May 20, 2005|
What is your investment criterion?
"You don't make money by investing in a good company. You make money by investing in a company that is better than the market thinks," wrote Warren Buffet in one of his letters to the shareholders of Berkshire Hathaway. Deciphering the performance of a company and predicting its future prospects requires 'analysis'. In light of this, we had asked our investors as to which technique of analysis they adopt for making their investment decisions. While a majority (54%) relied on fundamental analysis, 27% seemed to be following technical charts while the remaining 19% based their decisions purely on news and rumours.
Fundamental analysis, needless to say, primarily focuses on the company's and the related sector's fundamentals. This is neither an extrapolation of the past nor a wild guess of the future. It involves reading between the lines of a company's annual report and quarterly results, meeting managements and making calculated projections of a company's future prospects. The pros and cons of the company as well as the sectoral dynamics (for example, cyclical nature of industries) are all factored in while making the said projections. This analysis is based on the premise that any security (and the market as a whole) has an intrinsic value as estimated by an investor. This value is a function of the firm's underlying variables, which combine to produce an expected return and an accompanying risk. By assessing these fundamental determinants of the value of a security, an estimate of its intrinsic value can be determined. This estimated intrinsic value can then be compared to the current market price of the security.
The propagators of technical analysis on the other hand largely believe in the maxim that 'history repeats itself'. Technical charts and their analysis are based on the assumption that the company's price movement will repeat historical trends. These are not even distinctly correlated to a company's actual performance. As against fundamental analysis, this method cannot predict unexpected upsides or downfalls in a company's future growth trajectory. In fact, the 'signal' of upside or otherwise is hinted (in the charts) only when it gets too late to make the investment decision. Benjamin Graham quotes, "The one principle that applies to nearly all these so-called technical approaches is that one should buy because a stock or the market has gone up and one should sell because it has declined. This is the exact opposite of sound business sense everywhere else, and it is most unlikely that it can lead to lasting success in Wall Street. In our own stock-market experience and observation, extending over 50 years, we have not known a single person who has consistently or lastingly made money by thus 'following the market.' We do not hesitate to declare that this approach is as fallacious as it is popular."
News / Rumours
No doubt the cheapest and the most easily available source of information to the common investor, news and rumors, lack a very important element of decision making i.e. credibility. Although, off late most companies have started issuing clarifications on these media reports, they usually come to the knowledge of the investor only after the investment decision has been made. Thus the very premise, on which he has based his decision, turns out to be faulty and he may end up losing his money. Investors, thus, need to be cautious and not completely rely on media reports to make their decisions.
So what should you choose?
What an investor needs to keep in mind is that it is not sufficient to be able to choose good companies but it is pertinent to do so when they are undervalued. A technical analysis or news may give you a faint direction of where the company is heading (which also may not always be correct) but fundamental valuations can always give a crystal clear picture of the company's past, present and future. So the bottomline is that, do not get carried away by northbound charts or well-spiced rumours. Instead figure out what the valuations say!
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