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Monday, 30 January 2012

Fundamental versus Technical Analysis – Part 1 of 3

No, I am not going to explain via numbers and ratios. That’s so left-brained! Let me try with a right-brained approach.


Fundamental Analysis

Investors who favour this analytical approach like to comb through the published financial reports of companies with glee as they try to fish out useful nuggets of information for their buy/sell decisions.

There are 2 major sub-groups of this school:

1)      Numbers R’ Us

2)      Lazy bums


Numbers R’ Us

This group loves to dive into the balance sheet, Profit & Loss, and Cash Flow statements. Not only that, they will read and decipher every word/number in the appendixes! Numbers R’ Us are hard-core number crunchers! They would create their own spread-sheets and track the ratios of their beloved companies quarterly and annually.
   
I am puzzled as the only numbers I am interested in are: 36, 24, 36.

However, I treat these people with respect as they are frequently the early ones who can “smell” something is “fishy” just by looking at the numbers – especially when they don’t add up!

When in doubt, they vote with their feet and stay out.

Another interesting trait is they trust their own financial detective skills – they take responsibility for their own investment decisions. Hence you won’t find them suing the banks or blaming the authorities if they have bought Lehman mini-bonds.

For eg, if they invest in an S-chip (China companies listed in SGX), they do so with eyes opened.


Lazy bums

This group of “fundamental analysts” are outright lazy or don’t know what to look for in the numbers…

So they rely heavily on 3rd parties to do the summaries for them. So they download brokerage reports and read what financial bloggers have to say. Listen and watch CNBC or Bloomberg commentaries – what is said in the media must be true! No?

One obvious trait is they like to quote who said what or who wrote what. They are quick to follow advice; but when things go awry, they are equally quick to “outsource” responsibility!

Eh… Are they using Fundamental Analysis? Well, they can quote the P/E ratios, net asset values, P/B, dividend yields as good as their Numbers R’ Us brethren. Just don’t ask them how these numbers were derived!

For eg, if they invest in an S-chip, they go in following the “backside” of others.


The truth about Fundamental Analysis

When you look at the Sun, you are not looking at the “real” Sun. What you are watching is the image of the sun 8 minutes ago. That’s how long the light from the Sun takes to reach Earth!

It’s the same when you look into the mirror. You are looking what you were 2 nano seconds ago. 1 nano second for the light from you to reach the mirror; 1 nano second from the mirror back to your eyes.

There lies the truth about Fundamental Analysis! Unless you are an insider, everything in the market is old news to someone else!

All published statements or reports have a time lag. The question you have to ask is how high or low in the information food chain do you belong to?

In the middle ages, by looking at the Sun, it was the obvious “truth” that the Sun revolves round the Earth. It was Nicolaus Copernicus that pointed out that it’s in fact Earth that’s revolving round the Sun!

So next time you are doing your own fundamental analysis or reading a brokerage analyst’s report, you may want to pause and reflect:

Are you listening to the “obvious” truth (the spin others are giving you), or can you see beyond the numbers just like Copernicus?

Next post I will talk about Technical Analysis.


23 comments:

  1. wah lau, part 1 of 3!? ok ok i will read on haha.

    ReplyDelete
  2. wah interesting! haha I belong to the 1.5 of the FA. You never mention this group?

    I not hardcore in digesting the numbers although sometimes i would. Sometimes also d/l the numbers from elsewhere to see too! But I know what all these terms mean. Thus I neither belong to 1 or 2.

    You are right that we are seeing "8 minutes" later but that's the best we can get. Better than nothing! That's why these ppl like to see the consistency in the FA. If the company can do well for past 10 years, it should be able to in future although this is not 100% confirm.

    Sorry for the poor english! I am trying to type in singlish!

    ReplyDelete
  3. Besides the 8 minutes later, don't forget the numbers put there can be tweak somehow by whatever means. What you see may not be the truth. I don't have accounting background but I heard from ppl that it is possible.

    Accounting people please correct me if I am wrong!

    ReplyDelete
  4. i got it! next time if i read any fundamental analysis or reports, i 'll go and look at the sun directly.

    ReplyDelete
  5. oh i will also glue my face to my monitor so that i can get 1 nano second faster for my price feed.

    ReplyDelete
  6. joke aside, i like it that you start using your own analysis and thinking.

    fundamental analysis to me are rubbish. use price as indicator, they never lies and never delay.

    ReplyDelete
  7. by the way, it is not during the middle age that someone discovered earth evolving the sun.

    i can't remember who it was, but it was before christ i think in greece.

    ReplyDelete
  8. Hi SMOL,
    FA people will swear they are right. So is TA people. So they said if you can't beat any group, join both of them lol. Besides every "kungfu" style has a counter "kungfu" style. NO?

    ReplyDelete
  9. Whatever kung fu style. Make sure that we don't pass our hard earned money from our jobs to make someone else become rich from stocks.

    ReplyDelete
  10. I like the classification of "Numbers R Us" and "Lazy Bums". Very insightful analysis :-)

    OT83 - Financial statements that are audited and issued a clean report means that they were prepared in accordance to the prevailing accounting standards. However, even when a set of financial statements meets audit and accounting standard requirements, accounting itself relies on some assumptions. e.g. the company is a going-concern i.e. able to meets its obligations and debts as they fall due as well as continue operations on a day-to-day basis. Whilst the auditor could qualify the accounts if they suspect the assumptions may not hold, a lot of items rely on judgement and some assumptions hence true and fair (clean) audit reports do not guarantee but only provide reasonable assurance that accounts are true and fair.

    ReplyDelete
  11. OT83,

    Must keep it simple - black or white. Although I love shades of grey. Must limit to 2 x A4 page mah ;)

    So you are a hybrid!

    Yup, not only the 8 minutes lag, we have to be aware of "the spin others are giving us". IPO prospectus, road shows, "bamboo walled" brokerage reports their own investment branch, bloggers talking up their holdings, etc...

    ReplyDelete
  12. Coconut,

    I remembered too! The tour guide did mention to me when I visited the classical sites of ancient Greece.

    Found it under Google:

    Aristarchus

    Little is known about Aristarchus (200s B.C.) other than that he was a Greek astronomer who was the first to say that the earth revolves around the sun. His works were lost, but his ideas were quoted by the Greek mathematician Archimedes. In Aristarchus’s surviving treatise On the Magnitudes and Distances of the Sun and Moon, he does not mention his theory on earth’s orbit.

    Well, its like the Chinese were the first to arrive at the west coast of North America - long before Colombus.

    But like Motorola mobile, first means nothing if we are weak in follow through...

    Tell that to Atari too ;)

    ReplyDelete
  13. Temperament,

    Stay tuned for part 2 and part 3. I will reveal where I stand ;)

    LOL!

    ReplyDelete
  14. CW8888,

    Hear hear! Talk is cheap and everything is illusion.

    Only truth is how much money you had in your pockets when we went into the "market", and how much we ended up when we walked out - if we ever do get out!

    Guess where I "borrowed with pride" this part 1,2,3 trick? Shhh....

    ReplyDelete
  15. Panzer,

    Thanks for having a sense of humour and giving me my literary license to "poke" fun at ourselves.

    I am glad most readers by now knows my "bau" (pronouced as bawu). It's Malay word for smell or ordour ;)

    The occasional fraud and SGX fiasco are good "live" education materials on what "Auditor certified", "SGX vetted listing", "CPF approved", "MAS approved" really means - if things go wrong, they say to your face: You go in with eyes open what!?

    Now lagi no excuse. We all are now "certified" investors just because of our brokers or SGX say so.

    I got 20 out of 20 question right. Does they mean I will make money???

    LOL!

    ReplyDelete
  16. I didn't know what is 36, 24, 36 and googled it. Haha. How not to love them.

    There lies the truth about Fundamental Analysis! Unless you are an insider, everything in the market is old news to someone else!

    All published statements or reports have a time lag. The question you have to ask is how high or low in the information food chain do you belong to?


    Let me guess what is going to be in your part 2 ... You have actually pinpointed the weakness of fundamental analysis. The time lag. The strength of Technical Analysis over FA is that insiders cannot hide their tracks from the price and volume from students of TA.

    You are an all-rounder. I also like TA but never like to talk about it on FA-oriented forums like valuebuddies.
    Some FA people think TA guys still haven't got it.

    ReplyDelete
  17. hyom,

    Sometimes if lucky can spot 38,24,36 too!

    I got give my respects to Numbers R' Us Fundamental Analysts OK?

    But the good ones are far and few in between.

    I've read how one mutual fund manager spotted Worldcom's figures do not add up hidden under all the layers of appendixes. He sold before the tell tales signs appeared as you have correctly alluded - in the charts ;)

    I read, but since I cannot replicate, I use it to tell this story lor!

    ReplyDelete
  18. Thanks panzer for clarifying :) So the reports are truth based on assumptions. If assumptions fail, then everything will fail.

    Anyway, most important is what cw said.

    "不管是黑猫还是白猫,能够捉老鼠的就是好猫!“

    ReplyDelete
  19. I was once a lazy bum and was stupid enough to follow advise from my stock broker, ended up losing money. Now I am a numbers person and it is indeed interesting to compare financial statements across firms within the same sector and industry. :)

    ReplyDelete
  20. sorry smol, i just have to throw it here in stead of fat blog.

    when i see the word "biggest" my heart sink to the bottom and my hands keep shacking.

    i hope he meant by his trading career instead of his life. i really hope so.

    ReplyDelete
  21. Guru,

    Once we survived our first "baptism of fire" through painful losses, we soon realize there is no one more interested in our well-being than ourselves!

    I don't mind rewarding my "agents" well; but the relationship must be clear: I am the master; they are the servants.

    ReplyDelete
  22. Coconut,

    We all have to solve our problems ourselves. Have faith on the human spirit!

    You and I have survived what we thought were our "biggest" challenges in the past. Only to find new ones popping up again...

    I like your post on life mirroring trading and getting alignment.

    Life, like in Trading, moves in cycles. 30 years river east; 30 years river west.

    ReplyDelete

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