How Fundamental Are the Fundamentals?
Basic, obvious, plain, simple—all of these words describe fundamental in some way. But in practice it is difficult to decide which stocks to buy, how long to hold onto them, and when or if to sell. The very concept of value is itself complex. So when it comes to the market, the “fundamentals” are not always basic, obvious, plain, or simple. Indeed, they are far from it. Nevertheless, there are a small but important number of guidelines that you can follow to manage your investment decisions and to reduce and control risk. The fundamentals come in many forms, some complex and some simple. The best-known historical information is still found on a company’s financial statements. The summary of what a company owns and owes and its net worth, and the year’s operating results are, of course, very revealing because they provide you with the basic (fundamental) view of how all corporate results are measured: by the numbers. The numbers are never the whole story, only a starting point. Recognizing the complexity of accounting decisions made by a company and its auditors, the timing of when transactions are put into the books, and the internal valuation of assets a corporation uses, all affect the value of a corporation and of its stock. When you look at one company next to another, however, you do not know whether their financial statements were prepared using the same or similar accounting assumptions.
This presents every investor with a serious problem. If one corporation is conservative in the way it prepares its financial reports, but another is aggressive, then you cannot make a meaningful comparison. In this respect, the fundamentals are far from fundamental. The basis for comparison may not even exist, which is why you need to employ specific tools designed to test the numbers. Ratios and trend analyses are among the tools that fundamental analysts use every day. You do not need an accounting education to make informed judgments about the numbers and the trends they represent. The fundamentals contain far more than just the numbers. For example, most stock market experts would agree that nonfinancial aspects fall within the range of fundamental information. Matters such as management, industry competitive stance, reputation, dividend rate and payment history, and regulatory record, all affect what investors think about companies, even though these data are not strictly financial in nature. In addition to the fundamentals in a range of information types, investors look at technical information, trends related specifically to market price. It is a mistake to use only one form of analysis to the exclusion of other forms. Both fundamental and technical information are related to one another. That is why using a combination of fundamental and technical indicators is sensible and provides you with valuable information. Most investors recognize the importance and value of fundamental analysis but are not sure that they can master its use. Anyone who does not have an accounting education has a sense that fundamental analysis may be too complex. This is not true. Accounting and the reports that are derived from fiscal analysis are complex documents, but you will see in using this book that you do not require an accounting background to benefit from this range of analytical tools. The sense that it is simply too complex comes from the unfortunate fact that many information sources—such as the Internet, books, magazine articles—either present information in an overly complex format or oversimplify and present the same ratios without giving you any realistic, practical applications. Fundamental analysis does not have to be so difficult that you cannot grasp the information and put it to work to manage risks and make informed decisions. Here the information is kept simple and presented with illustrations, examples, checklists, key points, and definitions in context. This helps you move through the chapters, even when simply looking up a concept or to read a section, and then understand how the information is useful to you.
A problem every investor faces in deciding how to analyze stocks are not enough choices. The problem is that there are too many choices. There are many viable stocks to choose from, well-managed corporations with subtle shades of investment potential. How do you select a handful from among all of them? How do you achieve true diversification? How can the fundamentals help you to cut through the volumes of available information and simplify the decision? These are some of the questions this book is designed to answer. The tools of fundamental analysis can and should help you to narrow down your list of choices to a few important indicators. No one can reasonably be expected to study dozens of indicators and to then be able to make a sound selection. The key to making the decision is based on your personal risk standards and identification of a few key but revealing indicators. It is designed to help you put those tools to work in identifying risk levels, making valid and reliable comparisons, and ultimately in picking stocks for your portfolio. It is this activity—deciding which stocks to buy, how long to hold them and when to sell—that lies at the center of every investment program. Even if you pick the stock of well-managed, financially sound companies, if your timing is off, your profits will not be at the pace you would hope and expect. Fundamental analysis helps you to quantify value and financial strength; of equal importance, it helps you to time your decisions to maximize the potential for profits in your stock selection. With this in mind, you need the numbers as a starting point, the information you find in corporate audited financial statements and their footnotes, which includes quarterly filing papers and annual statements. Beyond these sources, you need to know how to read financial news and apply new information to a stock’s value; how to anticipate economic changes in the broad market; and how those changes are likely to affect stocks; and how to identify a company’s position within its industry and sector. This book provides basic information on the complex topic of fundamental analysis in a way intended to help anyone go through the concepts and definitions without trouble. The combined visual and learning tools—the many practical examples, definitions in context, key points, checklists, and graphics—take vague concepts and put them into real-world action in a way that relates to the same decisions you face as an investor every day.
Why Bother with Fundamental Analysis?
You might wonder why you need to hassle with fundamental analysis. After all, at every family picnic there’s undoubtedly the loudmouthed relative who’s filled with all sorts of can’t-go-wrong stock tips. Why bother with technical things like net income or discounted cash flow analysis when you can just turn on the TV, write down a couple of stock symbols, buy the stocks and hope for the best?
Similarly, you might figure learning how companies operate is just needless information. After all, you don’t need to know about fuel injection systems, suspensions, and car battery technology to drive a car. And you don’t need to know what’s going on behind the curtain to enjoy a play. Some investors figure they can just pick a couple of hot stocks, buy them, and drive off to riches. If the vicious bear market that began in 2007 taught investors anything, it’s that blindly buying stocks just because you might “like” a company or its products was hardly a sound way to tune up a portfolio. Chasing hunches and personal opinion about stocks is often not a great way to invest.
Some of the real values of fundamental analysis
Ever notice how there’s always a new wonder diet promising to make you skinny, and a new pill to make you healthier? More times than not, though, it seems these things never work. Getting healthy comes back to the basics — a balanced diet and exercise.
The same goes with investing. Believe it or not, investing can be somewhat full of fads. There’s always a new investment pundit or economist with a new way to pick winning stocks. And just as an hour on the treadmill will do you better than a bottle full of miracle pills, successfully choosing stocks often comes back to fundamental analysis. Fundamental analysis is the classic way to examine companies and investments for a variety of reasons, including the fact it is:
✓ Based on fact, not opinion: It’s easy to get caught up in general enthusiasm about what a company is doing or the products it’s selling. But fundamental analysis blinds you to this investment hype and gets you focused on cold-hard business realities. It doesn’t matter if all the kids in your neighborhood are buying a company’s products, if the company isn’t making any money at selling them.
✓ Good at pinpointing shifts in the business’ health: If a company’s success is starting to fade, you’ll see it show up on the fundamentals. No, there won’t be a giant sign saying “Sell this stock.” But there are clues if you know how to look, as you’ll discover. Companies are required to disclose key aspects of their business, so if there’s a problem, a fundamental analyst will often be early at spotting some trouble.
✓ All about execution: Companies’ CEOs are usually good at getting investors focused on the future and how things are going to get better next quarter. But the fundamentals are based in reality. Just think of children who say how hard they’re working at school. The report card is still the tangible evidence of how things are actually going.
✓ A way to put price tags on companies: What’s a painting worth? What’s a used car worth? Just as with anything else with subjective value, the price is generally what someone is willing to pay for it. The stock market, an auction of buyers and sellers, does a good job putting price tags on companies. But fundamental analysis gives you another way to see just how much investors, by buying or selling stock, are paying for a stock.
No comments:
Post a Comment