How to Find Stocks Near a Bottom Without Catching a Falling Knife

• A stock can look undervalued and still have further to fall.

• Netflix illustrates how fundamental scores and historical ratios can narrow the search.

• The real challenge is using Fibonacci levels to identify when a potential bottom is forming.

A stock can look cheap on fundamental measures and still fall sharply. That is the central problem addressed by this investment framework: financial ratios help identify companies worth monitoring, but they do not tell an investor when the market is ready to turn. The approach combines a value-investing filter with technical analysis, using fundamentals to narrow the watchlist and Fibonacci-based price structure to identify where a potential entry may emerge.

The balance between the two parts is deliberate. The fundamental filter accounts for around 10% of the overall system, while roughly 90% remains focused on technical analysis and Fibonacci impulses. The purpose of the filter is not to replace chart analysis or to produce an automatic buy signal. It is to help identify companies whose financial measures look reasonable enough to justify waiting for a technical setup.

Netflix Inc (NASDAQ:NFLX) is the example used to explain the process. InvestingPro’s model places the stock around 31% below its estimated Fair Value, while a custom filter built around several financial measures gives it a score of 82 out of 100. That score puts Netflix in the category of a stock worth monitoring, not one that automatically qualifies for an immediate purchase. The next step is to wait for the price to reach the relevant Fibonacci zone and look for signs that a bottom may be forming.

Source: InvestingPro

The Fundamental Filter Starts With Valuation and Growth

The first question is whether a stock appears undervalued. The framework rejects the idea of entering a company that looks substantially overvalued, using the example of a stock trading 50% above its estimated value. Netflix passes this initial screen in the example, with InvestingPro’s Fair Value model indicating 27% undervaluation.

Valuation is only the starting point. The filter also checks whether revenue and net income are increasing, whether five-year revenue growth exceeds 10%, and whether EBITDA and earnings are growing. Gross profit margin is another key measure, with higher margins preferred. These indicators are intended to establish whether the company is growing and improving, rather than merely looking cheap after a share-price decline.

The price-to-earnings ratio is included, with lower values preferred, but the framework also recognizes that acceptable P/E levels depend on the sector. The forward P/E ratio should be declining, while debt should be as low as possible. Share buybacks are viewed positively. The filter also includes a measure of the possibility of bankruptcy within the next two years.

Dividends are treated differently. The approach personally favors companies that do not pay dividends, because the investor can decide when to close a position without dividend payments creating tax deductions along the way. However, the framework does not claim that dividend strategies cannot work; it leaves room for investors to follow a dividend approach if it suits their own plan.

These are the core fundamental checks: valuation, revenue and earnings growth, five-year revenue growth, P/E and forward P/E, dividends, debt, share buybacks, EBITDA, gross margin and bankruptcy risk. The purpose is to build a practical filter, not to conduct an exhaustive valuation of every company.

Source: InvestingPro

Comparing Current Ratios With Five-Year Averages Adds Context

A current financial ratio can be difficult to interpret without a historical reference. A return on equity of 42%, for example, means something different if the company’s five-year average has been 33% or 34%. In that case, the current figure is above its own historical norm, which may indicate that the company is performing better on that measure than it has typically done.

To add that context, the framework calculates a five-year average for each selected ratio using the company’s results over the previous five years. The comparison can then show whether a current measure is above or below its historical average. For some metrics, such as return on equity, a higher current result may be preferable. For valuation measures such as P/E, a lower figure may be the more attractive outcome.

The custom filter considers performance relative to the S&P 500, return on investment, net profit margin and the number of years required to repay operating debt. It also examines short-term liquidity, the conversion of earnings into cash flow, P/E, enterprise value relative to operating earnings, and price relative to the actual cash generated by the company. The different measures are weighted according to their perceived importance, then combined into an overall score.

Netflix scores 82 out of 100 under this system. That is interpreted as a reason to keep the stock on a watchlist or retain it in a portfolio if already owned. It is not presented as proof that the share price must rise. The score is a way to summarize the fundamental picture and make the comparison easier to read.

The five-year comparison also helps prevent a single current reading from being treated as the whole story. A ratio may look attractive in isolation but still be weaker than the company’s usual performance. Conversely, a measure that has improved relative to its historical average may provide a more encouraging signal than the current figure alone suggests.

Source: InvestingPro

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Netflix Looks Weak Against the S&P 500, but Some Fundamentals Have Improved

The framework’s Netflix example illustrates why relative performance and fundamentals need to be examined separately. Historically, Netflix tended to outperform the S&P 500, with average relative performance of approximately 13% to 14% over the five-year period discussed. In the current period covered by the analysis, however, Netflix has performed exceptionally poorly relative to the index.

That weakness does not automatically mean the fundamentals have deteriorated by the same amount. The five-year comparisons show that Netflix’s return on equity and net profit margin have improved relative to their historical averages. The number of years required to repay operating debt has also decreased under the measure used in the filter. These are the indicators the framework flags for continued monitoring.

Valuation measures have also become lower relative to Netflix’s own history. Enterprise value compared with operating earnings, which had previously been around 12 times, is now approximately 8.73 times. The price relative to the actual cash generated by the company is around 25 times.

These figures contribute to the view that Netflix is worth monitoring from a fundamental perspective. But the system explicitly recognizes a limitation: the market price reflects expectations, and expectations can change. Current ratios do not fully account for what investors expect the company to deliver in the future. That is why even a company with strong fundamentals can experience a substantial decline.

The fundamental filter is therefore designed to answer a limited question: does the company look sufficiently interesting to remain on the watchlist? It is not meant to answer the separate question of when to buy. That decision belongs to the technical stage of the process.

Source: InvestingPro

Fundamentals Identify the Watchlist; Fibonacci Helps Define the Entry Zone

Once a stock passes the fundamental screen, the next task is to identify the dominant Fibonacci impulse in the market. The impulse is used to calculate an optimal zone, which becomes the area where the investor should concentrate attention when looking for an entry.

This zone is not a buy signal by itself. The process requires the investor to examine the price action inside it and look for evidence that a bottom may be forming. The author describes the optimal zone as a purple rectangle on the chart, and the idea is to focus technical analysis within that area rather than trying to buy at any point during a decline.

Correctly identifying the dominant impulse is essential to the method. Fibonacci analysis follows specific rules and takes practice; the framework does not present it as a technique that can be mastered in a few days. The objective is to establish in advance where a stock deserves close monitoring, then wait for a technical setup to develop in that area.

The patterns used to look for a bottom include a rectangle, triangle, double bottom, wedge, bullish engulfing candlestick, bullish island reversal and divergence. The author’s trend-ending system is another tool that can be applied. These patterns offer different ways to assess whether selling pressure may be ending and whether a potential entry can be defined.

The technical setup should also help establish a stop-loss level and a profit target. The framework’s approach is to allow a position to run once the trade develops from the optimal zone, rather than automatically settling for the minimum target. The objective is to remain invested while the trend continues, while still using the technical structure to manage risk.

Source: InvestingPro

Netflix Is a Monitoring Candidate, Not an Automatic Buy

Netflix brings the two parts of the system together. The fundamental filter gives the company a score of 82 out of 100 and indicates that its valuation is lower than its five-year historical comparison on the measures discussed. At the same time, its relative performance against the S&P 500 has been weak. That combination makes it a stock to watch, but not one that should be purchased solely because the ratios appear more attractive.

The next step is technical. The dominant Fibonacci impulse defines the area where a potential entry should be sought. Within that zone, the investor looks for a bottoming structure, such as a double bottom, rectangle, wedge or bullish candlestick pattern, and uses that structure to define the entry, stop-loss and profit target.

This sequencing is the main point of the method. Fundamental analysis helps narrow the field to companies that merit attention. Historical averages provide context for interpreting the current ratios. Fibonacci analysis then identifies the zone where the investor should look for a potential turning point, and price patterns help determine whether the timing is becoming more favorable.

The fundamental component remains a minority of the full system, at around 10%, while technical analysis and Fibonacci impulses account for roughly 90%. That balance is important because the approach does not claim that a stock with good financial measures cannot fall further. Instead, it combines the fundamental case for monitoring a company with a separate technical process for deciding when an entry may be justified.

For Netflix, the conclusion is to continue monitoring the stock and wait for an appropriate technical setup. The valuation estimate and 82-point score make it worth attention within this framework; they do not replace the need to identify the optimal Fibonacci zone and confirm a bottom.

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Disclaimer:This article is written for informational purposes only; it does not constitute a solicitation, offer, advice, counsel or recommendation to invest as such it is not intended to incentivize the purchase of assets in any way. Any type of asset is evaluated from multiple perspectives and is highly risky, and therefore any investment decision and the associated risk remains with the investor.