If you look at the formal robes of royal families, the colour purple often appears and John Schwinghamer has written a book called Purple Chips, John Wiley & Sons, 2012.

The author believes all stock prices go up and down, including the best ones – if you look at the past you will see a trading range for them, which means there is an opportunity to make money through concentrating on the purple chips or the best companies. To qualify as a purple chip the company must meet 3 criteria: 1) a minimum of 7 years of positive and growing EPS or earnings per share; 2) smooth and predictable growth in EPS; and 3) a minimum market capitalization of $ 1 billion.

One of the most popular method of analysis is called a ratio analysis which involves income and balance sheet numbers. For example Return on Equity is a net income divided by shareholders’ equity; Return on Assets is (net income + interest expense- interest tax savings) divide by average total assets. The idea is to calculate the ratios and compare them to other companies. Then you can make a decision which should be better to invest in. The advantage of the Purple Chips method is it is graphic or seeing how the EPS is doing relative to the stock price and making decisions. Both methods deliver the same results – a good company is a good company, to make comparison between good companies both methods should be used.

Using the Purple Chip method, you can determine when to buy and when to sell. If you believe in the normal or bell curve. The theory states that most of the time or 68.2% stocks trade near their fair market value. If the stock trade outside their fair value, it will  tend to go towards fair value. The how and why are the tricky parts but if the stock is trading at higher EPS valuation than it should be, eventually the stock will fall; if the stock is trading lower than it should be, eventually the price will increase.

Due to the long term profitability of the companies, Purple Chip stocks are well covered by Wall Street analysts. This means the analysts will forecast the earnings of the shares before the official announcement. If the stock market is paying i.e. 15 times earnings, and the expectation is for earnings to increase, when the company announces their earnings, the stock price should go up because of the higher earnings. If earnings are decreasing, the stock should be sold as the price should go down.

There are many elements to the theory and as long as you have access to the charts, you can use it. The basic elements are every stock is not stable or there is movement both up and down. If you pay attention to the EPS multiple then you determine when to sell and when to buy, for the market is correct. You can take profits and move to another quality company which the market is valuing less than the one you own. When the market begins to value your old company higher, you can move back. Stick to quality, receive a dividend while you wait for the market to catch up to your thinking.

There are more questions than answers, till the next time – to raising questions