On Using Fundamentals

In stock trading forums such as Finance Manila, technicians always have the floor. Many a fancy or crude chart is posted right and left, and price targets and predictions are aplenty. Next to rumor-mongering, technical analysis are the most popular posts.

What about fundamental analysis?

Well, it’s not quite as popular. As to why? My guess is simple: it’s too damn hard to do. Next to fundamental analysis, all other forms of analysis are generally for lazy people.

Unlike spreading rumors, consulting horoscopes, or drawing trendlines and plotting moving averages on charts–all of which, while they could possibly take some time and effort, are really peanuts compared to the time and effort it takes to do fundamentals.

Firstly, getting access to fundamental data (i.e. financial statements), especially on Philippine Stocks isn’t as easy as pulling off price data. There’s the accuracy issue to begin with: most financial statements are restated time and again even years after the original reporting period. Then there’s the almost non-existent sources of historical data.

Second, if you had an access to financial data, if you really want to do a good analysis of a certain stock, you would probably not stop at getting the financials of JUST that stock. You would need financials of other stocks for comparison. If there’s one thing that distinguishes fundamental analysis from technicals, it’s that fundamentals are more discerned as a COMPARISON between companies–whereas technicals are more centered on the price action of particular individual issues.

Third, let’s say you already have sources to obtain many financial statements of a number of companies–the trickiest part is to select which two, or three, companies to compare each other with. In order to get a true sense of a company’s value, you will want to compare it with another company in a similar line of business, and then draw insights on how one company stacks up against the rest. This is quite a difficult endeavour since many companies listed on the PSE, if they are not engaged in multiple businesses, also change business purpose quite often–depending on expansion. A company can start out as a financial services firm, then become an IT company, then later a mining company. This makes historical comparison of financials with other companies in similar fields pretty moot doesn’t it?

Fourth, let’s say you’ve overcome all three obstacles above, and you finally have a homogenous group with historical financials to compare with each other, the exact purpose of using fundamentals can get quite muddled at this point. Most fundamental measures and metrics are designed to rank companies in terms of their efficiency and profitability as a business. However, as a stockholder, you are not only concerned about the condition of a company’s business, but how this affects the comapany’s valuation on the market–which is the true source of your capital gains. The result is that once you have conducted a thorough analysis of company operations in comparison with similar companies, you need a second batch of analyses to relate those operational and profit relationships with the movement in those companies’ share prices.

By now you must appreciate why most retail traders stick with technicals, and why fundamentals are almost strictly the province of institutional and brokerage research teams. If you’re nodding and agreeing to this I have only one thing to say to you: YOU LAZY BUM!

Chart patterns and seasonality are NOT the only things we can test our statistical tools. Fundamental analysis provides a fertile ground of testing due to the dozens of ranking and valuation measures available to the financial analyst. But before we get to the test proper, we have to overcome the obstacles I mentioned above, which I will share here for the benefit of the aspiring fundamental analyst:

First and Second: availability of data. Well you can try the PSE Website and check out each stock you want to analyze, but I’ve found the best FREE source of financial statements is Reuters. There was a time back when Reuters suspended coverage of equities outside of the US, but somehow the data is back online. Just click “stocks” and type a ticker name, followed by a .ps (e.g. TEL.ps) to get the information of any Philippine Stock. Then click Financial Statements to view Balance Sheets, Income Statements, and Cash Flow Statements. 5-years historical financials are available on Reuters–practically a treasure hoard.

Third: homogenous group. This can be any group of stocks you can select at your leisure. Popular groupings with decent populations of stocks are Telecoms, Property, Mining, and Energy. However, for the purpose of my tests, I selected probably the most homogenous and inert grouping of stocks on the PSE: Banks. Although on a micro level, some Philippine Banks listed engage in non-bank activities, on a general level all of them do the same thing: get deposits and grant loans. Furthermore, the banking sector never has members that suddenly changed business purpose (never heard of mining companies becoming banks, or vice-versa)–which makes historical financial comparison pretty viable. Also, unlike another homogenous group: Mining, Banks are generally profitable and have a steady stream of existing business, which makes more financial ratios relevant compared to assessing mining companies which have no production yet.

Fourth: Two-step analysis. We won’t dodge the confusion, but will face it head on. The structure of the tests are simple: a) Relationships between banks will be drawn based on standard and non-standard fundamental measures and b) Relationships will then be drawn between the results of those fundamental measures and the resulting gain/loss of those banks’ shares in the period following the construction of the measure. This will allow us to easily determine how a fundamental relationship (say profit margin) affects stock prices.

Sound simple? OF COURSE NOT YOU LAZY BUM!

However, tedious as it was, the exercise was more than worth it. Compared to knowledge of chart patterns and technical oscillators, fewer people know historical effects of posted financial statements to the action of the market subsequently. These and more insights will be posted here in the days to come… stay tuned!