How to Find a Long-Term Stock Pick Using Fundamental and Technical Analysis

When people start to get interested in investing and begin to make decisions about their money, they are often faced with what seems like a bewildering array of information and opinion. It doesn’t take long to realize that you can’t factor everything in when making a decision about where to invest and that you need some kind of a system.

For some, that is as simple as finding someone they trust and following their advice. However, that kind of goes against the whole point of being a self-directed investor, so most people try to sift through the available information and data to find what is most relevant to their investing style. If you are at this stage, what type of analysis should you be using?

There is no “investing in a box” type answer to that question, but there are some things you should know.

Technical versus Fundamental Analysis

There are two basic types of analysis for a stock: technical and fundamental.

Technical analysis looks at price history, using charts to identify highs and lows and assess trends in a particular stock. It is what most traders use for short-term positions, and there are a lot of ways of looking at the raw data.

The simplest is to look at where a stock has attracted buyers and sellers before and after periods of weakness or strength. These are known as support and resistance levels, and the assumption is that if a stock has found a bottom or top and bounced off a particular level before, it will do the same thing again if it gets there.

There is some merit to that, but the long-term direction of a stock will be decided by other factors, such as economic conditions, how fast a company will grow and how much money it makes. If a company is growing fast in a strong economy and making a lot of money, then its previous high is irrelevant. It will reflect current conditions, regardless of what happened before.

That brings us to fundamental analysis, which assesses the intrinsic value of a security by looking at the economic and financial factors that influence it. But even this is divided into two areas: macro and micro.

Macro analysis is concerned with the big picture. How will the economy perform over the next few months or years? What are the prospects for the industry that the company you are interested in is involved in? What societal trends will help or harm their prospects? Micro analysis, on the other hand, is about the company itself. How well is it run? Is it profitable or will it be in the future? Does it have and can it maintain a dominant position in its own market?

Bottom-Up versus Top-Down

For long-term investing, fundamental analysis is more useful than technical analysis, but what fundamental factors should you consider? The answer, I’m afraid, is all of them.

That seems daunting, but it reminds me of something my late father-in-law was fond of saying when confronted with a difficult task. “How do you eat an elephant?” he would ask and then answer, “one bite at a time.” In other words, have a process.

There are two approaches. Investment professionals refer to them as “bottom-up” and “top-down.” Bottom-up analysis starts with a stock that you are interested in and then looks at the industry it’s in, as well as the domestic economy and the global situation. Top-down does the opposite. It starts with the big picture, picks a sector and industry that conditions favor, and then narrows down to a single stock.

The problem with bottom-up analysis is that no matter how logical and unbiased you think you are, there is a natural tendency to use further analysis to justify your pick after you make your decision. We tend to focus on what supports our view, not what challenges it.

If you take a top-down approach though, logic, not emotion, dictates your pick. So, start with a base case for the economy and the market, then decide what sectors and industries will benefit in the expected conditions. From there, look at several companies and decide what has the best growth prospects. That will then become your pick.

This is where technical analysis can come into play for the long-term investor. It can help them decide whether to buy straight away or wait for a better price. When you buy something matters, of course, but for long-term investments it is not your first consideration. In fact, most of the time it is simpler to just ignore the chart.

If you have decided to invest in a company based on a top-down fundamental analysis, you are buying it because the long-term prospects are good. You are not basing your decision on the current price. So, unless it is falling dramatically and you want to wait for things to settle down before jumping in, don’t consider the technical side of things.

Do the Work

One thing should be clear by now; there is no magic shortcut to picking stocks and evaluating long-term investments. There is work and research involved, but it is usually worth it. There is little more satisfying than using a logical approach to identify a stock and then seeing it outperform the market. And if you use the approach outlined above, you will have a good chance of doing that often.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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