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Another way to identify winners

Feb 04 2019 15:04
Schalk Louw

I recently came across a comment on social media on the technical analysis of shares. 

In short, this person believes that technical analysis gets “way too much” attention on social media and reckons a “horrible” technical analysis system combined with an excellent risk/portfolio management system would easily outperform the results of an excellent technical analysis system combined with a poor risk/portfolio management system. 

I definitely do not claim to be a speculative share trader, nor do I claim to be a technical analysis expert. 

I am also not saying that this person’s opinion is wrong in any way. 

But I do think it is important to understand the psychology behind the “Why is technical analysis so popular on various media platforms?” question.

I don’t believe it has to be an “either/or” situation when it comes to technical analysis, but rather an “and” situation. 

Why should a balanced investment management system only consist of one single investment tool? 

Combining a technical analysis with a fundamental analysis doesn’t mean that you won’t end up with bad apples, but it should definitely improve your chances of achieving success.  

Many might point out that a fundamental analysis is very complicated and, in most cases, also requires the use of some very expensive data systems, so I would recommend consulting an expert if you are unsure. 

After all, you won’t consult the best accountant in the country to perform brain surgery. 

And that doesn’t make the accountant any less competent, it just means that they are not an expert on brain surgery. 

I know that there are many readers who share my passion for shares and I would like to propose an alternative strategy for those who hold a preference towards technical analyses.

Identify companies with higher-quality characteristics

I always start an analysis by identifying companies that show better-quality growth. 

There are various ratios to look at, but according to most research reports, the return on equity (ROE) seems to be the most popular. 

Growth companies are usually companies that also have a higher ROE. 

Most stock brokers’ online systems offer filters which allow you to sort companies according to several ratios, including ROE. 

I did an online search and I found quite a few screeners that could sort ROEs from high to low. 

(Be warned though, that the results varied between some of them, so I would recommend that you always test the results on various data providers’ systems.) 

I personally prefer the larger, more well-established companies, so I picked the Top 80 largest companies on the JSE and sorted them by ROE from high to low.

From there, I moved only the 40 highest through to the next filter.

Look for value

I arranged the 40 shares that made the cut according to price-to-earnings ratio (P/E) from low to high. 

The reason for this is that the P/E, not unlike the ROE in terms of measuring quality, is probably the most popular valuation tool. 

After applying this filter, I got the final 20 shares that, based on the abovementioned criteria, currently seem to offer the best value (sources used: Iress, PSG Wealth Old Oak, Thomson Reuters, Tradeview.com). They are:

Schalk Graph

Looking for trends

Focusing on these 20 shares means that the companies you are conducting your technical analysis on should be relatively healthier companies. 

The indicators used will differ from person to person. 

Some investors like to follow a strong trend investment and don’t mind if it’s getting more and more expensive. 

As long as they have good momentum, those shares will remain popular. 

Let’s look at Assore as an example: Over the last three years, this share has had its fair share of ups and downs. 

Technically, however, the long-term trend is upwards, which keeps trend followers interested.      

Other investors prefer to buy shares when they appear to be technically oversold. 

There are several tools/indicators you can use to determine that, but the most popular ones seem to be the relative-strength index (RSI) and stochastic oscillator. 

A good example would be a share like Standard Bank, which appeared to be in oversold territory in October 2018, but has since strengthened and has not yet entered overbought territory.

There are good reasons why share prices move up and down and I would like to warn investors to always do their homework before buying or selling a share. 

At the end of the day a technical analysis (just like a fundamental analysis) is based on historical data which does not guarantee any form of future performance. 

But an extra arrow or two in your investment quiver definitely won’t make you weaker. 

Schalk Louw is a portfolio manager at PSG Wealth.

*Capitec is partly owned by PSG Group, which is also a majority shareholder in PSG Konsult, of which PSG Wealth is a division.

This article originally appeared in the 7 February edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

investment  |  shares  |  management
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