Fiver Capital's  Instablog

The monthly chart indicates a strong stock succumbing to the bearish mood. First the positive: higher highs and higher lows. After putting in a higher low in June 2010 ($57.56 vs. October 2008’s $37.71) the stock recently exceeded its June 2008 high of $173, so the long-term trend is up. Unfortunately the Relative Strength Index did not confirm the new high. After peaking in 2008 at 91.95, RSI has trended lower and only hit 73.57 when price hit its new all-time high. This is an important divergence and indicates slowing momentum. Also note the “season” of the MACD Histrogram - summer is turning to fall, which will ultimately lead to a winter bottom. The question is, are we facing a long cold winter or will we get a respite in the form of an Indian summer?     

 

On the weekly chart, we see that the medium-term uptrend was broken the last week of September as the stock moved down through the $135 area and is currently trading underneath its 15 and 40 week moving averages. Even with the first week of October bounce, the last bar on the MACD histogram made a new low meaning momentum remains to the downside. The dotted yellow line represents a potential level of support at the 2010 highs around $110.



On the daily chart, we see the stock trading underneath the 20, 50 and 200 moving averages. In fact it was turned around right at resistance in the form of the 200-day moving average and the underside of the medium-term trendline. There’s high volume into lows around $135 on August 8 and again on September 30 but volume contracts on up days. This is characteristic of a stock that wants to trade lower.



CF is likely to continue lower in the short to medium term. Fundamentally this makes sense given agriculture stocks’ sensitivity to a rising US dollar. I’m looking to establish a new position around $110 in anticipation of further stimulus in the States which will put a floor under commodity prices.



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

A few words on my investing style... 

After thrashing through the growth, value and momentum camps, I've come to favor the GARP, or Growth At a Reasonable Price, methodology made popular by famed investor Peter Lynch among others.  The single most important question to ask yourself as a GARP investor is, how many dollars are you willing to pay for $1 of growth?  

My initial screen for stocks looks like this: 

• 3 year average EPS growth > 15% 
• 3 year average revenue growth > 10% (to convince me the earnings aren't an accounting fiction)
• P/E < 20
• Debt to Equity < 1 
• Net Margin > 15%
• Return on Equity > 15%

Working from this short list of candidates, I divide the P/E of each stock by its growth rate to get its trailing PEG (price to earnings growth) ratio.  Some investors prefer to use projected growth rates to determine the PEG but I don't trust analysts so I assume history repeats until it doesn't.  In any case, the PEG ratio is highly relevant when constructing a GARP buy list.  .5 or lower is fantastic.  I view a valuation like this as paying fifty cents for a dollar of growth.  1 is not as exciting but acceptable.  Anything higher and I'm not interested.  Who wants to pay a buck fifty for a dollar of growth?  Yet if you buy the S&P index or any number of high-flying cult stocks, that's exactly what you're doing!    

While low debt is self-explanatory, strong net margins and return on equity shift the odds in my favor that management can continue the growth rates which attracted me to the stock in the first place.

Beyond the numbers, there are qualitative factors I consider.  Does the business have a competitive advantage?  Generate recurring revenues?  Warren Buffett favors simple businesses that make widgets and sell tons of them.  I also want to know if the company is shareholder friendly.  Is it buying back shares?  Paying a dividend??  These are all important questions that seperate the truly great GARP stocks from the value traps.