Expounding further, fundamental analysis looks at the balance sheet, cash flow statement, and income statement to determine a company’s value (intrinsic value). By using this method, investors can make determinations if the current trading price of the stock is above or below its intrinsic value. If the current price is below the intrinsic value, the stock is considered a good investment. Value investors are not as concerned about the supply and demand (fluctuations) of the stock market. They choose stocks based on their overall potential as a company. Consider this quote from Ben Graham:
But note this important fact: The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.
On the other hand, technical traders believe that the strength of the company is reflected in the stock price. Therefore, they believe that the information that is most important can be found by analyzing charts. Value investors, including Warren Buffett, call this approach speculation. Ben Graham stated the following:
There is a lot of juggling with figures that can be done now as always; but none of these methods in itself gives a dependable results. To a great extent the figures selected are determined by the general attitude of the man who is selecting them, and that general attitude is very often determined in turn by what the stock market has been doing. When the stock market is at 750 you take an optimistic attitude and use some favorable figures; but if it should have a severe decline most people would jump back to the older and more conservative evaluation methods
Now, with respect to stock market forecasting as such, as a separate occupation or amusement, I don’t there is any good evidence that a recognized and publicly used method of stock market forecasting can be relied upon to be profitable. Let me illustrate what I mean by reference to the famous “Dow Theory”…I found that when I studied the record from 1898 to 1933, a period of about 35 years–the results from following this mechanical method were remarkably good…in the 1920’s and early 1930’s, the public’s interest in the Theory increased enormously…The Dow Theory became extremely popular after 1933. I studied the consequences of using exactly the same method in the market after 1933, and I found peculiarly enough that in no case in the next 25 years did one benefit through following the Dow signals mechanically.
I, along with Buffett and Graham, believe in value investing, and a good place to start is by looking at the metrics listed below. But, first, as a disclaimer, these metrics are extremely useful but by no means paint the entire picture. A former student of Graham recalls a story in this video where Graham spent an hour comparing companies “A” and “B.” The class determined that company “A” appeared cheaper than company “B” only to find out that that the two companies were in fact the same company. The important lesson here is to use the metrics below while keeping in mind the overall context of the company, industry, and historical data.
Finally, consider this quote by Graham, which is also in the link above. Graham said,"If you want to make money on Wall Street, you must have the proper physiological attitude. No one expressed it better than the Philosopher Spinoza. ‘You must look at things in the aspect of eternity.’”
*The links below lead to general definitions of suggested metrics to consider. In future posts, we will go into more detail about how to use these metrics.
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