Four ways to study a share: read the charts, study the business, crunch the data, or watch the people. Plus how commodities are studied.
Investing means putting money in upfront to earn returns over a period. It needs careful study of the security's safety, income and growth potential.
Picks specific securities. Buys those priced below intrinsic value, sells those above. Constant review, more trades, more effort.
Goal: beat the return of the broad asset class.
Buys a broad set that represents the asset class, usually all the stocks in an index. No picking of individual securities.
Goal: earn the return of the asset class.
A fundamental analyst's job has two parts. Research is getting all the information needed to answer a question. Analysis is working through that information to reach a conclusion.
The annual report is a treasure trove, but it is not enough. It comes out once a year, so it goes out of date, and it says little about the industry and economy. So analysts also:
Material, non-public, price-sensitive information. Known only to a few people close to the company (or their relatives). Once published, it would immediately affect decisions to buy or sell.
Book example: the CEO talks about an unpublished acquisition proposal.
Joining many small pieces, each not significant alone, with other public or non-public information, to reach a useful insight.
Book example: an employee mentions a heavier workload in the purchase department, which may hint at more business.
| Technical | Fundamental | Quantitative | Behavioural | |
|---|---|---|---|---|
| Studies | Past price and volume | The economy, industry and company | Data and statistics | Investors' biases |
| Core belief | All information is already in the price. Patterns repeat. | In the long run, price follows the profits and cash flows of the business | Some metrics may be leading indicators of performance | Fear and greed push prices away from fair value |
| Horizon | Short term | Long term | Either | Either |
| Weakness | Less suited to long-term investing | Hard to estimate fair value | Past data loses meaning when accounting or business models change | Biases are hard to measure |
Technical analysts (also called chartists or technicians) assume that everything, from company results to the economy to market mood, is already reflected in the price. They forecast price direction from patterns in past price and volume.
Three essential elements:
A share is part ownership of a business. So in the long run its value should follow the profits and cash flows the business earns. If short-term moves push the price far from fair value, there is a chance to profit.
From expected business performance
Attractive: buy
Sell, or avoid
So profit comes from finding a good business and buying it at the right price.
Questions fundamental analysts ask: Is the economic trend helping the industry? How intense is competition? How is the company placed against rivals? What is its cost structure? Is its finance strong enough to grow or survive a crisis? Is management capable? Is governance protecting shareholders?
These fall into three baskets, each with its own chapter later:
Chapter 5
Chapter 6
Chapters 7 and 8
Going economy first, then industry, then company is the top-down path (E-I-C) seen in Chapter 1.
Some analysts approach shares purely through numbers. This works for both technical and fundamental analysis:
Decisions should follow the evidence, but they are often bent by the decision maker's biases, leading to poor choices. This approach assumes that prices move away from fair value, up or down, because of the fear and greed of market participants.
The book says the biases are covered "in Chapter 11". In this edition they appear in Chapter 12 (Fundamentals of Risk and Return).
Commodity fundamental analysis studies the economic, political and natural factors that move supply and demand, and so the price. It covers seasonality, macro conditions, news, currency moves, interest rates, weather, inventory levels and government action.
Uses: jewellery, industry, investment, central bank reserves. Gold is one of the most traded commodities in the world. It is an inflation hedge and a safe haven: when shares, bonds and currencies do badly, investors turn to gold. The book says gold has an inverse relationship with stocks, bonds and currencies.
China, Australia, Russia, USA, Canada
China, India, USA, Germany, Saudi Arabia
Called the "mother of the global financial market" and "black gold". Uses: fuel, plastics (polymers), lubricating oil, naphtha, bitumen. Distilled at different temperatures, it gives bitumen, lubricating oils, fuel oil, diesel, paraffin, naphtha and gasoline. Any supply and demand imbalance raises inflation worries around the world.
Crude quality depends on density and sulphur content.
High quality crude, produced and traded in the US. API 39°, sulphur 0.24%. Trades on NYMEX.
Benchmark for crude from Europe and Africa, from the North Sea (UK). API 38°, sulphur 0.4%. Trades on ICE.
USA, Russia, Saudi Arabia, Canada, China
USA, China, India, Germany, Japan
Supply is controlled by the US and OPEC+ (13 OPEC members plus Russia). The Middle East holds 48% of known oil reserves. The book also says OPEC owns almost 40% of the world's crude oil, accounts for 75% of proven reserves and exports 55% of the oil sold worldwide.
| Factor | Gold goes up when... | Crude goes up when... |
|---|---|---|
| US dollar | Dollar weaker | Dollar weaker |
| Economic data | Data weaker | Economy expanding |
| Stock market | Bear (falling) market | Bull (rising) market |
| Politics | Unstable | Unstable, especially in the Middle East |
| Supply | Lower supply | OPEC limits output; US output falls; US rig count falls |
| Inventory | US inventory falling | |
| Demand | Stronger demand; ETF and central bank buying | |
| Monetary policy | Expansionary (rate cuts) | |
| Inflation | Higher inflation | |
| Bond market | Lower bond yields | |
| Weather | Hurricanes in the Gulf of Mexico |
Blank cells: the book lists that factor for only one of the two. Red text: the two commodities move opposite ways.
OPEC quadrupled the price to almost $12 a barrel and stopped oil exports to the US, Japan and western Europe, which used over half the world's oil.
The May contract expired the next day. About 90% of the world was in lockdown. No buyer wanted to take delivery at Cushing, Oklahoma, so holders sold at any price, even below zero.
Many listed companies use commodities as raw material. When commodity prices change, their profit margins change, and so do their share prices.
Input cost changes
Profits improve
Costs rise, profits fall
Commodities are traded globally, so their prices signal changes in world demand and supply. Equity markets, which care about growth, react to those signals. Example: a fall in copper prices may signal slowing industrial demand, dragging down metal and infrastructure stocks.
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Scoring works like the real exam: +1 for a right answer, minus 0.25 for a wrong one, 0 for a skip. Skipping is allowed.