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Part 1: The Techniques > Trend Interpretation: Deciding What It Means

Chapter 3. Trend Interpretation: Deciding What It Means

Interpretation is the phase of analysis in which many investors begin to feel lost, because it requires an understanding of what the trends mean. By concentrating on the techniques demonstrated in the last chapter (using sales/earnings, capitalization, and PE analysis as your primary indicators), you can narrow down the focus of your study and then interpret the results so that they make sense. These initial fundamental trends help you to focus your search, to gain insight into the causes of trends, and to know where else to look to uncover their true meaning.

You already accept the basic idea that growth in market value is related (in the long term) to consistency in investment value and that the very meaning of investment value is, by definition, found in fundamental trends. For example, a company that can maintain its net margin even during periods of weakened sales demonstrates that its internal controls prevent erosion of profitability. If the company also can maintain or reduce its debt ratio over a period of years, that is another positive sign. When management knows the importance of controlling long-term obligations and exercises great care to preserve the balance between equity and debt, it is reassuring. Finally, core PE will remain consistent even during cyclical change. Recognizing that PE volatility can indicate market uncertainty, we may be led to further exploration; not only does variation in the stock price signal at least a short-term uneasiness about the stock, but it can indicate that the sales and earnings are volatile as well (see Chapter 5 for a discussion of volatility in operating results).


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