Looking for investment advice in NJ? Here at Mullooly Asset Management, I’ve been receiving several inquiries about the differences between fundamental and technical analysis. In this article, we discuss the advantages and disadvantages of each.
Fundamental analysis studies products, markets, management, earnings, market share (among other factors) of a company. Fundamentals help investors spot undervalued opportunities. Fundamental analysis helps identify potential for growth.
Does this make fundamental work better, more important (or more relevant) than Technical analysis?
Generally speaking, technical analysis covers the price action of an investment. Technical Analysis pays little or no matter to a company’s market share, earnings, management or any other fundamental factors. The trend is either moving up or moving down.
To a certain degree, technical analysis assumes (or expects) that all of the fundamental information has already been processed into the decisions made to buy or sell.
In 2010, many Wall Street firms, and the media that follow the markets, still rely on fundamental analysis to declare whether a company’s stock is investment-worthy.
This reliance on fundamental work (indicates to me) that Wall Street — and their clients — still believe an advantage can be gained by speaking directly with company management and following the company activity on a daily basis.
But “human intervention” is what makes fundamental analysis imperfect. In plain terms, “stuff” happens to companies. Products do not sell as well as expected, and yet some new products do much better than expected. Sometimes layoffs occur, or key people leave a company. A merger of two companies may be negotiated behind closed doors, to the surprise of many. And people will occasionally be “less than forthright” (in other words, omit material facts, mislead, gloss over details, or simply lie) about business conditions. And periodically, companies discover an error and need to go back in time to “re-state” earnings for a previous quarter (or previous year).
These are a few examples where the fundamental picture of a company can drastically change. And a company that was under-valued at today’s market price could suddenly be over-valued.
Technical analysis looks at the price and trend, and then paints the picture for all to see. While fundamentals try to “project” or forecast what a company may do in the future, technical analysis indicates what the share price has done in the past, and the current trend of the stock.
Regardless of the news, if more people believe the company is on the right path, they will buy the stock.
If there are more buyers than sellers, there is more demand.
More demand brings a higher price.
If more people believe a company is on the wrong path (regardless of the news), they will sell the stock.
If there are more sellers than buyers, there is more supply.
More supply brings a lower price. Too much supply of anything (tomatoes, houses in New Jersey, shares of a stock for sale) brings lower prices.
Remember, technical analysts believe the reason “why” a stock is rising or falling does not really matter. More on that later.
After all, well-run companies, with great management and spectacular earnings have seen their stock prices collapse. And there are examples of poorly run companies — companies with NO earnings (and some with gigantic losses), where the stock price has skyrocketed.
There is no blanket answer whether fundamental or technical analysis is better. Technical Analysis and Fundamental analysis serve different needs. It is far better to choose investments that have good (or great) fundamentals — and — have a strong technical picture as well.
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Tearing Apart the Headlines
by Thomas Mullooly on March 7, 2009
Did you know General Electric (GE) posted record revenues last quarter? That has not really helped their stock, has it? Remember always, price is the ultimate indicator, which is why I rely more and more on charts. Fundamental analysts and company management can pontificate all day long about market share, earnings and revenues. If the market doesn’t like it, the stock is going down.
I don’t think I’ll ever get tired of reminding people that the job of the media is to sell advertising. The fact that you get informed — or get information — is a side benefit.
I’m not saying the media dispenses incorrect information. What I’m saying is they tend to focus on some really dumb things, and then pound it over and over and over. Just keep reminding yourself: their job is not to hang around and “fill you in” on the news of the day. The media is there to sell ads. So their teasers and headlines will often be filled more with drama than facts.
And often, the drama persuades you into doing precisely the WRONG thing. My friend, Tom Dorsey has often said “Remember everything that is written or said in the media about Wall Street is made to make you do the wrong thing.”
Example of “News” headlines:
One of the headlines on CBS MarketWatch is Freedom Bank (Georgia) is the 17th bank failure in 2009. OK, look, in the previous recession, there were over 700 bank failures. Some will be spectacular. If we have less than 700 bank failures during this recession, now THAT will be news.
Here’s another:
General Motors shares trade near Great Depression territory. Face it, the stock trades for about a dollar, it’s not coming back. Sure, it might get to two dollars. But will this ever be a $30 stock again? I don’t think so, under its present structure. Now if they were to file bankruptcy, wipe out the common stock and reorganize (where the debt/bondholders become the new stockholders), anything is possible… see Kmart.
I am far more interested in learning what will happen to General Motors and the bondholders in a bankruptcy proceeding. The government has poured $13 billion into General Motors in the last few months, and company management is back at the trough asking for another $17 billion. Amazingly, the market capitalization of General Motors is less than $1 billion ($900 million currently — one third the size of Burger King). Where did all that money go?
And another:
This past week, the financial media focused on how the banks were killing the Dow Jones Industrial Average. This is total nonsense. Citibank trades for $1 per share, Bank of America trades for $3 per share. If these two companies filed for bankruptcy tomorrow (or were nationalized — essentially, the same thing), this would move the Dow Jones Industrial Average a total of 50 points. I wonder how long it will take Dow Jones to remove Citibank, Bank of America, General Motors and General Electric from the Dow Jones Industrial Average.
Another favorite topic:
Unemployment rate reaches 8.1%. Okay, lots of room for debate on this topic. Historically, the average unemployment rate hovers around 5%. Did you know, for the past 15 years, the economy has averaged an unemployment rate between 3% and 4%? This is actually a pretty spectacular news item, but no one was writing headlines about that. During economic recessions, the unemployment rate often reaches 10%. So be prepared for that, and don’t be surprised when that news arrives. In fact, there have been several times where the unemployment rate surges in the latter stages of a recession — and the first phase of recovery. You read that right — many times the unemployment rate will rise, as the economy is improving.
And lastly:
GDP numbers. The stock market fell out of bed last week when it was announced that fourth-quarter GDP came in at -6.2%. First of all, this should not be a shock to anyone. Secondly, the media never really puts it in its proper perspective. So let’s look at this number. It measures growth (or shrinkage) of the economy in the fourth quarter 2008. The quarter ended December 31, 2008.
The original estimate was released January 31, the preliminary number was released February 27, the final revised GDP for fourth-quarter 2008 will be released at the end of March. The final revision may be a completely different number — for better or worse. But by the time we get it, that information is petrified like a redwood. Irrelevant.
By the way, at the end of April we will receive the original estimate for first-quarter 2009 GDP. What do you think THAT number will be? I expect it will be absolutely dreadful. And the media will go crazy. Be prepared.
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