My Theory: Fusion Analysis | Announcement of NEW category!
After many years of experience in the markets, I have come across many different theories regarding the accurate valuation of companies. Through the culmination of knowledge, I will introduce a simple method that retail and layman investors can use to buy and sell equities. I’m calling the theory Fusion Analysis (but I’m sure a form of it is out there already).
What is Fusion Analysis and How is it done?
Essentially, Fusion Analysis makes use of trailing price-to-earnings ratios (PE) to estimate the range in which equities can be bought or sold! The reason it is called fusion is due to the fact that it incorporates the analysis of historical earnings movement (fundamental) with a technical aspect which is the share price movement (technical/market).
We can get it by plotting the trailing PE of the share in question over the years. I use Excel to plot weekly share price data divided by the trailing earnings per share (EPS) to obtain the trailing PE ratio every week. I then compile this data and obtain the mean, top 20% and bottom 20% trailing PE to determine proper levels of PE to buy or sell.
Why do I think this works?
In order to answer this question, we have to know what PE really is. PE actually measures the price multiple or premium investors are willing to pay for the company’s earnings. A high PE means the investor is willing to pay a higher price per unit of earnings generated by the company. Hence, PE reflects the optimism or pessimism that investors have with regards to, primarily, the revenue growth and cost to income ratio (which affects profit growth) and quality of earnings (economic moat).
During periods of optimism, investors often bid up the share price which makes the share have absurd PE ratios. The converse is true during times of extreme pessimism. However, it is my view that investors are mostly level-headed a large majority of the time and are only occasionally myopic which cause them to misprice equities.
Assumptions and tips to overcome shortcomings:
- Growth and economic moat has not drastically changed over the period assessed vs today. If the growth and economic moat has changed, the premium over the earnings is no longer valid. For example, do not use the trailing PE data of SIA before the impact of budget airlines. If you are using, do adjust accordingly.
- Your price data must extend beyond one economic cycle the business has experienced. What I mean by this is that you must have data that extends beyond one up(boom) cycle and down(bust) cycle. If you were to use price data from only a boom, your PE will be abnormally high and you would purchase the equity at an elevated PE.
Over the next few months, I will share with you my research that I have already done and profited immensely from. So stay tuned & remember to share this with your friends!
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Cheers & Good Luck
Founder & Contributor