I got an email from a client this morning, raving about this exceptional new stock everyone was talking about. It had already tripled since going public, and all the charts looked amazing.
Curious, of course, I went online to do some research. The company was in the mining industry, and had one early stage project, which, if everything worked out according to plan, would bring home a cash flow worth around $3,500,000. The market capitalization (the current price per share times the number of shares outstanding) was $40,000,000. Basically, the company was trading for more than ten times its worth, and yet this woman considered it an exceptional investment.
This is an excellent example of an instance where the two main schools in stock evaluation — fundamental and technical analysis — contradict each other. For someone who selects stocks using fundamental analysis, which deals with the book value of a company (its assets, in whatever form they come), buying this stock would be absurd. To the fundamental investor, companies trading below the value of its assets are good buys, whereas companies trading above this number are no-gos. And a company trading for ten times the highest possible value of its assets . . . well, you get the picture.
For a person using technical analysis, however, it could make perfect sense. In my next blog entry, I will explain how.
Note that selecting your stocks should follow this blog on the next day.