Fundamental vs. technical analysis

Chas Craig, BridgeTower Media Newswires

A friend recently asked why I don’t incorporate much technical analysis (i.e. chart reading) into my investment process. For one, in theory, a weaker form of market efficiency is required for technical analysis to add value than fundamental analysis, assuming both are carried out with a similar level of competence. However, where possible, we try to be more practical than theoretical in this column. The paragraphs that follow summarize the comments I shared with my friend.

I think the concept of “Mr. Market” from Benjamin Graham is the best mental framework with which to approach the market. The idea is that Mr. Market is a highly intelligent person, whose opinion should be respected, but he tragically suffers from bipolar disorder. Mr. Market shows up at your office every day offering to buy or sell securities with you. You, however, have no obligation to transact with him. You can wait until he is in a manic or depressive state.

As a fundamental analyst, I try to make conservative estimates of per-share value. When Mr. Market is in a depressed mood and offers a price way below the level of my value estimate, I buy from him. So, why not incorporate some technical analysis on top of my fundamental analysis? I have spent a lot of time training myself to be a skilled fundamental analyst – I think I have a decent chance of doing that better than most over time. I am not at all confident I can be a better-than-average technician. So, if I did not buy a stock at a price that met my margin of safety criteria because the chart did not “look good,” I would be, as Graham (along with co-author David Dodd) put it in Security Analysis, “turning a basic advantage into a basic disadvantage.”

Further, if you are following a technical-analysis-heavy investment process, you are likely going to be transacting a lot. One of the great ironies of the investment management business is that it attracts a lot of hyper-active people to a field where the do-nothing strategy (e.g., regularly add to an S&P 500 index fund) is a pretty good option. In pretty much every other profession activity is highly correlated with productivity – this is not necessarily true in investing.

Further, the way I do things is tailored to my personality and is simply consistent with the sort of lifestyle I want. I do not want to pore over charts and transact a lot, I want to think about business problems and transact seldomly. The point I am trying to make is not that the method I describe is the best recipe for everyone, but that it is best for me.

People debate whether investing is more art or science. While the approach one takes will impact the weighting to one or the other, to me, investing is clearly more art than science. If this were not true, people taking very different approaches could not have high levels of success, but they do. What is important is that the philosophy/process is rational and applied consistently. For example, in Warren Buffett’s “Ground Rules: Words of Wisdom from the Partnership Letters” you can read about the cigar butt smoking strategy (e.g. buying a windmill company below liquidation value) Buffett employed in the 1950s/1960s time frame with great success. Another book by Philip Fisher entitled “Common Stocks and Uncommon Profits” details his growth stock strategy. According to his own son, Fisher made the most hay in his career during the time Buffett was running his partnership (i.e. the pre-Berkshire days).

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Chas Craig is president of Meliora Capital in Tulsa (www.melcapital.com).