RUSSIAN President Vladimir Putin said, “Whoever does not miss the Soviet Union has no heart. Whoever wants it back has no brain.” Allow me to add a similar quotation: “Whoever invests and ignores the financials of a company has no heart. Whoever trades the financials of a company has no head.”
In 2013 the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded to Eugene F. Fama, Robert J. Shiller and Lars Peter Hansen. Hansen is not material to this discussion.
Fama and Shiller gained the award for their contribution to the “empirical analysis of asset prices.” It was also stated that Fama and Shiller “were recognized for their independent but complementary research on the variability of asset prices and on the underlying rationality [or irrationality] of financial markets.”
Usually, awards like this are given to someone who either offers a new unique theory to explain something or proves a previous theory. In 2013 the award to Fama and Shiller was like giving the prize to one who said the glass is half full and to another who said the glass is half empty.
Fama is the “creator” and proponent of the “efficient market theory” that says that “stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices.”
Shiller believes in the “inefficient market theory” that says that “an asset’s market price do not always accurately reflect its true value nor do they quickly move to match a security’s ‘true value’ as it changes.”
If you believe Fama’s theory, then all you need to do is look at a company’s financials and the accompanying ratios to determine the “fair market value.” You can determine if a stock price is too high or too low and know that it will quickly snap back to “fair value.”
If you follow Shiller, you must react to the price movement for a given period or you may be caught on the wrong side and lose a bundle. Conversely, you may be on the right side and make a fortune.
The “Oracle of Omaha”—Warren Buffett—brings the final word on the stock market to many local investors. His pearls of wisdom are dutifully posted on their computer monitors as they navigate the Philippine Stock Exchange.
His holding company—Berkshire Hathaway—just took a $26-billion loss for the fourth quarter of 2018. The company’s largest holding—Apple Computer—was down 30 percent. Net income was down 91 percent in the year from 2017.
In his letter to shareholders, Buffet says, “The conglomerate’s stock price will over time ‘provide the best measure of business performance.’” In conjunction with that, he plans to deemphasize book value, measuring assets minus liabilities, saying changes at Berkshire and the vagaries of accounting rules mean that gauge has “lost the relevance it once had.”
For the past 30 years, Buffett has always maintained that investors should not pay so much attention to what its stock price is doing. It is the “fundamentals” that count. Buffett has always led his shareholder letters with a discussion of book value.
Perhaps part of the reason is that “Berkshire will likely buy back ‘significant’ amounts of stock in future years, causing book value to fall.” The share price is down about 10 percent from the November 2018 high.
The significance of Buffett’s slight but continuing shift in thinking is that the old ways of assuming efficient pricing may not apply any more. “The book-value scorecard has become increasingly out of touch with economic reality.” If book-value is not in touch with reality, what will be next to fall in the fundamental analysis playbook?
E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter @mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.