Fire Your Stock Analyst!: Analyzing Stocks on Your Own

Step 8: Profitability Analysis

The value strategy requires buying stocks in the worst of times. Margins will be down, sales growth will have stalled, or even be negative, and earnings will probably have turned to losses. The value investing strategy is based on the reversion to the mean principle.

Reversion to the mean suggests that abnormally high numbers will come down, and unusually low numbers will move back up to historic values. For example, companies reporting unusually high operating margins, compared to historical values or to industry averages, will likely see those margins come down in future quarters, and vice versa. Where growth investors see above average or rising margins as good, value players interpret them as a potential sell ...