June 20, 2024

The Yin & Yang Of Stock Selection – Mixing Fundamentals With Technical Analysis To Seek Out Undervalued Stock With Precision Timed, Technical Trading Signals

While the majority of stock investors seek, what is in my view, an irrational tendency towards ‘either’ the fundamental analysis camp (studying stock reports, earnings, growth rates, management competence, etc.), ‘or’ the technical analysis camp (price study, charting, indicators, overlays, etc.), there is a third way – an option increasing numbers of self-directed traders, have begun to exercise, towards seeking out potential stock plays which offer a healthy reconciliation of both schools of study.

The stock selection strategy which I frequently bring into play, especially during bull market trends, involves a simple, common-sense mix of ‘both’ fundamental and technical analysis, designed to seek out undervalued growth stocks with robust fundamentals, combined with precise entry ‘timing’ signals offered by popular technical analysis indicators.

It starts by making use of two freely available, web-based stock screeners, namely finviz (fundamental screener) and tradepilot (technical screener).

The fundamental stock scan is applied approximately once per week (usually over the weekend), to identify and shortlist the latest list of fundamentally superior, undervalued growth stocks, based on a simple 3-step process, fully disclosed below. From the list of qualifying stocks, I then utilize the technical stock scans service to continually track each of these stocks for precise technical entry ‘timing’ signals.

In detail – starting with the fundamental screen – I apply a simple 3-point screening criteria, where I look for base fundamental metrics – specific stock selection with a ‘PEG ratio’ of less than 1 (stock price ‘undervalued’ relative to expected earnings), a ‘Price-To-Cash-Flow ratio’ of less than 10 (cash flow measures the true earnings ratio of a business, based on absolute cash flow, which I place preference over the commonly applied ‘P/E’ ratio), and proven year-on-year earnings growth (current annual earnings growth should consistently exceed the previous year’s annual earnings growth).

Once I have a list of stocks which meet the above criteria, I remove stocks with an average trading volume of less than 300,000 shares per day, to ensure ‘liquidity’. In addition, I remove all ‘financial’ sector related stocks.

The objective of this initial 3-step process is to produce a short list of stocks which provide an element of ‘quality’ (undervalue, cash flow, and growth), behind the businesses I am potentially investing in. Moreover, this simple, once-a-week process narrows down an original database of over 5,000 stocks, to around 20-30 key stocks I can practically focus on.

At this point, I apply the technical screener, to each stock within my fundamental watch list, to identify any specific stocks, which are also exhibiting strong, preferably ‘multiple’ technical bullish signals.

The stock charts screen provides a continually updating list of ‘multiple’ technical indicators signaling a bullish (or bearish) signal for any stock entered into the symbol field, but also displays a simple trend indicator directly below the chart, which provides an instant snapshot of the short-term technical bias for any selected symbol.

Any qualifying stock – effectively a fundamentally robust stock, with [multiple] trading signals – is then shortlisted for a potential trading opportunity, which I consider towards my ‘long stock/short ETF’ hedged pairs trading strategy (learn more at my home page).

To summarize – the stock selection process applied, is based on a precise, rule-based combination of both fundamental and technical analysis filters.

Fundamental analysis ensures I am trading only ‘quality’ stocks with key qualifying metrics, such as a low (<1) PEG ratio. The PEG ratio measures the stock price ‘relative’ to the company’s expected earnings growth. When the PEG ratio for a company is significantly below 1 (relative to it’s industry average), the stock is considered ‘undervalued’.

In addition, I also ensure the stock exhibits a low (<10) Price-To-Free-Cash-Flow (P/FCF) ratio, which indicates that the company generates free cash flow (net cash after all expenses) of at least 10% of it’s market capitalization, further ‘solidifying’ the undervalue opinion on the stock. This key ratio provides a superior insight into a business than the commonly used, earnings based ‘P/E’ ratio. Finally, the stock exhibits a continually rising earnings growth curve, where annual earnings growth consistently surpasses the previous years growth.

There are many additional metrics/filters traders can apply, but for my own personal stock selection process, the above three steps adequately (without excessive ‘over filtering’) provide a healthy list of stocks to focus on.

On each of the stocks within the watch list, I then (and only then) apply technical analysis towards ‘timing’ my entries into any specific stock I wish to invest/trade in.

Here, the stock charts (and stock scans) screens provide any imminent signals (often multiple technical indicators) in any one or a number of my list of stocks. These are ideal candidates which I consider towards a risk managed long stock/short ETF pair trade.

It is a good idea to take the time to learn as much as one can about fundamental metrics as well as technical indicators, towards develop your own unique ‘mix’ strategy. There is a synergy in uniting both approaches towards a cohesive trading plan. The above method is one of a number of key strategies I utilize towards the stock ‘selection’ process. Hopefully, I have provided some valuable, productive insights, and food for thought.

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