How Do Experienced Investors Analyze Stocks? How About ETFs?

Includes: DRN, FAS, PIN, SPY
by: Peter F. Way, CFA

Executive summary:

  • ETFs can't practically be analyzed like stocks.
  • A thematic approach to ETF evaluation does not work.
  • Essential Investment professionals provide a successful alternative.
  • Active Management practice multiplies the rate of wealth building.
  • Here are the top 20 current ETF forecast choices.


Experts' Analysis for stocks:

1) They try to know as much as can be found out about the subject company's operations, resources, managerial skills and particular advantages in the arenas where they compete. 2) They make educated forecasts about how those arenas are likely to change in the foreseeable future and what that is likely to do to the company's earnings and financial condition. 3) Then they make guesses about what other investors may be willing to pay for the subject's stock at some time later in the future and compare that change to other available investment candidate alternatives.

How do experienced investors analyze Exchange Traded Funds -- ETFs?

Not very likely do they do as above for every holding in the ETF, sometimes hundreds.

The usual shortcut is to take the "thematic approach" involved in the second sentence of that first paragraph above, basically ignoring company-by-company specifics, and jump to the task of assessing how the future may treat the presumed focus of the holdings in the ETF.

Unfortunately, in the rush to simplify the work that needs to be done, a good sense of what the ETF holdings may be able or be likely to accomplish is either not achievable or is not well-performed.

Among the reasons for this is that the imaginative descriptive labeling of the ETF, like many Mutual Funds and Congressional legislative bills, may not be terribly accurate or helpful. Part of the reason for that is the ETF's holdings may have changed significantly from its original contents.

Is this still really an ETF?

One of the principal advantages of the early ETFs was that the contents were fixed, both in their presence and in their proportions. The buyer knew what he/she was getting. Nowadays, any "actively managed" ETF is simply a mutual fund that can be traded during market hours. With almost all of the usual mutual fund disadvantages.

The muddy footprints of mutual fund marketers are obvious in the over 1300 ETPs (including ETN Products, which are not ETFs because they lack the ultimate veracity of a market-produced value guarantee, being supported only by some financial organization - one not necessarily "too big to fail"). Their ETP descriptions, in many cases, long since have ceased to provide any distinctions useful to the investor.

Promoters of such ETProducts often are far more interested in capturing investor capital upon which "management" fees can be charged, than they are in doing anything to benefit the investors.

What to do about this?

Paradoxically, a practical approach is to skip to stage three of the analysis, and see what other informed, experienced and involved market professionals are guessing that portfolio managers [PM]s for significant players (those with price-moving capabilities) in this serious game are likely to do to the prices "yet to come" [YTC].

Since the significant players have to operate at trade volume levels that tend to exceed the market's normal comfort, they often seek the assistance of market professionals, market-makers [MM]s, who can help them get their big trade orders "filled." The MMs know which big-money [PM]s already have positions in the subject stock and might be an "other side of the trade" as either a buyer or seller, at the right price.

Investment value assessment always involves two essential comparisons. The first is between what the security is selling for now and what it is most likely to sell for in a foreseeable time horizon, plus any dividends or other payouts to be expected in the interim. The second comparison is between that just described judgment and the same quantity for every alternative security that could be considered a candidate.

The buy and hold investor violates the value assessment requirement of working within a foreseeable time horizon, and in truth, becomes a long-term speculator over a judgment that cannot be accurately compared to others of the same nature. In return for the presumed ease of not having to do the regular periodic work of reassessments among alternatives, he/she sacrifices the regular opportunities of doubling or tripling the rate of wealth building, a rate that often is available to the active investor.

Worse yet, what is undertaken is the risk of losing not only capital, but the irreparable loss of time. The parent of a would-be college student or the soon-to-be retiree may not have the ability to start over in rebuilding what was committed a decade or more ago to a then blue-chip investment like Eastman Kodak. History is full of such experiences.

Equity investing, either in single securities or in mutual funds or in ETFs is not, to use a running athlete's analogy, a marathon. It is a relay event, where each runner is a team member contributing to the compound result with its energy available when others are fatigued. Far better to have a collection of relays running in parallel combination competing for you, as their investment team's manager, than to bet the outcome of your only event on a few "star" performers.

ETFs, regularly re-appraised and actively selected as they present opportunities for improvement over existing runners, provide just such an approach.

But be sure to know what is contained in each candidate, so that the second stage of value analysis can be performed in comparison to what the candidate has previously demonstrated its capacities to be. This is where most mutual funds and "actively managed" ETFs disappoint, because in the constant attempt to improve on their past performance, the contents are changed and no valid comparison to prior performance can be made. What is left to be available is only an unproven hope for improvement.

The true ETF that tracks a known index or defined group of related stocks provides the desirable continuity that is essential in the third stage of investment valuation: Guessing what others are likely to pay during the forecast horizon for the right to participate in the candidate's future price and payout performance. Now you have a valid comparison with past judgments. No guarantee that the past will be prologue, but it is better than being at sea with no landmarks, chart or GPS.

What past investor valuations have produced the better present prospects for YTC?

As of Friday, February 21, 2114, here are comparisons of what the best 20 ETFs offer as better investment candidates, based on their current price range forecasts by MMs, related to their current market quotes.

These 20 have been narrowed down from 360 of the ETFs for which we are able to derive MM forecasts by their hedging actions. Eliminating those with limited time-periods and those whose current upside-to-downside forecast balances offer an inadequate sample of prior experience to evaluate leaves 240 possible candidates.

From that group, selecting only those whose prior experiences produced a profit in at least 7 out of every 8 tries, when subjected to our standard time-efficient sell discipline, further reduced the eligible set to just 48. A further comparison of upside price prospect in the current forecast with average net gains in prior experiences following like forecasts brought the total to 34. Limiting them by a requirement of forecast upsides at least near-equal to their average worst-case price drawdown experiences brought us to the 20 shown in the table.

Ranked by their largest upside price change to sell targets, the most promising in size is the triple-leveraged Direxion Russell 1000 Financials Bullish 3X ETF (NYSEARCA:FAS). Reassurance that its current 13+% upside forecast can be reached is found in the fact that after over 200 prior like situations a larger average gain was achieved. This, even when including the 1 out of every 8 in which a loss was incurred. Reaching sell targets in short order gives their 30 market-day (6-week) average holding period an average annual rate of over 190+%.

Next in size of prospect is the PowerShares India Portfolio ETF (NYSEARCA:PIN), an internationally-focused ETF with favorably-appraised holdings of stocks in India, now offering good prospect of over 10+% price gain. Prior experiences of better than 15+% in average 8-week holding periods compose compounding rates in excess of 150+% per year.

Smaller prospects approaching 7½% price gains in the triple-leveraged Direxion Daily Real Estate Bull 3x Shares (NYSEARCA:DRN) puts it in the third-ranked position to bring further gains from a recovery that is already up about 20+% from year-end. That momentum has already helped achieve over 15+% gains in 147 prior cases of forecasts like the present. Holding period averages of 5 weeks and a day compound those gains into an annual rate of over 250%, and 93 of each 100 have come up with a profit.

These are the more outstanding of the highlighted 20 ETFs. Comparing them with the other 340 ETFs for which we have forecasts, only 2 out of every 3 tries have been profitable after forecasts like those of the present, and net gains have been at only a 8+% annual rate, compared to 19 out of 20 winners at rates ten times as large.

The general population of ETFs is priced at present to produce price gains inferior to the general market of S&P 500 stocks, as modeled by the ETF (NYSEARCA:SPY), which has an annual rate of gain track record of 18+% from forecasts like today's. Data for comparison with our whole population of market-maker forecasts is included for your examination.


The usual investment analysis minutia approach to specific company investment candidates is not practical for ETFs. Further, the "thematic" approach of seeking generalized-idea differentiations between ETFs accomplishes little that will not be covered in the essential direct comparisons of probable future ETF price behaviors.

Instead of basing those future price guess comparisons on conventional raw price histories or average P/E ratios of holdings, we offer a means of highly comparable measures drawn from how prior price range forecasts of essential, well-informed market professionals have performed in the past, subsequent to forecasts like those now being seen.

We are able to screen from several hundred possibles, the 20 ETFs that have had over 1500 prior forecasts like their present ones, where well over 9 out of every 10 produced profitable opportunities in an unambiguous, standardized, simple-to-follow management discipline. A discipline offering on the top ten ETFs average gains of +9% in some 5-week holding periods for average annual rates of 125+%, and on a second ten providing additions to make the overall averages at annual rates of 80+% from typical holdings of less than 6 weeks.

Worst-case price drawdowns during those holding periods were less than either the present forecast price gains or the historically achieved gains. Gains net of losses in 6 out of every 100 past experiences. The high rate of profitable commitments is evidence that most of such drawdowns were shortly subsequently reversed into satisfactory results.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.