Investors have very different strategies to grow their portfolios. Some are staunch believers in the efficient market hypothesis, which means they can’t outperform the market. Others believe that the efficient market hypothesis is a false premise, because market movements are determined by human behavior. They feel that human behavior is difficult to predict from news reports or earning statements, but can outperform markets by studying charts. Warren Buffet is one of the few efficient market critics that focus on fundamental investing theories.
Warren Buffet Attributes Success to Fundamental Analysis
Peter Lynch and many other Wall Street gurus have called Warren Buffet “The Greatest Investor in the World.” Buffet is one of the few investors that has consistently beat the market over most of his career. His company, Berkshire Hathaway, has earned an average annual return of 19.7% over the past 50 years.
Buffet said that his methodology is actually very simple. He focuses primarily on choosing companies with a strong Return on Equity. Buffet states that his approach is highly intuitive. There is a strong correlation between corporate profitability and shareholder returns. He feels that investors should study key financial ratios to determine a company’s profitability rather than looking at charts. The ROE variable is the single best indicator.
Efficient market believers argue that stock prices factor for all known information. Since ROE and other financial variables are public information, they feel that investors can’t benefit from them. However, Buffet has consistently beat the S&P 500 and other widely used benchmarks by over 10%. His track record should speak for itself.
Why Buffet Shuns Technical Analysis
Technical analysis is still very popular among the investing community. Buffet himself spent eight years working with it before deciding that it wasn’t worthwhile. He is quoted saying “I realized that technical analysis didn’t work when I turned the chart upside down and didn’t get a different answer.”
The problem with technical analysis is that graph interpretations can be very subjective. Investors can witness multiple patterns in a graph that historically tend to lead to very different outcomes. Many analysts swear by technical analysis, even though their track record is spotty at best.
Get Back to Fundamentals
As an investor, you will probably be much more successful focusing on fundamental investing strategies. There are a number of great tools such as http://www.trendsinvesting.com/stock-screenerthat can help you analyze stocks. Look at key financial variables to predict the direction of the market. Some people may have a knack for reading charts, but they seem to be few and far between.
Return on equity is a key variable, but there are others worth looking at as well. Return on book value, net income ration and sales to profit ratios should all be taken into consideration as well.
