Beginners Education: The Problem with Fundamental Analysis
There is a truth in the stock market that you will not find many brokers or fund managers admitting to. It is this:
Fundamental analysis only works on certain companies.
Meanwhile, there is a sub-world of stocks without solid fundamentals (APT), without earnings even (APT again), that defy fundamental analysis and you all need to get your head around it. You need to understand that the traditional, Buffetesque, numbers-based, sound, “safe” world of fundamental and particularly value-based analysis, has significant limits.
If you automatically adopt fundamental analysis as the template when you start investing you will, ab initio, significantly limit your universe of investable stocks. You also position yourself in a research approach that is a very competitive, predictable, unimaginative, and is based on consensus forecasts (which everyone is using) which renders it a commodity-based process, which means doing the same thing as everybody else and, on that basis, leaves you no edge.
Ultimately the stock market is a competition, for every buyer there’s a seller, and you need to exploit the herd, not join it. Adopt fundamental analysis and you put yourself on the lowest rung of insight when it comes to exploiting the unrecognised and most lucrative of opportunities in the stock market.
Adopting fundamental analysis as your standard approach to assessing a stock will also predictably corral you into larger, more obvious, conventional, lower growth, slower moving stocks, and, more importantly, and it is the most important point, it will exclude you from investing in any stock that doesn’t have earnings. And that’s where the sexy stocks reside.
That means excluding yourself from early (and even late-stage) growth stocks that are spending every dollar they earn and every dollar they can raise, taking advantage of an opportunity, a land grab, a revolution, a database building process, a first-mover advantage, an edge, that will disappear to the competition if they don’t move fast…and exploiting that chance costs money and that means capital raisings and little to no declared, taxable, visible, analysable earnings.
Amazon is the obvious example. Here is a chart of Amazon’s first five years as a listed company:
Between 1994 and 2002 Amazon didn’t make a profit despite in 2003 having turnover of US$5.2bn. And the reason they didn’t make a profit on $5.2bn of turnover…because they were building the business, they were (still are) in a global land grab to become the largest Western online retailer and it takes capital (hence no dividends) and in the early stages it took all the earnings they could produce. What fundamental analyst would have bought Amazon on an assessment of earnings and with no dividend. Meanwhile, the share price travelled from $10 in 2002 when it was still loss-making, to $3165 now.
This is Amazon now with that five-year chart above hightlighted in red:
The next most obvious example in Australia is of course Afterpay (APT). Here are their bare numbers if you can read them. Same thing. Last year they burned through $519m of revenue and a $384m gross profit to report a net loss again as they continued to build the business. They could easily make a profit, they choose not to. They are exploiting a once in an existence opportunity to replace credit cards with BNPL.
Meanwhile the share price does this (see below) and the value investors are the stuck in the mud, 'Intelligent Investor' quoting fundamental analysts, rip their hair out, whilst a few smart brokers and investors, buy into the "concept" and appreciate what is going on here without the need for a PE, profit, or yield to justify the share price.
The obvious conclusion is that fundamental analysis has its limits and will exclude the best market opportunities just because they don’t have a mature earnings record and dividend. We all need to constantly look beyond the very basic value judgements like PE, intrinsic value (which is based on earnings), and yield. If anything, we should constantly scan for all the opposite qualities, the qualities of growth stocks – high PEs, no PEs, no intrinsic value, companies raising capital to fund growth and enthusiastic brokers with ridiculous valuations and for comments from value investors wagging their fingers.
Bottom line, fundamental analysis is mainstream, a commodity and offers little in the way of “edge” to a stock picker. Marcus Today Members...open your minds because there is another world of concept rather than numbers based stocks that dumbfound value analysis but still offer fabulous value.