This year, Agilent's (NYSE:A) shares have experienced much volatility with very little gain. From January through March, shareholders enjoyed a 30% gain, but since then, shares have declined by nearly 20%. This volatility in share price signals uncertainty among market participants and warrants investigation from profit-seeking investors. Through this article, we will delve into the fundamental developments of Agilent throughout the past 5 years and arrive at the conclusion that this is a strong company, worthy of investment.
A History of Returns
In order to thoroughly investigate Agilent, I have relied heavily on return on assets and return on equity. Return on assets is the net income of the firm divided by average total assets. Return on assets tells the investor how efficiently the organization uses its assets to generate profits. Return on equity is the net income of the firm divided by directly-invested shareholder equity and this ratio tells investors how effectively management uses investments to generate profits. In the chart below, 5 years of return on assets and return on equity for Agilent can be seen.
The chart of returns shows a very clear picture of Agilent's historic fundamental performance. Between 2008 and 2009, Agilent experienced a plateau and decline in firm performance, much like the rest of the economy. During these years, organizational returns declined to the point where the firm actually began experiencing net losses in the fourth quarter of 2009. The market responded to this degradation in firm performance by shedding over 15% from the stock price. In 2010, Agilent recovered from its fundamental malaise and once again delivered performance which lasted until the middle of 2011. Over these quarters, the stock price rose nearly 70%. Between the third quarter of 2011 and the third quarter of 2012, performance once again deteriorated and share price experienced likewise declines of over 24%. During the third quarter of 2011, fundamental performance once again strongly rebounded and the stock price surprisingly fell by 8%. This represents an investment opportunity for the prudent capitalist. Prior to exploring this opportunity, please examine the following table which summarizes the time periods studied.
The table above effectively summarizes the past 5 years of organizational and stock performance for Agilent. Investors tend to complicate things by relying on a variety of factors, but I believe a simple and logical approach to investment is what is rewarded in the long run. The logical relationship that we have relied on throughout this analysis is this: as a firm improves fundamentally, its stock price should improve as well. The table above proves that this relationship has held true for the past 5 years - until this most recent quarter. In my opinion, this represents an investment opportunity. Agilent has shown an ability to improve itself from a fundamental standpoint and shares have not quite caught on the fact that returns, rather than temporary news, is what drive share price in the long term. If the simple and logical relationship of returns and share price performance continues to hold true, Agilent's share price is due to increase in the near future. In my opinion, investors seeking to profit should consider purchasing Agilent's shares.
Even though I believe that Agilent has a strong fundamental catalyst which will drive share price increases in the near future, I do not believe that investors should immediately purchase the security. Share prices have declined nearly 20% over the past 7 months and it is entirely possible that declines will continue. For this reason, I advocate patience for investors in Agilent. Since our fundamental thesis is that Agilent is a strong and growing company, I believe that we should wait until price confirms this analysis prior to investing. It can be seen in the chart below, that I believe that Agilent is in a pullback within a multi-year uptrend. In my professional opinion, Agilent will more than likely bounce in the near future, but I believe that investors should wait until price closes above the descending trend line prior to initiating a position. Specifically, investors should purchase if price is able to end the week above $40 per share. I believe that an immediate stop-loss should be placed at $33 per share in order to protect capital if price were to reverse its uptrend. Investors should seek to sell one-third of these shares at the significant price barrier of $46.50 per share. Price has battled with this level for the past year and a half and I believe that a battle could once again be fought for control of this threshold. If price continues past this threshold, I believe that investors should sell another one-third of the initial investment at $53 per share. This is a price threshold that Agilent attempted to overcome twice, and failed, in 2011. I feel that the final position should be allowed to ride until the fundamental condition of Agilent worsens, as witnessed by a decrease in return on assets and return on equity. For investors who follow through with this systematic method of investing, I believe that these final shares should have a stop of $46.50, which will protect profits should the market reverse its gains.
The table below shows the breakdown of the systematic approach to investing I just mentioned. The reward to risk ratio of this trade looks relatively low in that you only stand to gain $1.24 for every $1.00 you are willing to risk, but it is important to understand that this is the moderate-case scenario in which the market hits two of our targets and reverses. Realistically, the fundamental performance of Agilent dictates strong share price gains in the future. Historically, changes in firm performance have driven changes in share price 100% of the time, over the past 5 years. If you believe that the current increase in fundamental performance has an 80% chance of increasing share price, then you should consider taking this trade.