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As a relatively new student to the market, and as someone who would inherently define himself as a value investor, I can't help but feel that current market conditions beg the question: do fundamentals matter anymore in the market?

With the advent of the internet markets have been going sideways for nearly two decades. I have seen companies with already low multiples report higher earnings, appreciable earnings growth and yet somehow end up with lower multiples as the stock stagnates sideways. Gains made through earnings growth appear to be offset by PE shrinkage. That is, rather than a stock increasing in price for reporting strong earnings to at least maintain its PE, the stock price stays flat and the PE drops.

Correct me if I'm wrong, but if low multiples imply an expectation of poor prospects, how can a stock remain at those low (and even shrinking) multiples if fundamentals keep improving? Given supply and demand of markets, theoretically equilibrium price could stay the same, regardless of any fundamentals. One can only sell for a higher price if someone else is willing to pay for it, and it seems like there aren't many people paying for the fundamentals. It's almost the thought process of "if the stock is trending down, why do I care that they made $X more than last year".

So, are there still people buying on fundamentals? Do they matter anymore?

Assume things like margins, shares outstanding remain the same and there are no other notable changes besides growth in earnings and revenue. Assume a healthy balance sheet as well.

All opinions and answers are welcome! Thanks for the discussion.

closed as primarily opinion-based by Victor, Daniel Anderson, JoeTaxpayer Nov 6 '16 at 13:04

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    They have never mattered, at all, in any way. – Fattie Nov 3 '16 at 20:02
  • Care to elaborate? – Clawsmage Nov 3 '16 at 20:36
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All you have to do is ask Warren Buffet that question and you'll have your answer! (grin) He is the very definition of someone who relies on the fundamentals as a major part of his investment decisions.

Investors who rely on analysis of fundamentals tend to be more long-term strategic planners than most other investors, who seem more focused on momentum-based thinking.

There are some industries which have historically low P/E ratios, such as utilities, but I don't think that implies poor growth prospects. How often does a utility go out of business?

I think oftentimes if you really look into the numbers, there are companies reporting higher earnings and earnings growth, but is that top-line growth, or is it the result of cost-cutting and other measures which artificially imply a healthy and growing company? A healthy company is one which shows year-over-year organic growth in revenues and earnings from sales, not one which has to continually make new acquisitions or use accounting tricks to dress up the bottom line.

Is it possible to do well by investing in companies with solid fundamentals? Absolutely. You may not realize the same rate of short-term returns as others who use momentum-based trading strategies, but over the long haul I'm willing to bet you'll see a better overall average return than they do.

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Are you implying that Amazon is a better investment than GE because Amazon's P/E is 175 while GE's is only 27? Or that GE is a better investment than Apple because Apple's P/E is just 13.

There are a lot of other ratios to consider than P/E. I personally view high P/E numbers as a red flag. One way to think of a P/E ratio is the number of years it's expected for the company to earn its market cap. (Share price divided by annual earnings per share) It will take Amazon 175 years to earn $353 billion.

If I was going to buy a dry cleaners, I would not pay the owner 175 years of earnings to take control of it, I'd never see my investment back.

To your point. There is so much future growth seemingly built in to today's stock market that even when a company posts higher than expected earnings, the company's stock may take a hit because maybe future prospects are a little less bright than everyone thought yesterday.

The point of fundamental analysis is that you want to look at a company's management style and financial strategies. How is it paying its debt? How is it accumulating the debt? How is it's return on assets? How is the return on assets trending? This way when you look at a few companies in the same market segment you may have a better shot at picking the winner over time. The company that piles on new debt for every new project is likely to continue that path in to oblivion, regardless of the P/E ratio. (or some other equally less forward thinking management practice that you uncover in your fundamental analysis efforts).

And I'll add... No amount of historical good decision making from a company's management can prepare for a total market downturn, or lack of investor confidence in general. The market is the market; sometimes it's up irrationally, sometimes it's down irrationally.

  • "If I was going to buy a dry cleaners, I would not pay the owner 175 years of earnings to take control of it, I'd never see my investment back." If it includes the building in the middle of NYC or London, you just might. – user662852 Nov 4 '16 at 16:31
  • No, i was not implying that companies with higher P/Es are more worthwhile investments than not. In fact somewhat the opposite. I was implying that, from my limited view, stock movements have not correlated to typical measures of fundamental valuation and offered the PE as one such example. The question is more of a "do you guys still think evaluating fundamentals produces worthwhile returns in today's markets" than "can you guys help me evaluate companies using the PE". – Clawsmage Nov 4 '16 at 19:01
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    @Clawsmage Then my answer would be "yes." I think the folks that looked at GoPro (as an example) with an eye for the fundamentals would have stayed away, and that would have produced a better result than not staying away. I think it's about picking where not to go, the companies that don't get thrown off the pile during your analysis are the ones to invest in for a particular sector or industry. – quid Nov 4 '16 at 19:10
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It sounds to me like you may not be defining fundamental investing very well, which is why it may seem like it doesn't matter. Fundamental investing means valuing a stock based on your estimate of its future profitability (and thus cash flows and dividends). One way to do this is to look at the multiples you have described. But multiples are inherently backward-looking so for firms with good growth prospects, they can be very poor estimates of future profitability.

When you see a firm with ratios way out of whack with other firms, you can conclude that the market thinks that firm has a lot of future growth possibilities. That's all. It could be that the market is overestimating that growth, but you would need more information in order to conclude that. We call Warren Buffet a fundamental investor because he tends to think the market has made a mistake and overvalued many firms with crazy ratios. That may be in many cases, but it doesn't necessarily mean those investors are not using fundamental analysis to come up with their valuations.

Fundamental investing is still very much relevant and is probably the primary determinant of stock prices. It's just that fundamental investing encompasses estimating things like future growth and innovation, which is a lot more than just looking at the ratios you have described.

  • Also note that a high P/E could also result if large, one-off write-offs were booked in the previous year. – Nick R Nov 5 '16 at 16:28

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