Fundamental Strategies
Fundamental analysis starts with study of the corporation’s business model, performance, and prospects. It then proceeds through to a calculation of stock value based on future earnings. If market price is less than value, you buy. If more, you sell. The cornerstone of fundamental analysis is projecting future earnings and discounting future earnings back to net present value. The weakness of fundamental analysis is the projection of future earnings. Most forecasts of future earnings are inaccurate. That is where the opportunity is. If an investor produces an estimate that is accurate and different than the consensus estimate the current stock price is wrong.
Many fundamental investors avoid the tedious job of projecting earnings themselves. Chartered Financial Analysts’ (CFAs) job is to make earnings projections. Individual CFAs projections are available for a fee, or from a broker. Consensus projections are available on internet websites. Getting free information reduces investment expenses and it is more fun than projecting earnings yourself. But, does it provide an advantage over other investors?
Some fundamental analysis strategies are buy and hold. Stocks are purchased based on data gathered prior to projection of earnings. Purchases are based on long term prospects of the company rather on whether the current price is over or under value. Proponents of this strategy promote the idea that investors should be buying companies rather than buying stock.
The internet makes screening stocks based on fundamental data easy. A fundamental driven portfolio management strategy might have these rules:
- Purchase 10 stocks with the lowest PEG*. A low PEG implies stock cheap relative to its projected earnings growth.
- Keep all account equity in stocks
- Re-screen for lowest PEG weekly
- Rebalance weekly , selling stocks that fall out of low PEG 10 , buying stocks that are new to low PEG 10, and bringing all 10 positions to 10% of account equity.
The above is a simple strategy idea, and it might be profitable. Strategies can be more complicated. Screens can be sophisticated. PEG is just one of many fundamental variables available. Most screening websites allow multiple variables in one screen. Other rules can be added. Rules above can be modified to add such features as market timing. Say splitting equity and stocks in proportions derived from bond rates.
If you like motorcycles and you see a picture of a hot new Harley, does buying HDI qualifies as a fundamental strategy?
*PEG is Price/earnings/growth. A popular PEG calculation is current price divided by 12 months projected earnings divided by 5 year percent growth rate.