‘Follow the Trend’ in Fundamental Analysis

Some time ago I received a suggestion from a friend, 'Dear Sir, I know that you are a value investor who tends of using fundamental analysis. But as we know, in the market, there are more technicalists than fundamentalists. So what if you also write about analysis of a stock from a technical perspective? Your website will have more readers.'

Well, that's a great suggestion! But unfortunately I do not understand about technical analysis. For simple stuffs like moving average, bollinger band, I got it, and we've had discussed them here and here. But if more than that, then I might just like a kindergarten boy in the presence of technical experts at brokerage firms. I once had thought to hire an technicalist to write some technical things at this blog, but it is difficult to find a candidate who can write with some easy language while, at the same time, insightful.

However, I know enough about the basic concepts of technical analysis, namely: 'Follow the trend'. As you know, the job of a fundamentalist investor is to buy good stocks (fundamentally) at a low valuation, while a technicalist trader would buy stock that shows the uptrend in its price chart. Then about the timing to sell, value investors will sell their shares when the fundamentals of the stock are no longer as good as before, or if it has risen too a certain price level that cannot longer be said to be low. While traders? Well, they simply will sell their shares if the trend of the movement of the stock has changed direction, from the previously uptrend into an downtrend.

Some professional investors/analysts advise not to combine fundamental and technical analysis because, according to them, the results of both analysis can be quite the opposite. So if you use a fundamental, then so be it, do not take a look at the price chart. Conversely, if you like fast trading using the technical analysis, then you do not need to read the financial statements etc. If you use the fundamental and technical analysis simultaneously, then you will be confused when the fundamentals of a company indicates that the stock is worth a buy, such as the net profit has rose etc, but the technical of the chart shows just the opposite (downtrend). In addition, in any part of the world, there has never been an investor/analyst who are quite proficient in these two areas (fundamental and technical) simultaneously. If Warren Buffett do not know anything about stretching the lines, then George Soros only understand a little about the intrinsic value.

But in my experience so far, the final conclusion of the fundamental analysis of a single stock is usually in tune with the technical analysis, especially if the technicalist used a not-too-short time range, say like a few months (not a few weeks, let alone several days). So if you find a fundamentally good stock, for example with large ROE, small debts, its earnings increased significantly in the last one year, and the valuation is also still low, then try to take a look at the price chart of the stock within 3 to 6 months: the chart would likely shows an uptrend path. For example, Elnusa (ELSA). This oil company suffered losses in 2010 and 2011 consecutively (the stock is fundamentally bad), and consequently its shares continue to fall (downtrend) until stuck at Rp170’s per share. But in 2012, the company succesfully posted positive earnings (the fundamental turn around to be good). And the stock, at the beginning of 2013 (after the company's financial statements for the year 2012 released) began to rise into 250’s (uptrend). In 2013, ELSA continued the good work by posting a net profit that rose almost doubled (better fundamentals), and consequently since the early 2014, ELSA resumed its uptrend until now was at Rp600’s per share.

While for the longer term, take a look: The technical analysis is also always in tune with the fundamentals. In 2009 to 2011, the net profit of Astra International (ASII) continued to rise, and consequently the shares continue to uptrend from Rp2,400 to once 8,000 per share. But in 2012 until today, along with the slowing performance of the company due to a decrease in the price of CPO and coal which makes the company’s profits are no longer rising as high as before (but also did not down), then the shares are moving sideways in the last three years. Although during the three years there are times when ASII had move up or down significantly, say more than 10% (depending on the Jakarta Composite Index/JCI), but overall, it moved sideways aka flat, and it is in line with the fundamental conditions.

Another example is Bumi Resources (BUMI). The giant coal miner recorded a good performance with a profit of several hundred million dollars in the year 2011, and consequently its shares, which had tumbled to Rp450 per share because of the global crisis in early 2009, rose back to Rp3,000’s per share, two years later (BUMI’s chart trend during the two years was clearly uptrend). But in 2012 BUMI suffered a loss, so its stock began to fall (downtrend). Because in 2013 the company again suffered a severe loss that its equity becomes negative, the downtrend is continued until the stock lying at its current position, which is far below Rp450 per share.

In this case, you should note that even though from 2012 until today, the stock of BUMI had gaining several times and shows indication of uptrend on the chart (in the short term), but because its fundamental is yet to show improvement, then in the end the trend remains downtrend. I had an acquaintance who traded BUMI when it was still in 300's, and he indeed had made some profits, but eventually he have nothing but losses.

So once again, and you may see the example of other stocks, the conclusions resulting from technical analysis is usually in line with the fundamentals rather than the opposite, as long as you using at least the medium term of chart, which is over three months of time range (of the chart). Why three months? Because the company only released its financial statements on a quarterly basis, aka every three months, and that’s when the company's fundamentals may appear to change, either become better or worse. If you use technical analysis in a very short term, or even daily (in forex trading there is even a technical analysis method which, as people said, can detect a change in trend every three seconds!), that’s when the conclusion might be different with the fundamental analysis, in which a chart of a stock can shows a downtrend pattern so it would go down in the short term, whereas the fundamental is still fine.

However, my experience once again proved that the traders of 'follow the trend' type, after a few years are more successful than traders of 'racer' type, because these racers are often slip and fall (read: cut loss) when maneuvering around the corner (when a stock, based on the short-term technical analysis, shows that he will reverse the direction of the uptrend into a downtrend, and vice versa). Example? See BUMI earlier. While ‘follow the trend’ traders are usually neglecting trend changes in the short term and only see the long-term trend. For you investors who use fundamental analysis, if you buy a good stock at a low price and sell it some time later when the fundamentals are not good anymore or the valuation has been expensive (usually not the next day or next week, but rather a long time), then you might realize that your act is more or less the same as the traders who follow the trend, in this case the ‘trend of fundamental trend’.

So we may say that value investors are also familiar with the cut loss. If the fundamental of a stock has changed before the price had rose, then it’s okay, you can sell it. Only, however, we prefer to hold our shares when it dropped while there is nothing wrong with the fundamentals, because usually it would rise back later. And based on experience, the such situation is quite common.

The point is, still, FA (fundamental analysis) and TA (technical analysis) is not two things that are contradictory, but rather supporting each other. If there is a difference, then it is because TA sometimes indicate that a stock is moving up aka uptrend (usually marked with a break-out), so the recommendation is to buy, although the company had poor fundamentals. The example is BUMI earlier. Between May and June 2014, BUMI had started to moving up (uptrend) from Rp122 per share to briefly topped at 200, or gained more than 60 percent! The technicalist that can detect changes in the trend may be profited a few tens of percent from the stock, although BUMI is a fundamentally bad stock. The problem was, if you are too late to sell your BUMI, then you would eventually stuck at the stock, and your profits that you earn will run out completely.

Conversely, some stocks with good fundamentals are often dropped without an obvious cause. Lippo Cikarang (LPCK) is a stock that, fundamentally, may be crowned as the best property stock on the Indonesia Stock Exchange. But look at the share price: A year ago, for some reason it dropped itself from Rp10,000 to 4,600 per share (what a drop, it was more than a half!). And in last October 2014, it also fell to 7,100 from the previous 8,500, alhough there was nothing wrong with the financial performanc. If you used the TA purely, then when LPCK down to 7,100, there is no compromise: You had to cut loss! But at the end, because the fundamentals were still okay, then you can see for yourself: What is the current position of LPCK? Although it did have to wait a bit longer (from October to December, it means 3 months).

(Besides LPCK, when this article was written there are also some good fundamental stocks that are down either because of negative sentiment related to the sector or purely due to a decrease in JCI. But look again later after a few months: Usually they will also end up like LPCK, of course as long as there is no fundamental change).

Therefore, in the FA, particularly value investing, we ignore the stocks that go up if the fundamentals did not support. On the other hand, we are always interested in the shares that show a downtrend pattern, of course, as long as the company has good fundamentals and the valuations are already low. You have to note that just because a stock has gone down a lot, say from Rp1,000 per share to only 500, then it does not mean that you can immediately conclude that it had been undervalue. There are several indicators that we use in determining whether a stock is already undervalue or not, but not by seeing if the stock has been up or down. In fact, if there are stocks that have gone up more than 100% but the valuation is still low, then why not? Warren Buffett also bought Coca-Cola in large quantity in the early 1990’s, just after the stock rose several times over the previous years. So in this condition value investing method could also have concluded the same analysis with technical methods, ie, buy when breakout.

Okay, i think it is enough for now.