Avoiding the Pitfalls
As a follower of fundamental analysis, you already know that the market is not a roulette wheel, even though that kind of approach is popular and common. You know that depending on the financial information about a company is the real key to success. A long history of belief in the fundamentals has established this basic truth. It is supported by many analysts, even those who do not follow the fundamental guidelines. Investors who succeed over the long term are invariably dedicated to fundamental information and have learned to use it.
Even so, you need to maintain a perspective on fundamental analysis. It is to be used for the development of opinions, strategies, and beliefs. It is not a sure-fire method for always beating the market. All investors have losses mixed in with their gains, a fact supporting the principle of diversification. You need to monitor your portfolio continually after making a decision to buy. A hold decision should not be considered as permanent, because situations—both for the company whose stock you own and for yourself—change with time.
How do you keep fundamental analysis in perspective? Try the following ideas.
Constantly question with a fresh point of view. Even if you are convinced that the techniques you select provide you with solid information, and that your current portfolio contains excellent stock selections, remember to perform periodic reviews in a critical manner. Look at today's information with a buyer's eye. Would you buy the same stock today? If not, why not? What has changed, and should that change lead you to a sell decision?
Continue reviewing financial reports. Like everything else, financial status of a publicly held company may change over time. In fact, change is certain. Some industries that are popular and strong today will probably be weak and unprofitable in a few years. You need to look for changes using fundamentals, and to recognize when trends begin to turn.
Maintain your program of trend analysis. Never depend on a single trend, but use combinations of trends to confirm apparent changes in financial strength or profitability. Keep the analysis going, and remember that the actual selection of a portfolio is not the end of the process. It is only a step. A program designed to provide you with reliable information is to be used for buying, but also to evaluate a hold position, and to indicate if and when you should sell a stock.
Review the trend mix you use and be willing to change it.
Some trends that work today will not work in a few years, for a variety of reasons. For example, a company might change its own mix of lines of business through a series of acquisitions. Thus, informative trends in one period might not reveal much in the next; or a trend's direction might be distorted and you won't know how to evaluate the information. When a company makes a big change, that could make it necessary for you to start over with your trend watching.
Pay attention to the gossip, news, and rumors of the market.
Although the day-to-day rumor mill of the market should not be used to make decisions, they should not be ignored. The mood of the market has much to do with pricing of stocks, at least in the short term, and the fundamentals have everything to do with growth potential in the long term. So while your emphasis should be in the selection of good, long-term growth stocks, the immediate direction and mood of the market is interesting as well.
Don't discount technical in forma Hon altogether. Remember that some technical indicators can be used in conjunction with fundamentals. Some, like price-earnings ratio, are really not pure technical indicators, but technimental in nature, because they combine price (technical) with earnings (fundamental). Such information is valuable. Tests of volatility can be useful as well as a means for researching further into the reasons for the volatility; and as a method forjudging the market risk of a stock. A study of a stock's chart provides you with support and resistance information and long-term study of price patterns can enable you to predict a stock's market personality over the long term—useful information even for the dedicated fundamentalist.
Market investors—even those who believe in fundamentals—often act on their own intuitive sense of what is going on in the market. The hunch is widely used for impulsive decisions to buy or sell, or to change strategies. As dangerous as it is to bet on a hunch, you should not ignore a strong one when it occurs. Remember that the market is
218 Mastering Fundamental Analysis
overloaded with information and you have to process such a large amount of raw data that you don't really know how much of it is useful. One of the great difficulties in the market is deciding how to focus, to narrow the range of information you consider valid.
In that environment, your hunch might be an informed recognition of combined facts that mean something important. Our brains have analytical abilities that are not well understood, and a study has shown that what we often attribute to hunches is really considered opinion based on information. Intuition may work as a form of confirmation. Just as you should use one trend to confirm what you think you see in another, your intuition could work as a form of confirmation for what you already know, based on a study of financial information. For example, you might sense after many years that a particular company's ability to grow has peaked out, and future earnings will not expand. This sense could be intuitive if not indicated directly by trends, but it also confirms your observations over many years of studying that company's financial statements. You know some things intuitively, as Laurie Nadel observed in Sixth Sense (Prentice Hall Press, 1990):
Intuitive knowing is qualitatively different from other mental processes. It reflects your sensitivity to internal messages as well as to your external environment and can be described as an openness to flashes of insight that come as wholes.
The challenge is to think clearly when evaluating information and determining whether to consider it as valid. The comfort you can take in the fundamentals is that they are specific and exact. You may interpret the numbers as you wish, but the use of fundamentals, expressed as ratios and studied as entries in continuing trends, demonstrates what is happening in the company. Intuition is yet another sort of information: it is not independent from the knowledge you acquire through the fundamentals; it can be used as a confirming source of opinion; and you may decide to act on that opinion.

KEY POINT
Clear thinking is compatible with intuition, which can be a useful method for confirming what you already suspect.
It is a mistake to ignore hunches entirely, to be a pure scientist and to refuse to acknowledge what is occurring beyond the pure science of fundamentals. This is why you should keep one eye on the rumors and gossip of the market. Keeping in touch with the perspective and sentiment of the market may lead you to decisions you would not have been able to develop from a pure study of fundamental indicators.