This is how a UK fund manager picks stocks

Tuesday, 12 November 2019
Melbourne, Australia
By Murray Dawes

I want to start today by wishing everyone in the face of the enormous bushfires sweeping NSW and Queensland good luck. I remember standing on the roof of my parents’ house with a hose in hand watching a bushfire rage on the other side of the valley. Power lines were exploding. It was a frightening scene.

Stay safe and I hope you get through it unscathed.

Moving onto the markets and it’s clear that the about face by central bankers around the world over the past year has had the desired results. Equity markets are continuing to march higher as interest rates around the world have dropped.

The Alpha Wave Trader portfolio is currently 100% long and I have started buying a few things again after sitting on my hands since July as markets were directionless.

I need to see a monthly close below the 10-month exponential moving average in the S&P 500 before I will start to get bearish again. That currently sits at 2,936 which is 150 points or 5% below the current price.

The final level of resistance according to my model is around 3,100. That’s where we are right now. If prices can move above there we are literally in blue sky and there is nothing to stop the S&P 500 from marching higher in a straight line. I’m even contemplating the possibility that markets can move into a melt up phase above there.

If that is what’s on the cards we need to make hay while the sun shines and ride the rally for as far as possible.

Markets

Equity market volatility continues to decline as prices rally. The S&P 500 dropped six points to 3,087.

The VIX which measures volatility is within a couple of points of the lowest level in a year at 12.7.

European stocks were mixed and moved very little. The German Dax was down a few points to 13,198 and the French CAC was up a little to 5,893. Eurostoxx 50 was basically flat at 3,696.

The Hang Seng came under selling pressure with news of protestors being shot. It fell 2.6% to 26,926.

Gold continues to weaken as hopes of a US–China trade deal increase. It fell another $5 to $1,456.45.

Oil prices continue to tread water with WTI Crude falling 60 cents to $56.64.

Bitcoin is struggling to hold onto recent gains and is slipping further away from $10,000. It sold off 3.6% to $8,737.

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Of course, it doesn’t make much sense from a macroeconomic point of view. The flat yield curve has been flashing warning signs of a recession within the next year or so. The reason the central bankers have taken fright is due to the string of weak economic indicators over the past year.

But we have all gotten used to the twilight zone of bad news being good news. The worse the news gets the higher the markets go because everyone knows the central bankers will act.

The strength of the rally since 2009 in US equity markets is something to behold. It is a brave man that stands in front of a rally like that without having tight stop-losses.

I was up in Hawks Nest last week with an old friend from uni days who is now a fund manager in London. He said there have been quite a few smart traders who went too early on their bearish call and have paid a heavy price.

I wanted to pick his brain about his method for finding stocks and I was quite surprised by his response.

I was after hints on analysing balance sheets and what ratios he used when dissecting a company’s accounts. He was a top rated analyst in Australia for seven years running so I wanted to gain as much knowledge from him as possible in between trips to the beach and fishing.

But he said that you just need to use common sense. There is no perfect method to work out whether the stock you are analysing will be a winner or not. Even after doing a huge amount of work and feeling sure that you are across every aspect of the business you can still end up getting it wrong.

He said the main thing he focused on was the competitive landscape. He spends a lot of time interviewing competitors and even chatting to people within the business who aren’t in management to gain an insight into the current state of play.

He puts a lot of weight in face to face meetings with management. He says he can tell a spiv from a mile away and he can tell whether someone is lying to him. He will even ask questions that he knows the answer to so he can gauge whether the person is straight up.

Another thing he focuses on is investors in the company. He has a list of other fund managers that he respects in the industry and their vote of confidence in a stock is a big tick. He also likes management to have skin in the game. The set up of remuneration gives him plenty of insight into whether management are sticking their snout into the trough or aligning their interests with shareholders.

Despite having an accounting background his answers were quite organic. There was no mathematical answer that could be replicated across stocks. There was no trick to find out whether a stock would turn cash flow positive in the next six months or not.

He also looked at relative value across different stocks in a sector. It is something I find a lot of value in also. Looking at a company in isolation can be very daunting. What does a good set of numbers look like? But when you line up a bunch of companies on a spreadsheet and look at a list of variables, you can gain a solid insight into the current state of the company you are analysing.

Are they spending more as a percentage of sales on overheads than their peers? Are they gaining traction with their product or are they just benefiting from growth in the sector as a whole? What are their debt levels, enterprise value to sales, P/E ratios etc.

I may focus on technical analysis to guide me in timing my entry points, but I spend most of my time researching the fundamentals. Without understanding the fundamental situation, you are flying blind. But without understanding the technical situation your job of making money is far harder than it needs to be.

It is balancing the two that gives you your best trades.

I run a scan every month and quarter which gives me a large list of potential candidates from a technical point of view. I then do the legwork analysing the fundamental situation in each stock to whittle the list down. I end up with about 5–10 stocks that have a compelling technical set up as well as a strong fundamental story.

Then it’s just a matter of waiting for an entry signal and enacting the trading plan.

It may sound daunting but as my fund manager friend says, rely on your common sense. Don’t think that you can’t do it or that there is some answer out there that others know, and you don’t.

If you are interested in checking out my trading service, you can do so by going here. Be sure to check out my ‘Week Ahead’ video that I release each Monday.

Regards,

Murray Dawes,
Editor, Alpha Wave Trader