Fundamental Analysis Isn’t Enough – Why?
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The Problem With Fundamental Analysis
Understanding the Limits of Fundamental Analysis in Modern Investing
Marcus Padley | July 30th 2024 | Education Corner
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 (XRO, PDN, NXT), without earnings even, that defy fundamental analysis and you all need to get your head around how it works. 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 very competitive, predictable, unimaginative, and is based on consensus forecasts (which everyone is using) which renders it a commodity-based process. Which means you are 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. 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.
Of course it's all a matter of risk profile. For some of us, larger, more obvious, conventional, lower growth, slower moving stocks, especially those with high payout ratios and decent yields, are exactly where we want to be. In which case stop reading now.
And if you prefer the
ETF approach to making mooney in the stock market (Timing Markets and Secors and Themes), again, individual stocks are of little interest as well. So again, stop reading now.
But for those of you with the 20 stock "
Moron Portfolio" (BHP, RIO, NAB, CBA, ANZ, WBC, WES, WOW, WDS, TLS, TCL, RMD, COH, CSL, FMG, QBE, COL, AMC, GMG) doing fundamental analysis on obvious stocks, read on.
Relying on fundamental analysis 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:
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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). 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 $1 in 2002 when it was still loss-making, to $183 now.
This is Amazon now with that five-year chart above highlighted in red:
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The next most obvious example in Australia was
Afterpay (APT). Same thing. It peaked, collapsed and was taken over, but APT was one of the most fabulous money making opportunmities in Australian stock market history.
A more current one perhapos is
Xero (XRO). In a global land grab to get businesses onto its platform before anyone else does. Once there, it is almost impossible to move. They know that, and they are spending all their revenue in pursuit of customers that will pay off "in the end".
Here are the numbers:
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But here is the performance - up 83% since last November despite a PE in the hundreds.
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The bottom line is that value investing will stick you in the mud, exclude growth stocks from your portfolio, and resign you to mediocrity (which is OK for some). Stocks like Xero leave 'Intelligent Investor' quoting fundamental analysts, ripping 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.
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The obvious conclusion is that fundamental analysis has its limits. It will exclude the best market opportunities just because they don’t have a mature earnings record and a dividend. We all need to constantly look beyond the very basic value judgements like PE, intrinsic value (which is based on earnings), and yield.
It's a choice, of course, but for those of you looking to grow the nest egg, or transform the nest egg, you will not do it using Fundamentals.
Growth investors 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. For stocks that traditionally blinkered, investors and analysts are wagging their fingers at. Uranium stocks for instance, Lithium stocks, Technology stocks.
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.
Footnote. While growth stocks offer the best returns they are also much more volatile and very reliant on a bull market. Investing in growth stocks requires an acceptance that when the market has a significant top, stocks with high PEs, low or no earnings, no dividends, that are supported by sentiment and sometimes "faith", will sell off the hardest. At the same time, they will be the best stocks to buy for more rapid gains when sentiment returns. You need to be ready to trade growth stocks, not to avoid losses, but to cash up so you can take advantage of share price falls (opportunities). That requires much more vigilance compared to their blue-chip earnings counterparts. But fear not. For those of you worried about "when" to buy and sell, we do that for you. Making decisions every day based on facts, the market, and individual stock stories, going in and out as required.
Sidenote - Some Members trade just one or two favourite growth stocks all the time, getting used to their behaviours, their announcement cycle, volatility, and habits. It's sometimes a lot safer to focus than to diversify.
More about the author – Marcus Padley Marcus Padley is a highly-recognised stockbroker and business media personality. He founded the
Marcus Today Stock Market Newsletter in 1998. Over the years, the business has built a community of like-minded investors who want to survive and thrive in the stock market. This is achieved through a combination of daily stock market education, ideas and activities.
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