboard, the 5 that cuts through California or I-70 — you would think, “Wow, there is a real need to replace these trucks!”
After doing some preliminary research, you would realize there were several companies that manufactured medium- and heavy-duty trucks, including Paccar (PCAR). In your pre-trade analysis, you would be digesting all you could about the company, learning about its business, where it conducts its business, who its competitors are, key inputs that go into building a heavy-duty truck and so on. You’d also learn about the company’s dividend payout history and even its annual special dividend that it pays out in December.
Along the way, you might read about several truck trends and data points — build rates, order rates, backlog levels, truck tonnage and more — as well as sources for those data points. Some of those data points are easy to obtain, like monthly industrial production and purchasing managers data, as well as truck tonnage information, while others you would have to be more diligent in collecting, such as monthly industry statistics for truck order and build levels. While ACT Research sells that data, some detective work lets you uncover what you really need. Here’s a great example.
Once you’ve identified these items, you have to watch the vector and velocity — what direction they are traveling in and how fast. If the data is favorable, like when truck orders are rising faster than production while the economic data continues to improve, that’s a good thing. If orders fall below build levels for a sustained period of time, it likely signals weaker production levels ahead. That’s not a good sign, one that should have you thinking about trimming the position back or exiting altogether.
Other data to watch, such as steel, aluminum and other input prices, helps you gauge if costs are rising and what that may mean for margins and earnings. The same criteria still apply — are the costs of these inputs rising quickly and likely to impact margins and earnings, are they stable or are they falling?
By building this list of items to watch — signposts, as I call them — you can keep tabs on the business in a far easier fashion because you know what you’re watching for. Here’s the best part: like any muscle that you exercise, the more you do this, the stronger your aptitude will become. Want some more good news? Here goes — the more you do this, the more pitfalls you’ll avoid, because your signposts will help keep you on course.
Disclosure: Subscribers to PowerTrend Profits were alerted to the opportunity in Paccar (PCAR) shares on April 11, 2014, and the Thematic Growth Portfolio of Fabian Wealth Strategies owns PCAR shares.
NOTE: Fabian Wealth Strategies is a Securities and Exchange Commission-registered investment adviser, and is not affiliated with Eagle Financial Publications.
In case you missed it, I encourage you to read my PowerTrend Brief article from last week about how postmortem analysis can improve your investing process. I also invite you to comment in the space provided below.
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