The Curious Investor

Fundamental analysis for the individual investor is the application of those valuation measures mentioned in my previous post. It is a way that the individual investor, with minimal knowledge of true valuation metrics, can make educated decisions on a company’s stock’s current value. What is value? Value was defined in the early 1900s by Benjamin Graham (Columbia Pride wooo) when he developed Value Investing. Essentially, it involves comparing a company’s stock price to its net current asset value - that is how much money a company could give back to all its shareholders if it were to be closed down tomorrow and had all its parts sold off. The idea behind this is that a stock price should be reflective of the underlying value of the company. We know this empirically not to be true since stocks more often than not will trade at a price well above their intrinsic worth. But, this logic also would lead us to deduce that, should we find a stock trading near or below its intrinsic worth, the stock will sooner or later appreciate in price.

One of the most powerful ways to quickly find a stock which is trading at less than net current asset value is to use the Price-to-Book ratio. It has been found in various regressive research studies that those stocks which trade in the lowest 40% of price to book value ratios have a marked increase in performance as compared to others. Furthermore, it was found that the most undervalued stocks in the NYSE are typically those with Price-to-book ratios under 1.4. These stocks nearly always outperformed broad market indicators over a 1 year and 3 year period though they were less impressive over 6 month periods. As you can see, this fundamental indicator is very adept at providing guidance for stock picks in the long run. Adding this technique to a simple technical based market timing strategy would likely improve your portfolio returns quite noticeably.
To read more about the nuances of a price to book ratio selection strategy check out this very interesting research report by Tweedy Browne: What Has Worked in Investing. I will essentially be following this paper for the rest of this fundamental analysis “how to” and, if you don’t like my synopses, you can just read the whole paper and begin commenting on how I’ve misinterpreted or with any questions you have about my take on fundamental analysis.

If you’d like to learn more about the nitty gritty of value investing and how to perform analysis of company’s net asset value on your own, do check out the book on my sidebar, “Value Investing: From Graham to Buffet and Beyond,” which may be a little bit difficult for some people not familiar with basic finance and accounting but is a great primer into the world of more rigorous fundamental analysis as opposed to the simplified ratios based fundamental analysis that I will be talking about in this blog.

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