RIYADH, 22 November 2004 — What is it — technical or fundamental analysis is a detailed study of the financial performance of a company with respect to it’s past results and those of its competitors. This study is based on figures that every public company discloses regularly — every quarter and annually. The reports cover many areas but of particular interest are numbers that show revenue, profit, operating expense, cash flow, assets, liabilities and the applicable growth rate. More important than the actual number achieved in the above categories, is the rate of change of each area compared to the previous quarter and the preceding year.

Who Uses It and How Useful

Fund managers and professional investors select their companies based on technical analysis. Financial analysts study the results figures of particular organizations, analyze and compare them with historical figures and with those of other companies in the same industry, and consequently produce independent rating of each company. The ratings are pointers for investors to buy, hold or sell the shares of respective companies. Some of the parameters on which the analysts base their ratings on are: Revenue growth, earning growth, price earnings ratio and management performance. They examine the sales, net income and cash flow to see how well a company is translating revenue into earnings — which is necessary for growth. In making a selection, investors look for companies whose revenue, net income and cash flow are rising steadily — or at faster rate than their competitors. The analysis covers both historical activities and expected future performance.

A company which is able to sustain growth in its revenue and net income compared to its competitors is technically sound. This means that it will be able to increase its market value — market capitalization, in other words its share price. Such increase happens over a long time. Accordingly technical analysis is very useful for long-term investors, but not for those with short-term objective. Although selection based on technical analysis is important, however it does not guarantee success or profitability due to many other unknown factors — both external and internal.

What Parameters to Measure

The main parameters that the analysts, fund managers and professional investors look for while evaluating a company are: Earnings, revenue and earning growth, cash flow, research and development budget, price earning ratio, float, stock splits, and dividends.

Earnings, net profit or net income, is the net amount of profit that the company is able to generate during a specific period. It is very important because it represents the “engine” that drives the growth of a company. Without a significant net profit, a company will have to take some risk and additional expense to support its growth. Business success is measured by the amount of net profit it generates compared to its revenue, i.e. “net profit margin” in percentage terms. The higher the percentage the better is the performance of the company and consequently its ability to support its expansion. Profit margins vary among industries. Any company that fails to meet its industry average stands a lower chance of survival. An accurate measure of a profit margin should be based on at least several quarters’ performance. On average companies with net profit margin of over 15 percent are considered as good investment candidates.

Revenue growth rate, earning growth rate and their trend are among the most important health indicators of any organization. A successful company should grow its revenue at least inline with the industry, preferably increase its market share. Those who fail to grow at their sector average loose market share and with time get wiped out.

Source of Information

Decision making information needed by investors is abundant. In recent years the availability of information has exploded due to the proliferation of the Internet and the increase of financial service organizations. Information about the economy, a particular stock market, an exact industry or a specific company are interrelated and are all necessary requisites that might lead to a proper investment selection.

The above information is available in the annual reports of the respective companies, through their websites, and online through many media or financial services companies. The online information, accessible through several Internet websites, is more current and is updated on a daily basis.

Timely information is critical for good investment decisions. Several years ago this was a big challenge, but was later solved due to the propagation of the Internet. In fact we face at present a problem of too much information, much more than we can intelligently process or digest. The new challenge now is the ability to select and focus on a useful subset.

(Salim J. Ghalayini, [email protected], is the author of “Stocks for the Practical Investor”. He manages several investment accounts.)