Technical analysts are familiar with breadth indicators. This is a class of indicators designed to measure how broad the participation in a price move is. The general idea behind breadth indicators is that a healthy trend will have broad participation. In a bull market, for example, most stocks should be in uptrend’s.
This is based on the theory that a market with just narrow leadership is likely to reverse. This was seen in 2000 when just a few stocks were moving higher. These stocks carried a great deal of weight in the indexes and pushed the indexes up. Breadth warned of a problem and the bear market was a problem.
A popular breadth indicator is the advance-decline line which is calculated by subtracting the number of stocks declining every day from the number of stocks advancing.
A/D line = advancing issues – declining issues
Every day, technicians complete this simple calculation and chart the result, adding today’s result to the data. Generally, we see a line (the breadth indicator) that closely tracks the price action.
The Breadth of Fundamentals
When analyzing breadth indicators, technical analysts are generally looking for short term trends. There are tools and techniques technicians can use for longer term analysis but breadth analysis is usually focused on the short term.
Fundamental analysis, on the other hand, is generally focused on the long term. Fundamental analysts will study financial statements, using data that us updated just once every three months. The relatively slow pace of changes in the data drives a longer term perspective analysis for practitioners.
Tools of fundamental analysts are well known. They often consider different ratios based on financial statements to develop a market opinion. A financial statement actually consists of three different components and its possible to derive a ratio based on data from any of the components.
The first part of the financial statement is the income statement. This includes information about sales, expenses and income. Analysts created the price to earnings (P/E) ratio and price to sales (P/S) ratio to gauge the value of a stock based on the information in the income statement.
The next part of the financial statement is the balance sheet. Here the company provides information about its assets and liabilities. Analysts subtract the amount of liabilities from total assets to find the book value of the company. They can then use the price to book value (P/B) ratio to value the stock.
The final part of the financial statement is the statement of cash flows. This statement records how a company uses cash. Analysts have developed a number of calculations to help them interpret cash flow. Among the most popular tools are those associated with free cash flow (FCF).
FCF is a measure of a company’s financial performance, calculated as operating cash flow minus capital expenditures. FCF represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base. The price to FCF (P/FCF) ratio is used to measure a stock’s value.
These tools are generally applied to an individual stock. For example, we may want to know whether a stock is cheap, relative to its peers, based on the P/E ratio, the P/B ratio or some other measure. There are also a number of other tools that can be used to value stocks.
Less popular is the idea of applying breadth analysis to fundamental indicators. For example, we could find how many stocks are trading with a low P/E ratio. This would tell us whether or not the market as a whole is more generally overvalued or undervalued. These are stock market investment tips that need to be considered before buying them.
Some Stocks to Consider
For those looking for value in the current market, there are a few stocks that are cheap on all of our screens. These include Gulf Resources (Nasdaq: GURE), AU Optronics (NYSE: AUO), LG Display Co. (NYSE: LPL), Consumer Portfolio Services (Nasdaq: CPSS) and AEGON (NYSE: AEG).
During a bear market, that list of buy candidates will grow and value investors will be rewarded for their patience.