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Valyooo (99.64)

Thoughts for beginners part 2: Fundamental and technical analysis are usually the same thing

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March 13, 2013 – Comments (17)

I am more of a macro investor than individual stocks...not the best with those.  I remember there were a bunch of questions that I had that confused me when I was brand new.  A handful of CAPS players got me to where I am today, so I am offering my opinion on a few misconceptions.  There will probably be about 10 of these blogs over the course of a few weeks.  

 

Anyway, I wanted to debunk what I think is a myth, and that is that fundamental analysis and technical analysis are different.

Technical analysis is about finding market patterns that have had a high probability of working in the past, and applying them to the future.  Some people say they are just a bunch of random squiggles.  I say if psychologists can find and name disorders (commong pattenrs in people) then technicians can find and name trading patterns.

Now look at most forms of fundamental analysis.  A lot of people use discounted cash flow, or some sort of model of earnings growth, or a p/e number, or for the overall market they use stock market total market cap versus GDP.

What is the difference between using a model that involves numbers like the above mentioned, to mathematical formulas like RSI, or MACD?  They both equate to the same thing  : " I buy when X happens".

Now things like "I think people will continue to eat mcdonalds in the future" are a little different, but they are usually based off of historical trends of how people behave....kind of like a price trend


What about seasonality?  Or consumer sentiment?  Consumer sentiment over 90 = contrarian sell.  May = sell.  These are "technical".  It meets a criteria so you act on it. 

http://finviz.com/quote.ashx?t=dpz

 

Look at that chart...would you really think buying at the lower trendline is "just buying a random squiggle"?

Technical analysis is just another tool in the toolbox.  I personally don't think theres a difference between liking a chart pattern trend a sales trend, or liking a p/e of 10 versus liking an RSI reading below 30 (both are oversold).  I think they are two sides of the same coin.

17 Comments – Post Your Own

#1) On March 14, 2013 at 11:39 AM, TSIF (99.96) wrote:

Valyooo, I think your series will be very helpful to new investors who are burying themselves in the mire and possibly getting discouraged trying to learn all the variables/definition, etc.

I would caution, however, that you don't err on the side of over simplicity.  While both a fundamental and a technical investor/trader do have similarities in that they look at metrics around value, both are entirely different.

Fundamentalist will bury themselves in annual reports and generate cash flow models, P/E, and the other numbers you referred to.

Technicals will be buryed in the charts.   

 Their may be many people who are hybrids of the two and who do very well not diving down into the "muck" on either.  Personally, I'm happy when fundamental analysis and technical analysis align in an equity or sector, but this still does not guarantee success.

Pure technical investing is usually used by Traders/Short term holders. Pure Fundamentals is usually used by longer term holders.  Those using CAPS to learn should focus on what type of investor they are and work to refine their skill set/knowledge base accordingly. One generally doesn't have time/interest to remain skilled at both.

Both are useful, but can be upset by competitive factors or catalysts below the surface.

Again, however, I agree with the general concept that both are similar in that they use the toolset they prefer to value an equity or industry and attempt to find a point when the markets are inefficient.

Personally, however, both rely on the concept that the market is efficient in the long run and will "right" itself if there are inefficiencies that present good entries either fundamentally or Technically, some days, I'm not so sure there is a rational market!  :)

 

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#2) On March 14, 2013 at 12:20 PM, Option1307 (29.97) wrote:

Good series, +1.

TSIF

Great comment!

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#3) On March 14, 2013 at 2:03 PM, somrh (85.68) wrote:

@Valyoo

I think the problem you cite is valid; namely most fundamental investors aren't really fundamental investors; they're just doing an alternative form of TA using "fundamental" figures instead of price/volume type figures.

But I think you're missing the big picture on what fundamental analysis actually entails. Consider this counterexample to your thesis:

You can do fundamental analysis on a private business; you can't do technical analysis.

The true value of the stock isn't found in the ups and downs of the price; it's found in the discounted cash flows (dividends) that asset pays out over its life. Those cash flows are why anyone would (rationally) want one of these silly pieces of paper (and hell, stocks aren't even pieces of paper anymore!).

Of course you can potentionally profit from that "ebb and flow" but that may still be divorced from reality.

@TSIF

Personally, however, both rely on the concept that the market is efficient in the long run and will "right" itself if there are inefficiencies that present good entries either fundamentally or Technically, some days, I'm not so sure there is a rational market! 

If those stocks' dividends over the long-term don't justify the price you paid, you overpaid, regardless of what the market thinks of the stock. So fundamental investing doesn't need to rely on market efficiency. If the market never correctly values the stock, who care?! Just watch the cash flow in.

To summarize, good TA generally requires an active secondary market since you need a good amount of price/volume information to get a useful figure. Good FA requires you think about the asset as if there was no secondary market.

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#4) On March 14, 2013 at 3:09 PM, TSIF (99.96) wrote:

While my "rational market" comment was partially tongue in cheek; long term, if one is investing they are doing so with the understanding/expectation the market is rationale.  Short term, they are hoping  it's not. 

Dividends vs FCF is a nice metric if you're investing for dividends. But if you're investing in Growth or new technologies you will have to use other metrics. 

" If the market never correctly values the stock, who care?! Just watch the cash flow in"

Hmmm, anyone who is selling.....

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#5) On March 14, 2013 at 5:06 PM, dragonLZ (99.67) wrote:

My opinion is that fundamental and techical analysis are completely two different approches to investing that produce the exact same result: Sometimes you win and sometimes (for most investors this would be: most of the time) you lose.

I think both fundamental and technical analysts are just kidding themselves thinking one is better than the other.

I do however think that fundamental analysis is safer than techical analysis: Picks made by fundamental analysis have less chance of going to zero (but have equal chance of getting cut in half or not producing any money).

By the same token, fundamental analysis tends to be more wrong on "high-flying" stocks (how many times did you hear comments like "This stock is fundamentally week" or "This stock is way overvalued", just to see those same stocks go up tenfold in value).

I cringe everytime I hear someone say "This stock is a great buy at $50 - has great fundamentals", but didn't want to touch it at $5... 

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#6) On March 14, 2013 at 5:06 PM, Valyooo (99.64) wrote:

Good responses.

@somrh,

"You can do fundamental analysis on a private business; you can't do technical analysis."

Eh, you can chart the price people are paying for similiar companies, or chart the cash flow...the same way you can chart real estate prices.  You're mostly right though.

 

@TSIF: I think you are one of the best on here, thanks for commenting!  You are right, I SHOULD be careful not oversimplifying things for beginners.  My only reasoning for making it so, was that when I was a beginner I always used to think "which one is right? fundamental or technicals?" For a while I thought TA was stupid because it was just a bunch of squiggles.  Then for a while I thought FA was stupid because all news is already accounted for and TA showed what investors thought.  It took me a while to realize they're both tools for fixing the same problem 

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#7) On March 14, 2013 at 5:22 PM, Valyooo (99.64) wrote:

Dragon,

better than the reverse of saying something is a great buy at $15and they shouldnt sell, and an eve better buy at $8, and an eveN BETTER buy at $5 :)

 

I wont say names but it rhymes with shmendever shmilver 

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#8) On March 15, 2013 at 12:10 AM, dragonLZ (99.67) wrote:

Valyooo, not sure who do you have in mind.

Btw., have you checked EXK lately? An incredible value right now... :)

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#9) On March 15, 2013 at 1:39 AM, somrh (85.68) wrote:

@TSIF,

long term, if one is investing they are doing so with the understanding/expectation the market is rationale

While I do think the market tends to revert to fundamentals over the long haul, I don't think this is a requirement for investing.

Just take a look at Berkshire's long-term holdings. Many of them are paying annual dividends that are about the same as Berkshire's cost basis. None of those returns are dependent on market rationality; they're dependent on the true value of those stocks.

I'm confused by your distinction by "investing for dividends" and "investing for growth". If an asset never pays any dividends over the course of its future life, it's worthless, not matter how much it "grows".

If you're hoping to see the share price go up (for whatever reason) then I think Valyoo's comments apply; how is that really any different than TA (apart from looking at different factors)?

So I don't think there's any alternative to "investing for dividends". It's all investing for dividends, otherwise it's speculation. (Keynes had it correct in what was probably one of the only well written chapters in the whole book.)

What I suspect is that you're distinguishing between current dividends versus future dividends. If the company's cost of capital is 10% but they can earn a 20% return on capital, then it makes sense to retain earnings and reinvest in the business.

But presumably at some point they will pay dividends and those dividends will (assuming the reinvestment went well) be all the more "juicier" so to speak. So even investing for growth shouldn't require a dependency on the market. 

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#10) On March 15, 2013 at 1:42 AM, somrh (85.68) wrote:

@Valyoo

Eh, you can chart the price people are paying for similiar companies, or chart the cash flow...the same way you can chart real estate prices.  You're mostly right though.

:)

I think this would end up commiting the fallacy of division.

Suppose that you have an index of, say, restaurants. And some TA signal says that the index is a buy. Does that mean MCD's technicals are giving a buy signal?

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#11) On March 15, 2013 at 1:58 AM, Valyooo (99.64) wrote:

Why dont you just SHUT UP!

 

:D 

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#12) On March 15, 2013 at 10:44 AM, TSIF (99.96) wrote:

somrh, there are short term traders here, long term traders, short term investors, and long term investors and hybrids of the above.

This clearly also includes speculators.

For a pure value investor, with a LONG term, or infinite horizon then your points are very valid, but one still needs to apply them correctly. As stated, fundamentals are best used.  Even long term investors, at some point, however, (except for a small percent of Buffets who were successful enough to turn their investing into a "corporation" with an infinite life), we either need to cash out or leave what we have left to our heirs.  In which case we would care whether the markets rewarded us with some appreciation.

Overall, if dividend investing is your core focus, I certainly wish you well at it.  I just hope you don't think that those who speculate in the other options as too dense!  :)

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#13) On March 15, 2013 at 2:58 PM, JaysRage (90.55) wrote:

I do not agree with a thesis that equates fundamental analysis and technical analysis.   They do two different things, have two different purposes and there are only two points of intersection.....when to buy a particular stock......when to sell a particular stock.   

Well, that's what it's all about, right?   Short answer, no, not if you're buying anything for more than a few months....which is the difference between trading and investing.  

When I buy long-term, I buy stock of a company that is worth investing in, which can only be assertained by fundamental analysis.   Once it is confirmed that a company is worth buying, then it is worth looking at a proper price point for buying.....potentially using fundamental and technical analysis in parallel....evaluating risk/reward, based on price vs fundamental analysis.  

There are stocks that aren't worth buying at any price.  Lots and lots of them.     

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#14) On March 15, 2013 at 3:10 PM, somrh (85.68) wrote:

TSIF,

I actually have no problem with speculation. I do it often. But I call a spade a spade. When I buy, say, a put option, I know I'm entirely dependent on the market changing it's opinion on the stock within a short amount of time. 

Regarding the need for cash: that all can be mitigated by asset-liability management (ALM). If I need money in 2 years, buying stocks or, say, 30 year bonds is entirely speculative and I'm subject to the whims of the market. If I buy a 2 year bond, I don't have to care what the market thinks. 

Hussman has some good articles on how to apply this to stocks. See here for example. Using the Gordon Growth Model, the duration of a stock is 1/dividend yield. To quote a relevant portion:

Historically, the price/dividend multiple on the S&P 500 has hovered near 25 (even as recently as 1990), meaning that investors with a 20 or 30-year investment horizon could comfortably invest their entire portfolios in stocks, and feel that they were still being fairly conservative.

Not anymore. At a price/dividend ratio (and modified duration) of 62 on the S&P 500, only a handful of investors can count on a predictable retirement from a fully invested stock portfolio. Right now, those investors are drinking juice from their sippy cups and watching Barney.

This was in 2004. Right now duration is about 50 years for the S&P 500 which is still pretty high. 

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#15) On March 15, 2013 at 3:28 PM, Valyooo (99.64) wrote:

Treasuries have outperformed stocks for 30 years now 

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#16) On March 15, 2013 at 3:28 PM, Valyooo (99.64) wrote:

Jay nailed it. SPX would be much lower if they didnt rebalance it all the time 

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#17) On March 15, 2013 at 6:22 PM, Valyooo (99.64) wrote:

That was meant to be written in my other blog

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