Why You Cannot Afford to Ignore the Numbers
The point has been made that today's technical trends, including the DJIA, are of little or no value to your long-term investment success. However, while the daily news is of no significance in the bigger picture, you still must watch financial trends on a regular basis. This may not be necessary from day to day, but it does not hurt to keep abreast of emerging trends and tendencies that affect your investments.
When you compare the different forms of analysis available - remembering that all analysis is intended to forecast the future —fundamental analysis becomes the obvious choice for determining likely outcomes. Certainly, businesses depend on fundamentals. Stock market investors may learn much from the value of the business exercise of financial analysis. Accountants and other managers spend much of their time analyzing past results in an attempt to make forecasts. The exercise of forecasting sales, costs, and expenses is recognized as one of the most valuable routines undertaken in the corporate world. For the purpose of identifying future market oppor-tunities, consumer preferences, competitive trends, and the cost of doing business, the corporate culture is rooted deeply in the idea that forecasting the future is a valuable, important, and necessary part of management.
KEY POINT
If forecasting is of such obvious importance in corporations, where profits are all-important, investors may expect to succeed by applying the same principles to their own portfolios.
Making Fundamental Information Available
Fundamental information is not difficult to find. For listed corporations, it is widely published. Market research services are affordable and readily available, and the financial press is up to date and reliable. The Internet, too, contains a vast array of information. Perhaps the biggest problem with these sources is deciding what to use from among all of the market informattion you can find easily.
The next chapter talks about some of the problems with the fundamentals, and how timing is critical to the market decision-making process. You need to depend on information that may be weeks or even months old by the time it is published. The critical information you learn, though, is not what is taking place right this minute, but as part of the trend for that particular company. Keep the following two areas of distinction in mind when you look for financial information.
1. Long-Term Thinking Is Different from Short-Term Thinking
Today's news is not valuable as long-term information. It is only the latest element in a series of data that, when added together, paint a complete picture of a trend. The immediate news, even when it is purely intrinsic in nature, cannot be viewed in isolation or used to make an investment .decision. How that latest piece of information fits with the total picture is what counts. To see the total picture, you need comparative' analysis among companies in the same industry, among companies whose stock you are thinking of buying (or selling), and between one company's current and past results.
2. The Stock Price Is Not the Same as Financial Results
Great emphasis is put on the current market value of stock, in the belief that it is a reflection of financial results. That is not true. The stock price reflects current perceptions of value, which may have little or nothing to do with the company's financial status. In fact, market value per share (the current price of stock) often is vastly different than the company's real intrinsic capital value, also known as hook value per share. These two values—stock price and book value—have nothing to do with one another. Stock price represents the price agreed on by buyers and sellers at a particular moment. It is the highest price a buyer is willing to pay for stock and the lowest price a seller is willing to accept. When more buyers are available, the price is driven upward; when more sellers are available, the price is driven downward. Market price results purely from the forces of supply and demand.
In comparison, book value per share is the intrinsic value of a share of stock. To compute value, fiirst find the capital value of the company; that is, the total net worth minus any intangible assets. (Intangible assets include items like goodwill, which has no dollar value but which affects a company's stability, strength, and investment value.) Divide the net worth by the number of outstanding shares of common stock. This calculation is summarized in Figure 1.2.
FIGURE 1.2 Book Value Per Share
In the example, book value per share is about $7. In comparing this to the market price of a share of stock, you àre likely to find no relationship between the two values. For many reasons discussed earlier, market price could be substantially higher or lower than book value per share.
Make It Simple
Any program devised to help you make more informed decisions will work only if it is practical and easy to use. While this may seem obvious, remember that it is easy to fall into the trap of overcomplicating the task of developing a program for analysis. Keep these points in mind:
• Keep it simple. Study the numbers, know what you are looking for, and act on the information you develop.
• Comparison is the key. A particular company should be reviewed in terms of how its direct competitors look, and how their fundamentals size up. A particular industry also should be compared to others, so that your range of possible investment alternatives is not limited to one sector alone.
• Learn all you can about fundamental techniques. While simplicity is the key, meaning that you must limit the scope of your self-designed program, you will also need to consider an array of fundamental techniques that you might want to employ.
• Reexamine your portfolio regularly. Investment decisions are never final. The decision you make today might be viewed differently in light of future information. When you discover that the fundamentals have changed, an ongoing "hold" decision might be incorrect. Likewise, your rejection of one company today might be subject to change in a year or two.
• The decision to take no action is also a decision. Investors might overlook the importance of the "hold" decision. Inaction is as important as buying or selling.
• Don't discount technical analysis completely. You probably cannot avoid exposure to the DJIA or the financial news in general, where technical analysis rules and today's rumors have much weight. However, technical indicators create undervalued and overvalued stocks, information that can be valuable to you.
• Never stop researching. You need an efficient, working program that you like and understand, and to establish a schedule and routine to monitor the market according to your own program.
