Technically, Isilon Systems Is a Buy

Technically, you should buy Isilon Systems (Nasdaq: ISLN) right now.

We examined the company using moving average convergence-divergence (MACD), 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.

Signal line crossover is one of the more common ways to interpret MACD. It 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 chart of Isilon Systems' MACD profile:

Confused? Well, that's preposterous! How could you ever be confused by something as simple as a moving average convergence-divergence chart! OK, we jest -- but in all seriousness, this is 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 21 times in one year!

A better way to size up companies
Here at Fool.com, we're more interested in other measures of company value. When we look at Isilon Systems and its peers, here are the areas that interest us:

Source: Capital IQ, a division of Standard and Poor's; 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 areas 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 Isilon Systems, don't evaluate it for crossing a momentum line. Buy or sell it because: You watched the 3PAR bidding war raging between Dell and Hewlett-Packard and are wondering what other overlooked storage companies might be the next acquisition target. Well, Isilon might be the next name popping up as the loser of the 3PAR battle looks elsewhere to beef up its storage capabilities.
• Isilon fills a particular niche of storage very well. The company provides "scale-out" storage systems powered by its OneFS Operating System. Isilon's systems aren't as versatile as competitors', but when it comes to storing huge quantities of data, its solutions are best in class. Larger IT-focused companies are starting to see the market opportunity Isilon faces, so the company will either face increased competition or a buyout in the future.
• Some of the buyout price may already be priced in; the share price has shot up from around $5 a year ago to more than $21, which puts Isilon at nearly 10 times sales with negative earnings in the past 12 months. If a buyout doesn't come, and larger competitors enter the market, Isilon's valuation could have shot ahead of the company's intrinsic value.

Want to buy Isilon Systems based on technical merits today? Technically, odds are that you should flip and sell Isilon Systems sometime very soon. If that sounds like madness to you, well, we here at Fool.com 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 toward 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 relatively simple science, eliminating the vast complexities of evaluating true company value. However attractive, this theory 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 as much as 75% of market trading now done by Ph.D.-level programmers at massive high-frequency funds, even if opportunities existed, what chance would 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 Massey University's study across 49 countries, which 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: Isilon Systems crossed the crossover 21 times across the past year! While traders might not buy and sell with each crossing, cases of high momentum are normally short-lived. The amount of trading in most technical analysis schemes racks up commission fees and short-term capital gains taxes, eating 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.

That's why, at Fool.com, we recommend that individual investors establish a portfolio of well-managed companies with strong advantages over their competitors. In the end, we find that to be the best contributor to long-term wealth. More importantly, it'll spare you from sitting bleary-eyed in front of a computer with a Big Gulp full of coffee, frantically buying in and out of companies. But hey, if your idea of protecting your future is charting the ups and downs of moving average convergence-divergence charts, then Isilon Systems looks like a buy right now. Just don't expect to hold it for very long.