The Lowdown on Technical Analysis
Wise Words from Warren’s Wife
A Strong Solar Stock
I once read a fairly scathing post on the Web supposedly detailing why technical analysis of stocks is useless and why fundamental analysis is the only reasonable method for those who actually want to make money in the market.
I was less than amused.
For one thing, the whole piece was so dismissive that it amounted to “Numbers Rule and Charts Drool!”
For another thing, the writer’s argument was a crock. He set up a straw man of the sort that a logic teacher would have sent him to the corner for in years past.
By asserting that technical analysis was useless when used only by itself and only for long-term stock investing, the writer set it a challenge that it was never designed to meet.
The piece also cited an academic paper on technical analysis that “proved” that TA produced crappy results in more than 50 countries!
Then, just to heap up the abuse, the writer gave a list of famous investors (including Ben Graham, Warren Buffett and Peter Lynch) who used fundamental analysis to build great fortunes.
All those things are true, but the argument is still misleading.
Guess what, drag racers also don’t do well on NASCAR tracks and marathon champions tend to come up a little short in sprints.
I hate to get into an argument with someone who’s so obviously wrong, but here are a few rebuttals.
First, anyone who uses technical analysis as a complete guide to stock investing-to the exclusion of all other kinds of research-is either a swing trader or an idiot. Such a person would have to ignore the wealth of revenue and earnings data available on the Web, while also giving the cold shoulder to market analysis, sentiment, macroeconomic trends and seasonal factors.
Second, headline investors like Warren and Peter (Ben was an academic who didn’t make a living by investing other people’s money) built their legends by handling enormous amounts of money. And it’s just about impossible for really large investors to respond in a timely way to technical signals. It takes miles and miles to turn a big freighter around once it has a head of steam up. Big funds operate on valuations and economic projections because those factors fit their limited agility and their time lines.
Third, the research result that technical analysis didn’t work in more than 50 countries is a red herring, the kind of scurrilous statistic that would have the logic teacher pointing toward the corner with the stool and the dunce cap again. Yes, it’s true, if you design your analysis to show that the stupid use of technical analysis is a bad idea everywhere, that’s just what it will do.
My own approach to stocks, and the one that I use to make selections for the Cabot China & Emerging Markets Report, is about as eclectic as I can make it. As a growth investor, I am deeply interested in the general health of the market and which way the indexes are going. I know that it’s just as hard to swim against the tide in the market as it is in the ocean.
I also want the strongest fundamentals I can find, looking for companies that are growing revenues and earnings as rapidly as possible. There’s no substitute for positive results, especially when you’re trying to pick stocks that will also be attractive to the institutional whales who control the market.
And finally, I want to understand the company, its appeal of its products and the size of the potential consumer base.
Taken together, I call this the SNaC approach (for Story, Numbers and Chart). As a growth investor with an average holding period of less than six months for a stock, I will take every scrap of information I can get. Using the nimbleness that comes from being an individual investor with easy-to-buy/easy-to-sell positions is one of my favorite advantages.
I don’t have a single bad thing to say about fundamental analysis, but I think anyone who uses it all by itself is making a big mistake. To do any job right, you need all kinds of tools. So don’t throw away your shovel because it won’t help you to climb a tree. And don’t ditch your hammer because you can’t dig a hole with it. Do your research. Watch which way the wind is blowing. Pick your spots. Be ready to jump before the ax falls.
A few years back, there was a lot of buzz about Warren Buffett’s monumental donation to the Gates Foundation. It deserved that buzz, because it was (and remains) the largest charitable contribution of all time. But it was also remarkable because it amounted to the second-richest man in the world (now third) giving the bulk of his wealth to the richest man in the world (now second), who, in turn, left the helm of the company that he built (Microsoft) in order to pay full attention to the best way to give away the bulk of their combined wealth.
A big part of the story was that Warren was limiting the amount of his estate that went to his children and other family members to a relatively small annual payment. It was enough so that they would never starve, but nowhere near enough for them to live large.
One aspect of the story that I especially like is the reaction of Buffett’s children and grandchildren. Warren has said that he doesn’t believe in dynastic fortunes, but the amazing thing is that his progeny don’t seem to believe in it either. In an interview with National Public Radio, Nicole Buffett (one of Warren’s granddaughters who’s an artist in San Francisco) talked about how proud she was of him and how her family was raised to basically ignore Warren’s billions and just get on with making a living for themselves.
Late in the interview Nicole talked about five sayings that her grandmother, Warren’s wife, used to drill into her kids and grandkids. They’re pretty basic, which is what you’d expect from a down-to-earth, value-investing family, and they’re also pretty good.
1) Show up.
2) Tell the truth.
3) Pay attention.
4) Do your best.
5) Don’t be too attached to the outcome.
The first four are exactly the kind of sentiments you’d expect to find embroidered on a satin pillow in your grandmother’s house. But number five is a more profound and unexpected piece of advice, and a great lesson for all investors.
Investing, especially growth investing, always requires a leap of faith. You can do all your homework on a stock, check the fundamentals, analyze the chart, read the coverage from analysts and commentators (and advisories like Cabot’s), and calculate its potential for hours on end. But eventually you have to make the decision to push the BUY button. And then the fun begins.
I know from talking with many Cabot subscribers that some investors follow the progress of their stocks with an interest that borders on obsession. For some people, having a stock that goes down can ruin their entire day, in the same way that others are buoyed or bummed by what their bathroom scales tell them in the morning.
The problem is, that doesn’t lead to better results. In our growth advisories, we fully expect that a few of the stocks we recommend will curl up and die like cut flowers. We don’t like it, but experience has taught us this over and over. And if you can’t tolerate buying stocks and then selling them when they turn up their toes, you may not have the right temperament to be a growth investor. As Warren Buffett’s wife would say, you’re too attached to the outcome.
Obviously I’m not suggesting that you shouldn’t care about making money. But being too attached, taking it personally every time one of your stocks takes a dive, can only hurt you as an investor. It will make you too reluctant to jump into stocks that seem like less than a sure thing. And it can also cause you to hold onto losers longer than you should because you don’t want to finally admit that they’re not going to be the huge winners you’d hoped for.
The lesson is to keep your investments, especially your growth stocks, in perspective. Picking winners doesn’t make anyone a better person. And getting tagged with a few losers is all part of the game. It’s the process that counts-cutting losses short, letting winners run and staying in sync with the market. If you do these things, profits will follow.
People have been trying to follow Warren Buffett’s investing advice for years. But I’d say that listening to what his wife has to teach can also be helpful.
At this point, I’d like to ask you a favor. Every week, I write the Weekend Cabot Wealth Advisory, a free newsletter that goes out to thousands of subscribers. And one of my favorite features is called the Fortune Cookie.
The Fortune Cookie is a short bit of advice or wisdom from an eminent figure in the financial world or a thinker from almost anywhere. Sometimes it’s about investing and sometimes not.
Tim Lutts does a little commentary on the quotation and I do another one. And since I’m the editor, I get to respond to what Tim has to say. It’s a fun thing.
But great new quotations, financial or not, are hard to come by. Yes, there are lots of good ones, but the great ones have been squeezed over and over until there’s not much juice left in them.
I’m looking for a few good quotes, and I’d like to enlist you in finding them.
Do you have a favorite piece of wisdom, a choice piece of advice or a short set of rules that you live by-or maybe just some rule or phrase that helps guide your investing?
If you have one, and you’d like to share it, just reply to this email by July 30.
I’ll review all the submissions, and I’ll publish the winner in Weekend Cabot Wealth Advisory on August 2.
Plus, the winner will get a free one-year subscription to Cabot Stock of the Month, a publication that will give you the taste of five of Cabot advisories.
My stock pick this week wasn’t selected just as a refutation of fundamental analysis, but there’s an element of that in my choice.
The stock is SunEdison (SUNE), a solar power company that changed its name from MEMC Electronic Materials a few years back to reflect its change in focus from being a pure silicon ingot and wafer manufacturer to a focus on delivering turn-key solar power installations.
The critique of fundamental analysis comes in the form of some fairly weak numbers over the last couple of years. SunEdison’s annual revenues declined by 7% in 2012 and 21% in 2013. And earnings-per-share have been negative in four of the last five quarters.
But one look at the stock’s chart will show you that investors have been quite enthusiastic. This is a one-year chart showing SUNE’s progress versus the S&P 500.
What’s been fueling this advance is the success that SunEdison has had in bidding aggressively for large-scale solar projects worldwide. Especially important is the company’s contract to install a 159 kilowatt micro-grid project in India. India has plans to build 20,000 megawatts of solar generating capacity by 2022, and SunEdison’s foot-in-the-door project is a hopeful sign for future business.
In this case, it’s the SunEdison story and chart that are leading the way, with investors betting that the fundamentals (revenue, earnings and valuations) will eventually come into line with projected success in the future.
I’ve always been a fan of solar, myself, but I’ve recognized that it’s useless to expect a wide-scale move toward a power source that’s economically disadvantageous, no matter what the environmental arguments are. Fortunately for everyone, the economics of solar have improved to the point that there is no conflict between profit and environmental advantages. And that’s good news for SunEdison.
Chief Analyst, Cabot China & Emerging Markets Report
And Editor of Cabot Wealth Advisory