The Complexities of Fundamental Analysis
Fundamental analysis involves looking at either business conditions for a particular instrument we’re considering, a certain company for instance, or the economy or business conditions as a whole.
There is no easy way to do this or simple formula here, and with looking to predict stock prices, we’d be looking at a company’s future business prospects and seeking to predict where it is headed based upon where it is now business wise.
There are a lot of factors we can look at when we attempt this analysis, many of them measures of competitiveness and forecasts of future competitiveness, as well as factors that relate to the soundness of their positions in the marketplace and the competency of their management.
This is complex enough, but the real complexity involves looking to predict all of this and also predict future market conditions as well, where the market as a whole may be headed. This is because the price of a stock is not just influenced by its business performance, it is also heavily influenced by supply and demand in the market as well, where more or less people may be putting more money or taking money out of stocks.
We do know that the stock market does tend to move forward over the long term, but that’s about all we can really be even reasonably certain of, and even this isn’t certain. We could go into a very extended bear market for instance and some day we probably will, when for instance large governments exhaust their borrowing power and can no longer manage their economies that well, or worse.
While this isn’t really on the horizon yet, the market has been mired in longer term bear markets before and will again, and we may not be able to or be willing to ride them out and see them surpass their previous levels so that we can say that hanging on in some sense was a good move.
While we have a fairly good idea about economic fundamentals, this knowledge is pretty much limited to the nearer future, and predicting these things a decade or more out is very challenging and involves a lot of guesswork.
This is the case with looking to predict the movements of particular stocks over the long term as well, where we’re needing to get both the fundamental analysis of the company and the economy right well enough to be able to make a good enough prediction to make the decision to invest.
When we do this, what happens in reality is that our particular predictions tend to lack the certainty we need, and while we may still be looking to take advantage of the very long term bias that is present in stocks, whether this bias applies to a particular stock is another matter. If we really want to rely on fundamentals, it is far wiser to look to reduce the complexity here and just focus on market fundamentals only, and leave the stock picking to those who wish to enjoy less certainty and more risk.
This idea has become much more popular lately with both funds and their investors, where we’ve seen index funds grow tremendously over the last few years, as we learn the merits of simplifying all this and just looking to reduce our predictions to the market overall, which is easier to predict.
Our Investments Do Need to be Managed Somehow
Now that we’ve sought to simplify our holdings by looking to eliminate the complexity of having to choose between individual investments such as stocks, and to choose to just trade the market itself essentially, we’re going to need a plan on how to do this best.
We could just buy and hold a stock index, and this is the approach that most investors take, but the idea here is to look to simplify the management of our investments, and we therefore should be striving to manage them, especially if we’re looking to become better investors.
You don’t get better or help yourself in any way by doing absolutely nothing, like those who simply choose to hold long positions in the market regardless of what happens. To become better at this, we’re going to need to be at least open to making decisions.
Once we have simplified things such that our stock holdings will simply be in an index, we need to ask ourselves what decisions are left, given that we’ve shedded the ones about which particular stocks we want to be in.
If we still insist on choosing our own stocks, our initial assessment, no matter how well thought out, is going to be subject to changing conditions, changing fundamentals for instance, as well as changing market conditions, all which need to be managed. We cannot just say that a stock looked good back in 1996 based upon anything, and then bought it and just held it and even pretend to be relying on analysis over time to any meaningful degree.
We can’t do that with our index entries as well, that the market looked good at some point in the past and we just bought or continue to buy and just insist on closing our minds to analysis entirely, forever more, until we need to cash out and spend the money.
Becoming a better investor means that we’ll be making better decisions, and making better decisions involves making decisions in the first place, and these decisions cannot merely be made once and for all, as markets change.
So, the first step for an investor to take in order to become better at this is to realize that investing better means making decisions in the first place, and then seeking to both make them and make good ones.
We can, of course, make bad decisions as well, but that’s not becoming better, and we instead need to strive to decide well, to come up with a good investing plan that involves more than just pumping money into our positions over time and hoping for the best.
What Deciding About Market Positions Involves
When we invest in something like a stock index, we’ve simplified things to the point where the only decision that is left to make is the amount of our portfolio that we have invested in the position at any given point in time.
While static investors just keep investing mindlessly, perhaps only seeking to bail when their positions take a huge hit to the downside, there is no skill in that and being better at investing involves both acquiring and leveraging investing skill.
While many investors are fearful of looking to time their investments, and those who sell investments work hard to keep people afraid so that they don’t take money out of the investments they have with them, those of us who are able to conquer these fears by examining them more closely and understanding this process are the ones that are positioned to seek to improve.
There are some real skills involved in managing our investments, and even though we’ve simplified things a lot by just going with index positions, we still have to know when we’re going to want to be in them more, knowing when the odds are in our favor, and knowing when they are not.
Investing is all about playing the odds and playing them well, and this is what managing index positions is all about, being in more our out more depending on the changing dynamics of the market.
When the market is rising and we’ve chosen to go long markets, as almost all investors do, it’s easy to ride waves of momentum upward, and everyone who is long during these times will do well.
The trick though is learning to determine well enough when the momentum has shifted in a significant enough way to turn the odds from being in our favor to against us, whether we use shifts in market fundamentals, price trends based upon technical analysis, or both.
This in itself does not involve the debate of which technique is more sound, it instead involves our actually using a technique to determine all of this, and taking action when our analysis tells us we should.
This is really the first step to improving as an investor, to actually seek out and use some form of analysis, some way of telling whether conditions are favorable or unfavorable, so that we can make better investment decisions.
The quality of our analysis will also determine our success, but in order to even give us a shot at becoming better, we have to first come up with a plan that involves trying to succeed more.