Give the Nasdaq Stock Market at least this much: Its sense of irony is acute.
A year ago Friday the Nasdaq composite index closed at its all-time high of 5,048.62. To mark the anniversary the index plummeted 115.95 points Friday, or 5.4%, to end at 2,052.78--a new 27-month low and just 33 points above the level that would mark a record 60% loss from the peak.
By now, many investors who have continued to hold on to collapsed technology stocks must simply be numb. That's also a big part of the problem: This sell-off has gone on for a year because the level of disbelief over the stocks' losses has remained high. But with each new low, more investors who said they'd never sell at these prices do just that. Each new low also pushes another group of holders closer to the edge and ready to jump.
The greatest source of anxiety for most tech stock owners is, of course, the money they've lost on paper or for real. But what's also deeply troubling for many investors is the jarring realization that they can't intelligently evaluate the companies they own.
If your only investment "strategy" in recent years was to buy a stock because it was going up, you probably put little or no effort into studying the actual business, the company's financial health or its true long-term potential for success.
As tech stocks soared, simply playing the momentum price game was a great money-maker and a virtual no-brainer. Now, as the stocks plunge to multi-year lows, investors who still own the shares--or who are tempted to buy at these levels--find themselves turning to a discipline that was ignored or even mocked a year ago: fundamental analysis.
For those who've forgotten or have never been initiated, the Barron's Dictionary of Finance and Investment Terms defines fundamental analysis like so: "The analysis of the balance sheet and income statements of companies in order to forecast their future stock price movements."
If it sounds like work, it is. But then, successful investing in the years ahead is likely to involve some effort--which would just be a return to the norm. The old line "If it was easy, anyone could do it" should apply to investing if it applies to anything.
Many investors' only attempt at fundamental analysis is to look at a stock's price-to-earnings ratio based on the last year's earnings per share and hope that it will instantly reveal whether the share price is cheap, fair or overvalued.
Though the P/E is an important element of fundamental analysis--and outrageous P/Es on tech shares a year ago were the most visible signs that the stocks' risk levels were off the charts--no single statistic can tell you everything you need to know about a stock or a company.
A first step in evaluating any company is to ask two basic questions:
* Where does the money come from to make the business grow?
* How does the company use the money it takes in?
Required reading material, if you're addressing these questions, is the company's latest annual report and its most recent quarterly report.
The first question will lead you to an analysis of the company's sales growth--how much it's selling in goods or services each quarter or year and the percentage increase or decrease in the dollars generated by sales.
The first question also forces you to consider the company's debt situation and other capital-raising issues: Has it borrowed, and does it continue to borrow, as part of its growth program? Is the debt manageable--or is the interest-expense item on the company's income statement rising far faster than sales or earnings?
With younger companies, debt may not be an issue. But if the company's growth is largely financed by the sale of additional shares to the public, that presents a different potential challenge.
If investors in many now-failed dot-com companies had merely focused more closely a year ago on the question of where the money came from, they might have understood that much of what the companies promised was totally dependent on their access to capital markets. In other words, with relatively little in the way of sales, the only way these businesses could sustain themselves was to devour capital from investors.
But the door to capital markets isn't permanently propped open. It closes from time to time, as investors' willingness to take on risk ebbs and flows. When it closed on the dot-coms, they were doomed.
The second question--how a company uses the money it takes in--gets to the heart of what most investors ultimately find interesting about fundamental analysis.
People get excited about a business because of the products or services it offers and the potential for those products or services to find a wide audience. If that happens, shareholders figure, they will reap the winnings.