Typically, I inform my readership about the latest developments in the investment markets, particularly cryptocurrencies and the precious metals complex. However, in this latest piece, I want to switch things up. Rather than focusing on a specific news item, I want to share with you a valuable piece of information I learned through years of capital investment strategies.
No methodology is perfect. Whether you’re discussing fundamental analysis or technical analysis, a perfect system would imply perfect success. That, of course, is impossible. The investment markets by default feature variability and a typically high level of unpredictability. Even on a so-called “sure thing,” we hedge our bets knowing that the markets have a logic all of their own.
But I think a warning for fundamental analysis is warranted because it’s so ingrained in our culture. Turn on CNBC or Bloomberg and you’ll notice pundits rattling off metrics like revenues per share or forward-earnings valuation. Technical analysis, on the other hand, is just now gaining mainstream acceptance but is also widely dismissed as tealeaf reading.
Such derision leads people to assume that fundamental analysis has more validity than technical analysis. Nothing could be further from the truth. Both have their uses, and both have their pitfalls, especially if you approach either ignorant of their potential for deceptions.
Just recently, I was assigned to write a story about Amazon for a mainstream publication. The current criticism about AMZN stock is that it’s overvalued relative to forward earnings. In other words, shares are no longer on discount. You have to pay a premium for Amazon’s earnings growth.
That sends many people away from AMZN. But if the first rule of engaging the investment markets is to not lose money, then you should be pushing your way towards Amazon. Here’s the deal: Amazon has a high price-earnings ratio because it can consistently deliver on those earnings. Lesser companies, such as brick-and-mortar department stores, typically feature lower P/E ratios because earnings delivery is a crapshoot.
In comparing “overvalued” Amazon to “undervalued” Sears, I stated that Amazon gives you a higher probability to make lower gains. Sears gives you a lower probability to make higher gains. Sears is undoubtedly the sexier investment — can you imagine the uproar in making a brilliant call if the company somehow regains its footing?
But Amazon is the smarter investment. Let’s be real — it’s very unlikely that Sears will pull off its comeback. The troubled retailer is neck-deep in debt, and few customers want to walk through its doors. The opposite is true for Amazon: e-commerce is rapidly integrating itself into every aspect of our lives. Amazon sees nothing but blue skies ahead.
Traditional fundamental analysis will tell you that Amazon is overvalued. At least it will give you some value, whereas a discount may not give you anything at all!