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Fundamental Analysis
Fundamental analysis is the initial analytical method used by most
people when they become interested in financial markets. The
"fundamentals" can be defined as the financial, economic, political
and social conditions prevailing, whether they relate to an
individual company, a market sector, a country or even globally.
Fundamental analysis
attempts to use all these known factors or conditions (as well as
those expected to occur) in order to arrive as a "fair value", i.e.
market price, for any given stockmarket, currency, company etc.
If the fair value is
higher than the present market price, then a buying decision can be
justified based the "fundamentals."
Fundamental analysis, on
the surface, is a logical starting point for most people because it
would appear to offer conclusions which are based on rational
criteria. However, fundamental analysis does have some weaknesses.
Assessing fair value based
on fundamentals is subjective and will vary from person to person.
This variance in opinion is the very reasons markets exist - buyers
and sellers hold diametrically opposed views on their interpretation
of market conditions and prospects.
There is considerable
scope for disagreement with respect to forming a view based on
fundamentals, for example:
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What are the fundamentals
in this particular case?
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Which fundamentals are
relevant and which are not?
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How can the accuracy of
the fundamentals be verified?
-
How much weight can be
attached to each?
-
Are certain factors
already in the price, i.e. discounted?
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To what extent do unknown
variables need to be estimated?
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When can we expect the
fair value to be attained?
-
How long will it take to
obtain and weigh all this information in order to arrive at a fair
value?
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How long would it take to
perform this type of analysis on a hundred companies?
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How useful is the
information if it's dated?
But possibly the worst
problem to overcome is the "timing" problem. Let's consider the
following three points:
- In the stock market crash
of 1987 a massive change in values occurred between 16th October and
19th October. Yet, NO CHANGE took place in any of the fundamentals
which would normally affect market prices, e.g. trade deficits,
interest rates or political events.
In other words, a complete
understanding and knowledge of all factors which supposedly
influence market values was of no use in anticipating the timing of
the crash
- The day when a market or
share peaks, is frequently the day when the fundamentals look the
strongest. They have to in order to be consistent with the high and
the advance which has taken place. However, the apparent strength in
the fundamentals is not reflected in the market price.
Conversely, fundamentals
nearly always look their worst near market lows - the ideal buying
opportunity.
Hence fundamentals can
give misleading cues, and may be 180 degrees out of phase with the
price.
- In addition, most people
will be well aware that it is perfectly possible to lose money
investing in big, established companies which show good
profitability, simply due to poor timing.
Once again, appreciation
of the fundamentals is not sufficient to ensure a profitable
investment. Indeed, one can lose money in good companies, and, with
opportune timing make money investing in companies which are not
making a profit.
The above arguments should
have highlighted the essential difficulty with fundamentals analysis
- timing!
But......................
'TrendTrader' Logic
The value of an investment
has very little to do with logic.
This may fly in the face of the mountain of fundamental analysis,
technical analysis, and even astrological analysis peddled by
investment
gurus. But the price of an investment has much more to do with
emotion
than anything else. If something is new, trendy, stylish or just
plain
'hot' its price will go up. If not, no matter how good
'fundamentals' are, it will stay down.
You don't have to do much research to prove this is true. Recall the
days of 1999-2000, in the midst of the 'Internet boom,' when just
about every technology stock seemed to be headed to the moon.
The price rise had nothing to do with fundamental or technical
analysis.
Indeed, companies such as Amazon.com, which were/are losing hundreds of
millions of dollars each year, skyrocketed, even though they're in
the red.
What then, was responsible for the boom in technology share prices?
In a nutshell, it was the media, which proclaimed the tech stock
bubble
a 'new era of investment' and bid prices of stocks like Amazon
beyond
any rational valuation. The investment public, in turn, believed the
hype and bought billions of dollars/pounds of tech stocks, with
absolutely no concern about any kind of analysis. They simply
believed prices would rise - and for awhile, they did.
If you're right about a trend, sooner or later, the media will
discover
it. It helps if the stocks that you choose have good fundamentals
and
fit whatever technical analysis parameters you choose. But, in this
era
where the media can make an investment profitable independently of
its
underlying value, it makes sense to consider this approach
for
your portfolio.
Not only does such a strategy yield superior investment results, it
allows you to spend time on the things that really matter in
life,
rather than to sit glued to your computer watching quotes. You buy a
share, and then watch how media reports make it rise month after
month.
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