Financial Analysts: Fundamentally Flawed
Apr 8, 2022
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Price to earnings ratio (P/E). Gross Sales. SG&A expenses. Revenues. Earnings before interest, taxes, depreciation and amortization. Subscribers. When it comes to fundamentally valuing a company, pick your metric. In fact, pick whichever metric makes you feel best about investing or not investing. That’s what Wall St. analysts do and between you and us, it doesn’t really matter which one you use because the market is already telling you what you need to know.
There was a time, pre-internet, before 24 hours television news, before market prices were easily accessible, that an intimate understanding of a company’s financials and then an analysis of those financials was the best way to value a business. Analysts spent their days pouring over every finite detail of a balance sheet in order to assign a value they could then share with investors who could then decide if that company was worth investing in. But those days of yore are gone.
Growing up, if we didn’t feel well we went to the doctor. We needed that expert opinion. Today, rapid at-home test kits are available for most common ailments and simply typing in symptoms online can quickly give you an idea what’s wrong. The medical market evolved and is now more efficient than ever. Equity markets have evolved much the same way.
The immediate dissemination of information has replaced the need for analyst reports. Advancements in technology making market access easier and more affordable have made markets more liquid. The combination of the two has resulted in the most efficient marketplace we’ve ever seen.
The truth is, fundamental analysis is based on a metric du jour. Price to earnings ratio was the gold standard. As the internet began taking hold, revenue growth took over the reigns. In the early 2000s, EBITDA was the focus. After that, the focus shifted to subscribers. In other words, what mattered only mattered until it didn’t matter (or didn’t justify valuations).
Fundamental analysis is a moving target decided by a small group of CFOs and/or analysts. Relying on those people and their chosen valuation metric is not nearly as efficient as a liquid marketplace. In fact, one could argue the only reason financial analysts still issue reports based on fundamentals is to avoid litigation. If an opinion they issue goes wrong but is rooted in a fundamental approach, it provides legal protection. In other words, fundamental analysis is nothing more than CYA.
Written by Dylan Ratigan and Josh Fabian
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