What to Look For in the Trends

The effective use of averaging makes trend analysis easier than it would be if the latest entry were merely placed on a graph. In the chaotic and random outcomes you will see in financial statements, it is difficult to predict what a single outcome means. You need the longer term—the trend—in order to fully understand what is happening.

Here are a few pointers in how to interpret trends.

• Expect a leveling effect in growth trends. Any measurement of growth will not continue to improve indefinitely. An improvement in sales volume or net margin (the two most common growth measurements) are limited in value except to the degree that they confirm rates of change; meet expectations; and satisfy anticipated outcomes within a range of results.

KEY POINT

Make sure your expectations are realistic. Nothing improves at an ever-growing rate, forever.

Don't expect predictability. Trends do not answer all of your questions, nor do they reveal a clear and unmistakable direction. The value of trends is that they reveal emerging tendencies; they do not provide you with a predictable means for knowing what will happen next.

Wait for confirmation. Even when a trend appears to be changing in some manner, do not act on the information unless you have a second or third indicator from some other trend. No one trend should be enough to cause you to act.

Decide how you should react to a change in the trend; use performance standards. Set goals for yourself that relate to your trend analysis. For example, you may set a minimum standard for a range of profitability; growth in sales volume; or maximum debt in total capitalization.

Constantly evaluate your base assumptions. You select a base year on some premise, and that can change.

KEY POINT

Constantly question your own assumptions. Everything is likely to change in the future, even the best of your own assumptions.

Be willing to abandon a portion of your analysis. Some trend studies end up being disappointing, or providing you with nothing of real value. Abandon analysis that is not providing you the insight you need.

KEY POINT

Flexibility is the most important attribute for long-term study of a stock. Just as companies change over time, so will the fundamen-tals that really show you what is going on.