Technically, Brocade Is a Buy

Technically, you should buy Brocade right now.

We examined Brocade Communications Systems (Nasdaq: BRCD) using moving average convergence-divergence, which is one of the most popular and long-used technical analysis indicators. Technical analysis is the field of buying and selling stocks not based on the underlying merits of a company, but rather on the patterns and formulas around its price movements.

There are many ways to interpret MACD, but a common interpretation is signal line crossover. Signal line crossover uses a series of moving averages (in this case, nine, 12, and 26 days) to look for bullish and bearish crossovers that indicate a stock has momentum in one direction or another. Below, you can find a current chart of Brocade's MACD profile:

Confused? Well, that's preposterous! How could you ever be confused by something as simplistic as a moving average convergence-divergence chart! While we jest, it's actually one of the simpler methods for technical analysis.

Still, if you'd strictly followed the rules, seeking out upward and downward momentum, you would have seen the stock move between buy and sell categories a fantastic 16 times!

Want to buy Brocade today? Technically, odds are you should flip and sell Brocade sometime very soon. If that sounds like madness to you, well, we here at the Fool agree. In every market decline, technical analysis gets its share of proponents. The cries that "buy and hold is dead!" get louder, and individuals race to schemes that promise greater wealth in a shorter amount of time.

I don't deny that technical analysis could make investors money. In any random short-term transaction, you're essentially playing a 50/50 game of chance. However, at the same time most technical analysis schemes are a relative simple science: eliminating the vast complexities of evaluating true company value. It's an attractive theory, but one that is ultimately the wrong path for individual investors. Technical analysis relies on long-held beliefs about exploiting momentum and consistent patterns throughout the market.

However, with 80% of market trading now done by Ph.D.-level programmers at massive high-frequency funds, even if opportunities existed, what chance does an individual have to sniff these deals out? With so much volume now driven by these funds, how can you be certain the same rules of patterns still even exist?

I could also point to studies. There was Massey University's study across 49 countries that showed that more than 5,000 trading rules add no value. However, the real reason to forget about technical investing is what we mentioned earlier. Brocade crossed the crossover 16 times across the past year! The amount of trading in most technical analysis schemes eats away at profits. More importantly, it takes away from the idea of holding a portfolio of great companies that can accrue wealth over a long time horizon.

That's the antithesis of what we preach at Fool.com. When we look at Brocade and its peers, here are the areas that interest us:

Source: Capital IQ (a division of Standard & Poor's) and Yahoo! Finance. YOY = year over year. TTM = trailing 12 months.

We prefer to look at the fundamental drivers of value. Investors should closely watch statistical fields like return on equity as well as qualitative values like competitive advantage and managerial effectiveness. These are areas that led investors like Warren Buffett and Seth Klarman to decades of outperformance. Buying and holding great companies is the best solution for individual investors to build lasting wealth and achieve their financial goals.

So when you look at Brocade, don't evaluate it for crossing a momentum line. Buy or sell it because:

• Brocade has aggressively moved into the Ethernet switching business. While this puts it on a collision course with the 800-pound gorilla of the market, Cisco, there's also tremendous opportunity. When Cisco rolled out its unified computing system, it ruffled the feathers of longtime partners such as IBM and HP, as Cisco began directly targeting their server business. Both IBM and HP have responded by getting more aggressive about looking for new networking solutions. To that end, IBM signed a deal to rebrand Brocade's products under its own name. HP is now getting more aggressive with its ProCurve line of networking systems but has also strengthened its ties to Brocade. For a small player like Brocade, even small market share shifts could have a large impact on its bottom line. If it can execute on delivering competitive products, it's in an advantageous position to achieve rising sales through its powerful OEM partners such as HP and IBM.
• The company has pushed into new areas in the past years such as host bus adapters. Companies such as QLogic and Emulex have long dominated the billion-dollar market, producing healthy gross margins in the process. Brocade has multiple opportunities to expand its expertise in storage products, which could provide further opportunities to expand if Ethernet networking opportunities don't pan out.

These are the factors that will drive Brocade's long-term growth.

Best of all, establishing a portfolio of well-managed companies with strong advantages over their competitors spares you having to sit bleary-eyed in front of a computer buying in and out of companies with a Big Gulp full of coffee. That's the kind of future I'm looking for. Although, if your idea of protecting your future is charting the ups and downs of moving average convergence-divergence charts, then I recommend buying Brocade right now.

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