Destroying the Faith

Every technician I icnow naturally claims that his particular system works, his case is different. It is his judgment, he will say, that is the final determinant of which of the dozens of available tools to use, and what emphasis to put on each. To examine this claim would take an infinite number of tests. Still, the technicians have offered nothing to date, either in theory or in practice, which disputes the academic evidence. In the end a supposedly systematic and dependable method of beating the market is reduced to faith.

And this is the time to introduce our first investment rule:

RULE 1

Do not use market-timing or technical analysis. These techniques can only cost you money.

Curiously, considering that technical analysis has been continuously refuted for three decades, chartists continue to flourish, boasting of their successes and forgetting their bad calls, as though their doctrines had never been challenged. In fact, their status hasnt changed on Wall Street. But they should not be singled out, as the next chapter will demonstrate.

Bigger Game Ahead

I HERE you sit, browsing through the Alchemical Street Journal, over your moming ale, reading in Latin some of the current articles and trying to understand the reasoning. (I suppose this puts us somewhere in the Middle Ages of Europe.) Ah, this is interesting; thereve been some promising claims about tuming lead into gold. Here are some charts showing how similar the two elements are, in weight, malleability, and other characteristics. Here is an analysts projections of the breakthroughs to come, although he concedes there may be a few minor problems that, as yet, lack solutions. But progress is clear. Perhaps its time to buy some more lead mining stock.

In that case, careful perusal of the astrology pages is in order. No serious investor would want to make a move without checking the stars, or, perhaps better, consulting with a hcensed professional. Things have gotten so technical these days that the top astrologers are commanding enormous fees. Its come to the point where the individual investor will soon be pretty much left in the dust, at least until the personal computer is invented some five centuries from now.

Which brings us to fundamental analysis, the mainstay of investment techniques in the last years of the twentieth century. In chapter 2, we saw how the academic juggemaut rolled over the ideas, if not the hearts and minds, of the technicians. More formidable opposition lay ahead. Technical analysis, for all its wide following, is dwarfed by fundamental analysis. This method is considered more sophisticated, and is preferred by pension funds, bank trust departments, mutual funds, money managers, and brokers. It is also used by much of 1 America to make decisions from purchasing other companies or divisions, to investing in plant and equipment, to opening new markets.

Value Investing

Lets look briefly at the principles and faihngs of the two major schools of fundamental (or security) analysis: value investing and growth investing.

The most systematic work on value investing is the 658-page epic, Security Analysis, by Benjamin Graham and David Dodd, first published in 1934 and revised four times subsequently. The book has been called the bible of value analysis, and for decades Graham has been regarded by Wall Streeters and academics as the father of modem value analysis.

Grahams investment technique stresses the preservation of capital. He defines risk as the possibility of losing your savings. Because of the difficulty of pinpointing real worth, Graham always insisted on an "adequate" margin of safety. Stocks should be purchased by applying stringent valuation formulas, which normally eliminates new issues, concept, and growth stocks. Security Analysis lays out rigorous procedures for determining intrinsic value. Grahams rules, based on the lessons of the Great Depression, were so strict that following the ones he devised in the thirties and forties, which he subsequently revised, would have kept investors out of much of the bull market that started in 1947, and almost completely out of the Great Bull Market which began in 1982.

In essence, the fundamentahst holds that a companys value can be determined through rigorous analysis of its sales, its earnings and dividends, its financial strength, and a host of related measures. To value a stock, the analyst tries to evaluate all relevant information, often supplementing his or her work with visits to the companies to meet with senior management.

The fundamentalist believes that stock prices can diverge sha ly from their real worth. His methods allow him to search out the true value, buying solid companies that are unde riced and selling those that are ove riced. The market, he is convinced, must eventually recognize the error of its ways and correct them. Fundamental analysis is considered to be more advanced than its technical cohort, because it draws on sophisticated accounting, investment, business, and economics techniques.

As with technical analysis, there are numerous branches of fundamental analysis. And as with rehgion, the bitterest disputes are not between contrasting beliefs, but among the various sects of the same faith.