Gold Mining, Hang Gliding and Power Walking

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You can roughly divide investment strategies into three overall types: fundamental analysis, technical analysis and efficient market theory.  Each one has subsets, but a majority of fundamental investors study the financial condition and prospects of a company in which they might invest.  Most technical investors pay attention to price levels either of the market in general or of a particular stock and try to determine the probable direction in which either or both of them might be headed.  Proponents of efficient market theory reject the other two and believe a stock's price says it all.

Those investors who make investments based on fundamental analysis, the gold miners, spend the majority of their time looking for public companies with financial characteristics they feel will lead to an investment profit.  They analyze things like the company's price earnings ratio, debt to equity level, asset to liability ratio, revenue and earnings growth rates, return on assets or on equity, profit margins, dividend payout ratios, interest coverage ratios, quality of management, overall prospects of the general industry in which the company does business and the like.  The goal is to find a company whose financial strength and business prospects are such that an investment in its stock will increase over time with the anticipated growth of the company's finances, business and profits.  They are searching for gold nuggets in a mine full of financial data.

Those investors who look to technical analysis, the hang gliders, spend the majority of their time looking at either the state of the market in general and the way its overall price level is acting or a stock in particular and its price movement.  They pay attention to the price action of a stock, not its financial characteristics.  They analyze things like 65 and 200 day average price movements, trading volumes, advances and declines in prices, prices being held at or breaking through resistance levels, price charts and the like.  The goal is to find a company whose stock price is behaving in a way that signals the opportunity to profit from its anticipated momentum.  They want to catch the wind and ride it to a profit.

Those investors who rely on the efficient market theory, which was developed by academics in university economics and business schools, believe that markets constantly and efficiently set the price of each and every stock in the market.  Since the market price reflects everything known about a stock at the time, neither fundamental nor technical analysis provides an investor with any benefit or advantage.  This is popularly referred to as the random walk theory of investing.

Fundamental investors see a stock as an investment in and an ownership of a company's business.  Technical investors see a stock mainly in terms of its price and the probable direction in which that price will move.  Random walk investors see a stock price as revealing everything there is to know about a company and its stock at that moment.

We will examine each of these schools of thought, their proponents and heroes in subsequent blogs.  We will start with a famous fundamental stock analyst, Philip L. Carret, in the next blog.

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