Fundamental analysis reports are an important tool for determining the feasibility of a seasonal trade. Most fundamental analyst reports include “nuggets†of information that are useful for timely investing. The job of the seasonal investor is to identify the “nuggetsâ€. Unfortunately, finding “nuggets†in most research reports is like finding a “needle in the hay stackâ€. The investor must read through a lot of “chaff†before the truly valuable information is found.
Useful information from fundamental analyst research reports is obtained by examining comments about future events. Equities and Exchange Traded Funds respond to anticipation of a series of future news events including launch of new products and services, exploration and development activity, earnings momentum, revenue momentum and potential dividend increases. The seasonal investor particularly focuses on future events mentioned by fundamental analysts that are known to recur on an annual basis.
Information from fundamental research reports based on past data is useless and should be disregarded. Valuing companies based on historic earnings growth, historic revenue growth, book value, historic dividend yield and historic dividend payout ratios is virtually useless. Unfortunately, most fundamental research reports frequently are “loaded†with useless historic information.
Two absolutes should be noted when examining fundamental analyst reports:
- NEVER buy an equity security or ETF only because it is undervalued based on fundamentals analysis. Undervalued securities can remain undervalued for extensive periods of time. Even Warren Buffet, the most famous value investor in the world considers factors other than valuation when making an investment decision including quality of management and earnings growth potential.
- NEVER sell an equity security only because it is overvalued based on fundamental analysis. Less experienced fundamental analysts lacking market “savvy†are notorious for downgrading an equity or ETF based on an historic parameter such as price-to-book value ratio, price-to-earnings ratio or price-to-cash flow ratio. All too often, the downgrade occurs just after the equity has resumed an upward trend. All too often, the fundamental reason for the new upside move is revealed shortly after the fundamental analyst has downgraded the stock.
Comments from fundamental research reports about the future also have their limitations. Fundamental analysts frequently are required by institutional investors to provide corporate models projecting results for the next three to five years. However, the market rarely gives significant value to an equity investment based on prospects beyond the next six quarters. Fundamental analysts have enough difficulty estimating earnings and revenues for the next quarter let alone the next three to five years. Most projections beyond the next six quarters assume continuation of current market conditions. Market events, that could cause a significant divergence to projections, frequently are not included in their models.
Fundamental analysts generally are bright people who go through an extensive (and sometimes onerous) process to become an analyst. One of the virtual requirements to become a fundamental analyst is to earn a Chartered Financial Analyst (CFA) designation. The designation is earned by completing three “grueling†exams usually over a three to five year period. Studies for the CFA designation focus on value analysis and portfolio management. Technical analysis is mentioned briefly. Seasonality analysis is rarely mentioned.
Some fundamental analysts are better than others. Top fundamental analysts are “worth their weight in gold†and receive the appropriate yearend bonus. Top analysts frequently are people who have at least ten years of experience in the investment industry. Most have built a reputation for knowing their companies and knowing how share prices in their sectors respond. Fewer have a reputation for knowing how share prices in their sectors respond relative to overall equity market conditions.
Comments by “ranked†analyst usually are valuable. Most analysts are ranked by outside “independent†surveys. Most investment firms pay special bonuses to fundamental analysts who make the “ranked†list in surveys. The top two ranked analysts in a sector are the most valued. Their opinions are sought by institutional investors before making investment decisions. Several analyst ranking surveys are conducted in the U.S.. The most respected is the Institutional Investors analyst survey released each October. Comparable surveys are conducted in Canada. Results of surveys frequently are published in business newspapers including the Wall Street Journal in the U.S. and the Globe & Mail and National Post in Canada.
A few fundamental analysts (frequently with a high rank in their sector) are students of seasonal analysis and use seasonality as one of the factors that influence their recommendations. The classic example is a ranked analyst in the U.S. who followed the fertilizer sector in the 1990s. He learned from experience that recommending purchase of fertilizer stocks near the end of June and recommending profit taking near year end was a wise strategy in most years. Seasonality was mentioned in his report only as a passing comment (Seasonality analysis back then was considered equivalent to astrology: not a serious form of analysis). Over the years, he became known as “Mr. Fertilizerâ€. Not the most flattering name, but at least the moniker showed that investors respected his calls! Unfortunately, contact with this analyst has been lost. Fortunately, many investors have continued to follow his strategy during the past few years and have realized significant profits.
Several “seasoned†fundamental analysts on Bay Street and Wall Street, who follow the forest product, gold and base metal sectors, have correctly called seasonal trends in their sectors in recent years. Their comments on seasonality are infrequent, but usually are valid. Their comments are highly valued by seasonal investors.
Consensus earnings estimates offered by fundamental analysts are useful. Free consensus earnings estimates for individual companies are available from several reliable sources. www.globeinvestor.com provides U.S. and Canadian corporate estimates. www.zacks.com provides U.S. corporate estimates and estimates for Canadian corporations listed on U.S. equity markets. Other consensus estimate services are available for a fee. Examining consensus estimate data is useful when comparing data over time. Are earnings estimates rising or falling? Seasonal trades are more likely to be profitable during a time when analysts are raising estimates.
The best sources for information on future events are free and come from readily available sources: corporate conference calls following release of quarterly reports, quarterly reports, annual reports, SEC reports and statements at annual meetings. Most corporate statements are readily available either from the company, corporate web sites or publicly available websites (e.g. EDGAR in the U.S., SEDAR in Canada, GlobeInvestor in Canada).
Unfortunately the effectiveness of fundamental analysis has diminished in recent years. Laws have changed in recent years to the detriment of investors. Prior to Full Disclosure (Regulation FD) legislation in the U.S., a fundamental analyst could call a corporate executive randomly for an update during the quarter. If by chance, the corporate executive had just received fresh new useful information in the “non-material event†category, information was forwarded. The market was informed bit by bit over time and stock prices responded bit by bit accordingly. Following Regulation FD, corporate officers were prohibited from forwarding information on a bit by bit basis between quarters. Net result: fundamental analyst estimates have become less accurate and earnings surprises on the upside or on the downside have become more frequent. Risks associated with surprising earnings reports have increased significantly.
To be fair, some fundamental analysts do go the extra mile. They check supply channels and question competitors to confirm validity of their estimates. However, this type of analysis requires a substantial amount of “leg work†and time. Many fundamental analysts do not have the time or resources to do “extra curricular†analysis on a consistent basis.
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