Tuesday, September 02, 2014

Who is analyzing and valuing individual stocks?

What percentage of individual stocks are bought and sold based on fundamental analysis?  There is no answer here, but it appears that it is only a small number.  There are three reasons for that from this perspective, and this is not a unique thought.  First, as detailed in a chart in a Barron's article this weekend, over the S&P 500's rise during the last three years, it has traded within an increasingly narrow band, suggesting a concentration of opinions.  Second, high frequency traders represent as much as half of all volume on a given day, and those traders have no interest in company specifics.  Third, investors large and small have increasingly moved to index funds or ETF's, which require sector decisions but no individual company decisions.

Quoting Martin Whitman, the octogenarian Chairman of Third Avenue Funds, "Understandably 100% of high frequency traders, as well as the vast majority of other market participants(with the exception of those engaged in risk arbitrage), have little or no interest in becoming knowledgeable about individual companies and individual securities... Most market participants just are not in a position to make determinations about intermediate to long term fundamental values."

Is this important?  One could guess that it should be.  A fundamental attribute of index fund investing is a belief that securities markets reflect price equilibrium.  At any time, the prices for securities are right, meaning efficient, and will change as the market digests new information related to a company specifically and to broader market issues as well.  If there are fewer and fewer market participants doing company analysis, how does this "efficiency" evolve?  Does it mean that a smaller and smaller pool of securities analysts at investment firms and brokerage firms wield greater influence than in the past, or does it mean that there will greater opportunities for those who actually do fundamental analysis?  Is the investor who does fundamental analysis the marginal investor that prices the stock.

Over and over again it has been demonstrated that actively managed mutual funds, after fees, on average do not perform better than index funds, and often do somewhat worse.  There will always be those fund managers who seem to differentiate themselves from the crowd in a positive way, but finding them is always based on hindsight.

One could latch onto a star like Will Danoff of Fidelity's huge Contrafund, and feel comfortable in the hands of someone who can beat the market regularly and with an expense ratio of 67 basis points.  Even Danoff could have a bad year, although he hasn't for the last 20 or more, but look at Bill Miller of Legg Mason who had a 15 year benchmark beating winning streak before being clobbered by the great recession.  Nothing lasts forever, but the indexes do whether one likes the "market" result or not.

Here doing some analysis and research is either valuable or just an enjoyed hobby.  Positive results can be a result of luck or insight, and mistakes can be made.  Eliminating mistakes quickly is a discipline, but doubling down, or more, is a risk.  Both are done here depending on the situation.  Like I said it's an enjoyable activity here, certainly not harmful and at times beneficial, but God help the person or family members who might need to unwind all of this someday.  Really it could be easy.  Just push the sell button multiple times and buy index funds with the proceeds.  My goal is to begin to simplify over time and to make a little money in the interim.



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