Monday, September 29, 2008

Is fundamental analysis dead?

The US stock market dropped nearly 10 percent last Monday, after the $700 billion rescue plan was rejected at the House of Representatives. Did the business prospect of all the listed companies go down with the rescue plan? The PSEi was at 3,677 on 2 October 2007. On 30 September 2008 it was 2,569, a decrease of 30 percent. Did the Philippines' business environment deteriorate that much during that time?

Many investment education programs, including the CFA program, emphasize fundamental analysis, which looks at a company's income prospect, liquidity ratios, debt to asset ratios and so on. However, in the past 14 months, what dominated the US stock market were the housing market's condition, and, more significantly, the availability of credit, and these factors also have an overriding effect on the stock markets in far away countries, some of which undoubtedly have strong trade ties with the US, but the extent of the impact on their stock market still seems disproportionate to the trade impact.

Analysts who relied solely on fundamental analysis would see the stock prices of many good companies battered to 'unreasonable' levels. In ordinary market conditions, the analysts would disregard short-term price misalignments, or even regard them as opportunities. For example, Warren Buffett's fund bought shares of USG, a US building materials manufacturer, in mid 2007 at around $38. However, this time round, the 'misalignment' has lasted more than 14 months, and who knows how much longer it will last. USG is currently trading at below $26.

Is it time for analysts to admit that the supply of liquidity and market sentiment are also important factors in determining stock price levels? and at certain times, these factors can override fundamental factors by a large margin and for a long time?

3 comments:

Snowball said...

"The stock market behaves like a voting machine, but in the long term it acts like a weighing machine." - Benjamin Graham

Check out Berkshire Hathaway performance of +15% for the 1 year period.

Chester said...
This comment has been removed by the author.
Chester said...

You most likely already know that the price of a stock is not necessarily indicative of its value. Sometimes, the price of a stock is higher than its value. Other times, the opposite is true. Does the length of time that the value and the price of a stock differ affect the value of this business? No. A gold mine worth ten gold bars at present is worth ten gold bars even when the last twenty potential buyers bid only two gold bars for it.

The more accurate check of one's value analysis in my opinion are the cash flows of the underlying business you bought (if you bought it for its future earnings) or its current net worth (if you bought it for its liquidation value). A value investor should be looking at these two things more closely, not at stock prices, to make his or her continuous assessment of value.