So-called ‘technical’ investors study charts to look for patterns which can signal when to buy and sell a share. At the other end of the spectrum is ‘fundamental’ analysis which seeks to understand the intrinsic value of a business by examining its profit, cash flow and balance sheet and its competitive position.

Often the two approaches are seen as polar opposites, but that does not mean they cannot work together and bring something useful to the table. This article looks at two technical indicators which could help investors make more money from fundamental analysis.

Any fund manager will tell you that buying too early is the same thing as being wrong. That is not to belittle fundamentals either because eventually share prices follow profits.

SHARE PRICES OFTEN MOVE AHEAD OF NEWS

Because the stock market is forward looking, share prices tend to anticipate changes in fundamentals ahead of them showing up in company announcements and quarterly reports. A good example is private equity manager 3i (III) which is discussed in more detail later in the article.

In practice that means share prices can provide information about the future direction of a business. Purist value managers may disagree. Legendary investor Ben Graham famously said
the stock market is there to serve investors not to guide them.

That may be correct in the very short-term because stock prices are much more volatile than earnings which can throw up opportunities to ‘go against the crowd’ and exploit share price overreactions.

But the two technical indicators presented here are not short term in nature or designed to capture a ‘quick profit’. They are helpful in identifying long-term trends. The first indicator discussed is a trend line. The idea here is to identify a long-lasting shift and stick with the trend until the line is broken.

The second indicator discussed is the Coppock indicator which is specifically designed to identify the start of new long-term trends. The two indicators can be used together to pinpoint new up-trends and complement fundamental analysis. First, though, we will introduce them separately.

DRAWING A TREND LINE

There is not a formula to help draw trend lines, you draw what you see by connecting the dots. From the lowest price point on a chart draw a line which connects successive low-price points which are higher than the first point. That forms the trend line.

A break of the line happens when the price breaches the line. Often a re-test and failure to break the trend line is seen which confirms the break.

FLUTTER FLYING HIGH  

Gambling shares did very well during lockdowns as people stuck at home had more time and money to spend on leisure activities. Flutter Entertainment (FLTR) shares peaked in March 2021 as the economy reopened and gave back all the outperformance against the FTSE 100 index eventually bottoming in July 2022.

A broad down trend line can be drawn connecting the peak in March 2021 and the top of a counter trend rally in late 2021. This line was broken in February 2023. However, a steeper trend line drawn from the top of the counter trend peak was broken in July 2022, confirming a potential new uptrend.

At the low the shares had underperformed the FTSE 100 for over a year which may have attracted long term buyers. Fundamentally the shares looked much more attractive after the one year forward
PE (price to earnings) ratio dropped from a dizzy 53 times to 28 times.

The latest strong share price rally has been predicated on the company getting shareholder approval for an additional Nasdaq listing and the continued outperformance of market leading fantasy sports operation FanDuel.

WHAT IS THE COPPOCK INDICATOR?

The indicator is named after its inventor, economist Edwin Coppock, and is designed to find long-term buying opportunities. The indicator is constructed from the sum of the 14-month rate of price change and the 11-month rate of change which is then smoothed by a 10-period weighted moving average.

A buy signal is formed when the indicator makes a trough by turning up from negative territory. The Coppock is not designed to give reliable sell signals.

3I GROUP ON A NEW UPWARD TREND

Private equity manager 3i is a good example of how trend lines and the Coppock indicator can be used in conjunction to find good entry points. The strong rally from the March 2020 pandemic low broke the strong uptrend in the middle of January 2022 with the shares gaining 150% from trough to peak.

Note that using longer term trend lines means missing exiting at the peak, but it has the benefit of improving the odds that the uptrend has finished. The shares broke the uptrend around 10% below the peak.

In late January 2022 the shares made an unsuccessful attempt to break back above the trend line. This confirmed the downtrend was
now in place. The downtrend took the shares down by around a third from the peak. After making a bottom in June 2022 which was tested again in October the shares broke the downtrend in early November 2022.

At this point the Coppock indicator had yet to turn up to form a trough. However, this did occur in the middle of December when the shares ‘tested’ the new uptrend. With the shares moving higher after testing the trend and the Coppock also forming a trough, it created a potential entry point.

The price action led the fundamentals by a couple of months. In late January 2023 the company revealed net asset value had increased more than a quarter over the previous nine
months leading to a 5% rally in the shares.

Scouring the FTSE 100 for shares which have broken a downtrend to form a new uptrend combined with a Coppock buy signal Shares discovered these two shares.

STOCKS TO BUY

ROLLS-ROYCE (RR.) 152.4p 

Shares in aircraft engine maker Rolls-Royce (RR.) have been in a brutal downtrend since August 2018 which seems to have ended in November 2022 after they finally broke the trend.

From peak to trough the shares lost 90%. The firm’s troubles stretch back even further with the shares peaking at just under 400p in December 2013.

The Coppock indicator turned up at the same time the shares tested the new uptrend line in February 2023, confirming the move could have further to run.

Looking at the fundamentals, analysts increased their earnings estimates for the first time in two years with upward revisions starting in February 2023.

Since then, earnings estimates have increased by 42% with the consensus expecting 2023 net profit of £410 million and 2024 profit of £614 million according to Refinitiv data.

Incoming CEO Tufan Erginbilgic has been scathing of Rolls’ operating performance and pledged to transform the business by targeting inefficiencies and exiting low return parts of the business.

In March Erginbilgic brought BP (BP.) executive Helen McCabe on board as the firm’s new finance chief to implement his transformation programme.

Investors and analysts are starting to give the new management team some credit for turning the business around so it might be worth waiting around to see what they can achieve.

SMITH & NEPHEW (SN.) £13

Medical products company Smith & Nephew (SN.) was hit hard by the lockdowns as knee and hip replacements were considered non-essential procedures and postponed.

The firm has befitted from the reopening of the economy as the backlog of hospital procedures is reduced.

From a peak at just under £20 in March 2022 the shares halved over the subsequent two and a half years before making a bottom at 980p in October 2022.

The shares then rallied up the falling trend line which was reached in early January before testing ‘resistance’ and breaking above the line in late March. This later move coincided with the Coppock indicator forming a trough and registering a long-term buy signal.

In the middle of February, the company revealed 2022 full year sales and profit ahead of market expectations and raised medium-term guidance.

Revenue growth is now expected to be ‘consistently’ above 5% in the medium-term compared with prior guidance of 5% to 6%. A key driver is expected to come from a return on innovation investments and execution of the firm’s 12-point plan.

Momentum has continued with first quarter revenue climbing 6.9% on an underlying basis against a market backdrop which Berenberg described as being ‘in robust health’.

A favourable market backdrop and further evidence of the turnaround success should underpin the positive trend in the shares.

‹ Previous2023-05-25Next ›