Ask Colin

Do you think there is too much emphasis placed on fundamental analysis?

It will assist those who read this in my newsletter and on my website if I quote your full question:

In hindsight you can see how a growing company created wealth for shareholders, but in real time it's not always evident that it will grow. And of course even when we see a great track record, it is at that point where it all can go wrong, e.g. CSL, BIL, LLC, COH to name a few. In essence, fundamentalists are trying to predict the future by using the past track record of a company. They rarely seem to want to admit that their projections could amount to nothing if conditions change. I actually believe their projections are based on an element of hope (hoping the good performance continues to validate their analysis).

You have cast me in a somewhat unfamiliar role as a defender of fundamental analysis, when I am primarily a technical analyst. However, that is not as silly as it may sound on first glance.

While I am primarily a technical analyst it is for the very reason that you allude to in your question. Fundamental information is only available from time to time and rumours often travel slowly into the news. However, people act on information and rumours that may not be public yet and that influences the price. This is where technical analysis gives us a slight advantage.

However, I think it is silly to just cast out fundamental analysis because it is based on past information. It is the mainstream analysis method and not without good cause. Ben Graham himself said quite clearly that he did not believe we could predict the future. His claim for fundamental analysis, which he invented, was that the past was the best guide we have for the future. If you could find a company with a good past record, it was more likely to continue to perform than a company with an unreliable or non-existent past record.

Of course, companies like the ones you quote had great records of success before things went wrong. This is a pattern that has repeated itself throughout recorded stock market history and should not be a surprise. Their demise was clearly evident on the charts. However, there were also plenty of clues in the fundamental analysis. Since most of the market volume is driven by investors using fundamental analysis, all we are looking at in the chart is their change in attitude. It is too simplistic by far to suppose that if we locked up all the fundamental analysts, there would still be good chart patterns to trade.

My own view is that it is foolish to ignore the insights available from other methods. Technical analysis adds value to a fundamental analysis approach. Equally, fundamental analysis adds value to a technical analysis approach.

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