jbe,
Fundamental analysis -- can't live with it and can't live without it.
One reason why fundamental analysis is so tricky is that you are trying to predict future fundamentals. To give an example many here can relate to: what will be the level of crude oil prices at some point in the future and what will the impact of crude oil prices be on the level of drilling activity and the profitability of drillers and oil service companies?
As we have all seen, the various ideas people have about that produce very different expectations about the future earnings of oil-related companies. So one fundamental choice is to go historical, measuring rates of revenue and earnings growth, ROE, ROA, debt levels, dividend growth, etc. While that history may persist or recur there is no guarantee that it will. Or you can take an approach based more on the relationship of the present to an estimated or anticipated future -- things like forward PE, estimated rates of growth (both short and long term) relationship of PE to growth rate (PEG), accelerating/decelerating earnings models, etc. But all of these future estimates are based upon assumptions about what will happen that simply may not occur.
This is one of the reasons certain companies and industries are favored based on higher confidence in predictions. If they are easier to predict, there is more confidence and presumably less risk in the expectation of a future result.
If you look back to last autumn, you could say the decline in drilling and oil service stocks reflected an increasing uncertainty and lack of confidence in the future profitability of these companies. As oil prices dropped, and the uncertainty increased, the share prices dropped, too. Trying to make the argument that the companies were/are undervalued depends on assumptions about future events and their effect on future earnings that may or may not be reliable. If future earnings estimates are way off base, shares may not be undervalued but overvalued. That's what makes a market - or a horse race. One guy I know describes the market as an ongoing handicapping of the future: changing perceptions of the odds for or against future events are enacted in stock prices.
Baird |
