How Good Is Fundamental Analysis?

How Good Is Fundamental Analysis?

The Views from Wall Street and Academia

How could I have been so mistaken as to have trusted the experts? (John F. Kennedy (after the Bay of Pigs fiasco).

In the beginning he was a statistician. He wore a white, starched shirt and threadbare blue suit. He put on his green eyeshade, sat down at his desk, and recorded meticulously the historical financial information about the companies he followed. The result : writer’s cramp. Automation meant using a slide rule.

But then a metamorphosis began to set in. He rose from his desk, bought blue button-down shirts and gray flannel suits, threw away his eyeshade, and began to make field trips to visit the companies that previously he had known only as a collection of financial statistics. His title now became security analyst.

As time went on, the security analyst’s stature continued to grow, and increasingly women joined the profession’s ranks as full participants. Portfolio managers began to rely on analyst’s reports and recommendations in deciding which stocks should be bought or sold. Eventually analysts reached the pinnacle of professionalism and came to be called bonafide chartered financial analysts.

Toronto recreation parks. St.Clair Reservoir at Sir Winston Churchill Park.St. Clair and Spadina Reservoir. Address: 301 St. Clair Ave W. & Spadina Road. Photo by Elena

Some of Wall Street’s portfolio managers actually invest on the basis of the charts and various well-known technical schemes. But even on Wall Street, technicians are considered a rather strange cult, and little faith is put inn their recommendations. Thus the studies casting doubt on the efficacy of technical analysis would not be considered surprising by most professionals. At heart, the Wall Street pros are fundamentalists. The really important question is whether fundamental analysis is any good.

Two extreme views have taken about the efficacy of fundamental analysis. The view of many on Wall Street is that fundamental analysis is becoming more powerful and skillful all the time. The individual investor has scarcely a chance against the professional portfolio manager and a team of fundamental analysts.

An opposite-extreme view is taken by much of the academic community. Some academicians have gone so far as to suggest that a blindfolded monkey throwing darts at the Wall Street Journal can select stocks with as much success as professional portfolio managers. They have argued that fund managers and their fundamental analysts can do no better at picking stocks than a rank amateur. Many have concluded that the value of professional investment advice is nul.

My own view of the matter is somewhat less extreme than that taken by many of my academic colleagues. Nevertheless, an understanding of the large body of research on these questions is essential for any intelligent investor who observes the major battle in an ongoing war between academics and market professionals that has shaken Wall Street to its bedrock. Current field reports have the academics claiming victory and the professionals screaming “Foul”.

Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc.