Question:
My GM (guru mate) said that if you have a handle on fundamental analysis, that’s the ultimate secret to making money. One day the “market” will understand and uncover the knowledge you have uncovered, and the price will likewise catch-up with this “knowledge.” I believe now that this is crap! The market is the market and price does not necessarily reflect fundamental analysis. What do you think?
Bryan from DownUnder
Answer:
Bryan, I love this question … Although I don’t agree that fundamental analysis is “crap,” I do agree that “… the market is the market and price does not necessarily reflect fundamental analysis.“ To substantiate this, all you have to do is look at any blue-chip company that fell to 52-week lows starting last fall.
Fundamental analysis is an excellent tool for establishing what I call “context,” or understanding the bigger picture. You see trading on technical analysis requires faith, faith that the patterns are correctly predicting a trend. Well, I am not one of the devoutly faithful, although I do have some faith. This week, for example, I bought GE simply because it broke through the technical resistance at $15, and it has paid off nicely. I would not have bought GE if I hadn’t looked at its fundamentals to understand its context, or the bigger picture. Although it has some issues fundamentally, it has enough strength to convince me to buy it for the longer term. Therefore, for me, fundamental analysis is primarily a confirmation tool.
It is true that with some stocks, the price does eventually “catch up” to the positive fundamentals. The converse is also true. Fundamentally unsound stocks can run high and higher, but eventually the fundamentals catch up and the stock drops. One glaring exception to this Amazon.com. Year after year, I said to my friends, “how could that stock be as high as it is for a company that is not making a dime.” Well, look at it today. Again, this is an exception. Usually, when the “story” gets old, investors (traders) lose patience and sell.
The larger point is, don’t throw the baby out with bath water. Use fundamental analysis as a confirmation tool, or a tool to find potential trades. Like technical analysis, though, don’t rely on it as the sole criteria for choosing trades. The reality is, as you say, “the market is the market,” and as I have said so many times before, the markets simply reflect our collective investment consciousness, and greed and fear are still the primary drivers of that consciousness, unfortunately.
Trade in the day; invest in your life …
