Saturday, 8 September, 2007

Does Fundamental Analysis Really Work?

Does Fundamental Analysis Really Work?
This is again one of the most commonly asked question that i come across every now and then. Similar to my earlier article, Does Technical Analysis Really Work? i will try and dig into FA or Fundamental Analysis and see if it does work all the time.

Is Fundamental Analysis a fluke?

NO. Fundamental analysis is a study of Numbers and Ratio Analysis. It is Definitely not everyone’s cup of tea. One needs to invest 1000’s of man hours to understand the concepts and how to break up numbers so that it makes sense. Or else one must have some sort of Accounting background. Either ways, the end result is that they both lead to innumerable calculations and computations which leads you to a simple conclusion. Is the stock a buy or a sell.

Can someone really predict future Stock Prices using FA?

Definitely. Fundamental analysis uses the Facts, Books used for book keeping. And hence any analysis done and results thereof are a good indication of what the stock price should look like. For example, Projected Earnings growth is used by analysts to predict the current and future prices. Similarly common investor uses P/E ratio to understand and predict future stock prices. However, does it always, work. NO. Simply because Fundamental Analysis only gives you an idea of what the Current/Future prices of the stock should look like. That does not necessarily mean, the stock will go there tomorrow.

Does Fundamental Analysis have a timeframe?

Not really. Why? Because Fundamental Analysis is not used usually for short term trading. It is used for someone with a longer term investment horizon, usually more than 1-2 years. One generally gets out of the stock Only if the stock has not been showing the same kind of results that it generally does. Any Fundamental weakness would trigger a sale of the stock.

What is the success percentage?

Fundamental Stock Picks always yields excellent returns because they follow the basics. After all, one would always like to invest in a business that has some legs.

Let us take a live example

I have randomly picked Canara Bank and am comparing it with ACC, Weekly chart. Now, both companies are extremely great Fundamental plays. But if you look at their respective performances, you will notice a difference.

Canara Bank was around 800 a couple of years back. It is still around the same figure as of this writing. So, if you invested in this company looking at just the fundamentals, which were probably good a couple of years back as they are now, you would have earned nothing.
Compare this with ACC, which was less than 500 a couple of years back and right now it is over 1000. A neat 100%+ profit.
What does the above comparison tell us? Though a company may be good fundamentally and whatever you analyze, ratios, balance sheets etc, at the end of the day Market pays what the Market thinks is a Fair Value. This is the reason, you notice some Companies at over 50 P/E, while the others less than 10 P/E. Both companies being extremely good Fundamentally.
Conclusion is that Fundamental stock picking is good and tends to give good returns, however, it may not always produce the same results.