Everything I need to know about fundamental analysis, I learned from the Genovese crime family.
Let me clarify something. The “fundamentals” of a corporation are important for stock-market investors. By definition this is information, such as profitability, revenue, assets, liabilities and growth potential of the core business.
“Fundamental analysis” is the interpretation of that information in hopes of arriving at a stock-market price evaluation. Benjamin Graham published a book in 1934 that created the idea of value investing. You buy when the price is lower than the “fundamental value” and sell when the price is too high. By 1970 many other books had been written validating value investing.
By the 1990s, though, studies started showing that there were “anomalies” in the theory. For example, companies considered to have too high a “book value to market price” performed much better in the stock market. Book value is net asset value of a company—total assets minus intangible assets and liabilities. In other words, the stock price could be consistently higher than the “value” of the corporation.
The same situation started showing up in studies using Price-to-Earnings Ratios, Return on Equity and the discounted cash flow model. Warren Buffett used value investing to successfully buy distressed companies. But for the average stock market investor, there were problems.
Proponents kept looking at stock prices from 1931 through 1975 and concluded that the theory was correct but that the now-frequent anomalies showed that investors were not following the proper rules of investing. It is sort of like calling voters stupid for electing the wrong candidate.
The Genovese crime family was closely tied with corrupt officials who were running large labor unions. In spite of holding nearly uncounted millions in employee pension funds, unions borrowed money through mafia front corporations with generous “commissions” to the union bosses.
The crime families started substantial buying of shares in public corporations as did the union pension funds to the extent that the families could exercise some control of corporate decisions. They could ask a union to go on strike against a company, forcing that company to eventually sell assets to stay in business, which would be bought at a discount by the criminal organization.
One particular transportation company in 1972 was the darling of all the stockbrokerage analysts. However, the guys in the basement who did the technical analysis were recommending a sell as the price showed weakness.
By 1975 the company was bankrupt, having sold most of its assets. Further the stock price had gradually gone down 85 percent and it was the fundamental analysts that were left holding the bag, not the crime family.
Jollibee Foods Corp. started 2019 with its price at about P320 and it basically stayed between there and P300 until April 15th when it broke below that support. On May 5th—in the words of one local stockbroker —the earnings were “Smashed by Smashburger.” Jollibee is now trading around P270.
A move from P310 to P270 is not large, about 12 percent. However, the market moved the price—and generated a “sell” signal—long before the fundamental analysis moved its recommendation to “hold.”
Graham’s value investing is not wrong. However, fundamental analysis is rooted in a time before all currencies were backed by ever increasing government debt. The world did not run on crude oil, which price is determined by traders sitting at a commodity futures desk. Graham who died in 1976 could not imagine interest rates being artificially controlled by central bankers and stock- market investors executing trades at the speed of light.
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.