Fresh Perspective on Fundamental Analysis
Five Highlights From Chapter 4 of Psychological Analysis
This was one of those weeks where I just don't know if messing around with growth stocks is really for me. I was stopped out of ACLS and GFS to start the week, then I bought the BROS breakout, only to be stopped out of that within a few days.
Between my disappointment with those trades and the regular stress from my day job, I'm feeling pretty fried this weekend. Fortunately, I know that the best way for me to recharge is to close off all of that negative energy to focus on reading and writing, so let's get into this week's chapter of Psychological Analysis by Adam Sarhan.
Chapter 4: How to Use Fundamental Analysis Like a Pro
I was initially concerned that the chapter on fundamental analysis would be a boring rehash of the same ideas that have been covered to death in dozens of other books. I figured it was just something that had to be in the book, but probably wasn't going to be fun for me to feature in the newsletter.
However, much like we have seen with the rest of this material, Adam found a fresh and exciting way to cover the material that worked as a review of the basics while also bringing in some wisdom from some of the greatest traders of all time.
I can't stress enough how excellent this book has been, and I'm not just saying that because the author promotes this newsletter every week. :-)
Value is What You Get
Warren Buffett once said, "Price is what you pay; value is what you get." Pause for a minute and really try to understand the deep meaning behind what he said. It reflects the reality that the market price for an asset doesn't always match the underlying fundamental value.
I was pretty quick to pick up on the distinction between the price of an asset and its value. I found it interesting this week because I'm currently reviewing my monthly spending to identify what expenses are providing more value than the dollar amount next to them on the spreadsheet. Like with stocks, it's not as obvious as you might think.
I spent the second half of 2021 building every LEGO set that I could get my hands on, but after reviewing the astronomical expense figures that obsession created, I realized that I could be just as happy for a way lower expense going back to reading books at night.
On the other hand, even with hotel rooms costing an arm and a leg right now, the value I am getting from overpaying to get away for a couple of nights with my wife every month brings me far more value than the cost.
The Stock Market Can Remain Irrational
There's a famous quote by an extremely influential economist John Maynard Keynes. Keynes famously said, "The stock market can remain irrational longer than you can remain solvent." What he means is that the market is more emotional than it is logical. That said, it is very important to react promptly when the underlying conditions change and always respect risk.
I write these parts before I write the introduction, but I already know that this week's opening will cover the fact that I'm frustrated after getting stopped out of GFS, ACLS, and BROS in the past week.
I felt a strong urge to argue with the market on these trades. I did the right thing, but the market didn't agree. I still think I was right, but I'm also wise enough to know that I can't afford to prove that point, so I'll be better off if I admit that I missed something and move on.
Wildly Successful in the Future
Famously, Amazon posted huge losses for years while its stock price climbed higher and higher. During that time, Amazon's founder, Jeff Bezos, was reinvesting the vast majority of the company's revenue into innovations that would eventually transform the upstart online bookseller into a global e‐commerce juggernaut while concurrently reinventing the entire supply chain. Many investors believed in Bezos's vision, they saw the potential, and despite the fact that Amazon in the early days wasn't a profitable enterprise, they bet it would be wildly successful in the future. They bet right.
IBD and MarketSmith have my eyes pretty well trained to look for the EPS Rating and the recent earnings and sales growth. I'm always attempting to start my watchlists with companies that boast bulletproof fundamentals, but this was a nice reminder that sometimes the earnings aren't there because the company has something bigger in mind for the future. I shouldn't be ignorant of that.
The Market Looks Forward
The market looks forward but most investors look backward. This illustrates a key problem: financial reports do a great job of revealing where a company has been but not what's going to happen in the future—although they sometimes try.
This builds on the prior quote, and it's also something that I can hear Jim Roppel repeatedly saying in my head when I'm trying to figure out why he likes a company that doesn't pass my screens for strong earnings. Usually, when that happens, he says that the market must know something we don't. Or it's looking forward to something bigger on the horizon.
Their Perception of Reality
George Soros says that price is based on the perception of value. His reflexivity theory suggests that actions that people take based on their perception of reality have a tangible impact on the market. This principle is extremely powerful. Your perception and emotion control your decisions. Market prices are determined by the perception of value and that depends on where market participants perceive value to be at any given time.
This quote from George Soros brings me back to the first quote we discussed this week. I have become pretty comfortable with the understanding that people will act irrationally in the market. Still, I often catch myself trying to figure out why they do the same thing in other aspects of their lives. Attempting to explain this is a fool's errand. I should just accept it and look for ways to capitalize on it.
With that in mind, it's time to get into the weekend review and see what the charts say about the market. Let's get to work.
Have a fantastic and profitable week!