Lesson Overview

Is Fundamental Analysis Dead?

As we wrap up our discussion on options trading in this section most of you will undoubtedly ask if fundamental analysis is still a top factor in determining which securities we trade? Quick refresher; fundamental analysis is the study of a company's earnings growth, P/E ratios, dividend yield, etc as a predictor of future stock growth. Personally, I consider fundamental analysis to be a "non-factor" when trading options because if we are trading a highly liquid security then nearly all information available in the market is efficiently priced into that securities current stock price already. We can gain no additional edge. Therefore it is a complete waste of our time to do fundamental analysis before making a trade that typically only lasts about 30 to 60 days out. Whether you agree or disagree with me know that I was an analyst on Wall Street and that I have successfully traded for the past 8 years without doing any fundamental analysis.

Show Video Transcript +

In this video, I want to talk about a question that I get often, and that’s, “Is fundamental analysis completely dead?” The death of fundamental analysis as it relates to trading options and trading stocks.

We know that with such efficient and liquid markets here in the US, that question can be posted and I think it’s a valid question to ask. I’m not trying to rain on anyone’s parade that loves fundamental analysis, but it’s a valid question to be asked, and we need to go through it.

Here are my thoughts having worked on both sides of the “Chinese Wall” both as an M&A analyst and investment banking and then also as a REIT research analyst on the other side.

For those of you who don’t know what the Chinese Wall is, it’s this divider in companies that they have. It’s not a physical wall, though sometimes it can be a division between floors or workspaces, it’s this idea that there are two sides of the business.

There's the private side of the business which I was part of in M&A where we’re structuring merger and divestiture deals with companies and then also the public side of the business that doesn’t have access to that private information when companies are going to join or selloff one of their assets and that’s that REIT research side.

That’s where I was asking questions and working on a team that would talk to CEOs and CFOs about future projections, and we would publish research on where we expected a stock to go in the future and why and what were the underlying conditions.

It was a lot of fundamental analysis, and it had nothing to do with technical or options probabilities or statistics. It was all fundamental at that point. I think I’ve got a pretty good idea of how that works having worked both sides of the industry.

The first thing I’ll tell you is that it's not dead if you're a long-term value investor. I think for me, it’s a no-brainer that I don’t use fundamental analysis anymore, but that doesn't mean that you can’t be aware of your surroundings.

Sometimes people talk about it just having an understanding of what's going on in the market. If you’re trading let’s say JCPenney, but they might end up filing for bankruptcy or something, or they have some important board meeting about selling the company, there’s got to be some understanding that you have.

I think if you're a value investor or somebody that’s going to be in a particular stock for a long time, then maybe some of those fundamentals are important, how quickly is the company growing, is their market share growing, if the margin is growing, is the revenue growing, some of the things that you can ask that are definitely important. Obviously, it's not dead in that sense.

Number two though is that the community of advisers that are out there and then financial advisers, both private financial advisers, public financial advisers that are seen on CNBC, I’d throw everyone into that advisor category, anybody who’s got an opinion on the market.

They typically don’t ever have their interests aligned, or they don't have a vested interest in whatever they’re talking about. I think as a community, and as an industry, it’s such a bad thing that when I was working in REITs as an analyst, we could never have ownership in the companies we covered.

I get it on one side of it that you don't want to have ownership in that company because it would taint your investment, but at the same time, I got to have a little skin in the game. You don’t have any vested interest in how well this company does.

It just doesn't put you in a good position to make a smart decision. I think often, people will talk about it and I’ll hear this all the time on the news or in media. “You should go out and buy this company.”

But then they don’t go out and buy it. It’s such a huge disservice to this industry as a whole that advisers don't have the same vested interest and alignment and I think it becomes more of a game of seeing who can collect and open as many new accounts and have “money under management” where it shouldn’t be anything about that.

Number three is that as options traders, we’re trading shorter timelines. Though we’re not day-trading, we’re not day-traders in the sense of we’ll be in and out in the same day.

We will be maybe in and out in a week or two weeks for position traders, but that means that on a shorter timeframe how well can fundamental analysis help us and it doesn’t.

It’s more about volatility, short-term overbought and oversold areas of support and resistance. That has much more of an impact on what we do for our timeline than fundamental analysis does.

Number four is what I call disrupters like Amazon that are moving quicker than ever into new territory. I’ll use this example, but Netflix was one of the first movers if you will, the quickest mover into the space of offering this digital streaming content.

Amazon has got a huge subscriber base, and they quickly came in and took a huge chunk out of Netflix’s customer base by having their own Amazon Prime and video streaming.

In this day in age, markets are so efficient, and companies are so efficient that they can quickly overtake someone else's territory, whereas most people may have thought that Netflix had the end all in digital streaming media online, they’ve quickly found out that Amazon can come in and some other players like Redbox now, they can come in and disrupt and move the momentum of that company.

I think as a fundamental investor, if you’re looking at that, that’s hard to see those moves coming. In most cases, most of that should be priced in anyway. Alright, number five here is that markets are frankly so efficient now and so efficiently priced that when news hits from a company, it's not worth chasing.

The end result here is that markets are so fast and if you're trading liquid underlying stocks as we suggest, things like Apple and Google and Microsoft and Intel, those companies have so many people covering them, and there are so much information out there that it's virtually impossible for you to gain an edge by having some fundamental analysis information. Think about it this way.

If you read as a retail investor, as somebody just like me that we’re not in the market, we don't have insider information on any of these companies, but if we see a new story that hits maybe the front page of Yahoo or maybe hits a Google blog or something like that, and maybe some company that we’re looking at just got an FDA approval.

By the time that it gets all the way through the channels to somebody writing it up and putting it online or talking about it on a media show or even on radio, by the time it gets through all of those channels to the point at which you hear it, read it or see it, somebody else has already taken advantage of that. Information is so quickly priced and so efficient in our markets; it’s not worth chasing.

What we have to do as traders is realize that fundamental analysis can play a role in longer term investing, but as options traders, we completely need to avoid it and just have a little bit of market understanding, we need to have our head on a swivel and just know what's going on, but we don't need to be looking at PE ratios and cash flow analysis.

It doesn't matter, and frankly, I haven't used it in eight years, and I’ve been doing just fine without using it. I think when we talk about this question of “Is fundamental analysis dead?”

I think that it's not completely dead, but I think it's dying as it relates to options traders and stock traders who are going to be a little bit shorter term in the market. As always, if you guys have any questions or comments, please add them right below this video lesson. Until next time, happy trading!

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