Wednesday, September 18, 1996
There Is No Divine Method
or
Where's The Beef?
By MF Runkle

My last Fribble generated more e-mail to me than any other I have written. I compared interpretations of Technical Analysis with using a divining rod. I got one flame, a couple that disagreed with me somewhat, a couple that agreed with me completely, and a couple with "dirt" jokes (as opposed to "dirty").

The writer of the "flaming" post was quite incensed that I referred to Technical Analysis as "just stocastics" (his spelling). I didn't say Technical Analysis was "just" stochastics, I said it was "basically", which isn't meant to downgrade it. Stochastics is a valuable method of finding trends. Anyway, it seems I may have poked at a sacred cow.

Continuing in my electronic mail bag, another writes, "Do you know what level of uncertainty you have with Fundamental analysis? I.E., Look at the fundamental analysis done on AMAT, KLA Instruments. Contrast it with that done for AMER and IOMG. With IOMG, where did the fundamentals suggest selling, rather than give back 70% of profits." Good point, I can't argue with that at all. Hmmm ...

Well, since I poked at one cow, why not get the other? I'll send young George out back to fetch our Fundamental Analysis sacred cow, her name is "Bossy" (Grandpop told me that all cows are named Bossy), and while he's trying to round her up, I'll start. First, let's use a casino analogy. I read about a nerdish guy who could card count. This gave him a slight statistical edge in Black Jack, about 51%. Not a whole lot, but over a lot of hands, he would make 2 dollars on every hundred he bet. On any one hand he could lose everything, but over time, he won a lot of money. Suppose you compare this to Technical Analysis, and write a book on it, and tell everybody it works perfectly, always. That way your book will sell better.

Here comes another guy, and he's going to make money. He read that he could make $2 on every $100 in the casino. So, our man takes $10,000, and plops it on the table. What happens? He loses. Oh no! This method stinks! So, he decides he needs to gamble fundamentally. Here comes young George with Bossy now. What should I poke her with? Ahh, where is my divining rod? Oh, here it is ...

Our aspiring gambler gets out his book, the Tom and David What's Their Names Sure Fire Gambling Guide, and realizes he needs to give the dealer money to gamble with. Why, over the long run, history proves this method works! Besides, it's better than Technical Analysis, "they" (whoever they are) said so. So, our intrepid gambler puts $10,000 on another dealer. What happens? The dealer loses it all! Why? This method is perfect!

Well, he is told, this dealer had a hangover. That was unforeseen. He needs to diversify. So, he gives five dealers $2,000 each. Unfortunately for our gambler, one of these guys is getting married, and they all take him out on a bachelor party. Can you imagine what can be done on a bachelor party in Vegas? I don't even want to get into it. He loses again. Was this method bad? Were both methods bad? No, our gambler didn't understand how to apply either. I better stop poking Bossy with this stick, she's making so much noise the neighbors will call the police.

The same goes for Technical and Fundamental Analysis. Neither method seems to be wrong to me. Everybody wants to see into the future; why else would Ouja Boards, Eight Balls, horoscope books, and so on, sell so well? Stock analysis can't see into the future either. If Fundamental Analysis was so great, why does Coca-Cola have such a phenomenal PEG? Why is Iomega so "undervalued"? Now, understand, I'm not an "expert," but I can't seem to find a true method that works all the time to predict a target price for a stock. It seems there are too many variables to quantify. People find an excuse with every example that seems to contradict "their" method. With Fundamental Analysis, it's "the company is a cyclical," or "there is a value to the brand name," or "market expects an earnings surprise". Oh, I'm sorry Bossy, I said I wouldn't poke you any more.

I like Fundamental Analysis, because it is easy to understand. Also, I don't have the time, or temperament to engage in the short-term trading that appears to me to make Technical Analysis work. On the other hand, I do understand that there are a number of variables that can make the market move somewhat randomly. I've seen all the explanations of what happens, and in my opinion it all boils down to risk. To be Foolish, it is important to understand the risk, and whatever method of investing you choose, you need to understand the proper way to use it. Now, that wasn't so bad, was it, Bossy?

Transmitted: 9/18/96