An article this morning says ‘Here’s What Savvy Investors Look For When Analyzing Company Fundamentals – Do You?’ – reading time 4 minutes.  The article highlights three factors its author says are the three most important company fundamentals the equity markets react to (my words) being (1) the ‘earnings beat rate’, (2) the ‘revenue beat rate’, and (3) the ‘guidance spread’ – and that because the third-quarter earnings season is set to begin, the troubles in Europe are about to become background music.  My observations on this:

• Corporate acquirers and private company owners don’t think remotely like this.  In my experience quarterly earnings play very little part in any valuation/acquisition analysis those groups do.  The exception to this is that where a corporate acquirer is itself public and looks to make a business acquisition, it factors into its analysis whether the equity markets will see the acquisition as accretive or not (i.e. is it likely the equity  markets will immediately add more value to the acquiring company’s market capitalization than it is paying for the acquisition);

• From 10,000 feet, the author’s view that ‘the troubles in Europe are about to become background noise’ – if proven to be true, and I suspect that unfortunately there may be more than a little truth in it – clearly demonstrates for me the ‘immediacy of the equity markets in a ‘pricing context’ as contrasted with an ‘underlying value context’.  Value at a point in time is the present value of all future discretionary after-tax cash flow expectations to infinity.  Price is what at a given point in time arm’s length parties will buy and sell something for.  One person’s perception is not that person’s reality if everyone else thinks the opposite.  In a public equity markets context the reality today is, or so I think, that the equity markets are largely trading markets and hence dangerous ‘short term places’ for value investors who actually do invest based on underlying valuation fundamentals but don’t have the deep pockets or the stomach to hold for the long term;

• I see the author’s ‘earnings beat rate’ observation worrisome on three counts, being (1) the fact that I do believe the equity markets act in knee-jerk reactions to this factor, (2) accounting earnings are based in part on the application of subjective accounting rules, and hence are subject to vagaries of the opinions of those that prepare them (company management), review them (company Boards), and approve them (independent accounting firms).  Hence quarterly earnings may prove with hindsight to be over or under-stated, and (3) in the case of public companies dependent on the public capital markets, company Boards and managements are under tremendous pressure to show quarter/quarter earnings growth.  This is because the price earnings ratios that the equity markets so love as a ‘primary value indicator’ have a subjectively determined continuous growth factor built into them.  This is a pressure on public company boards and managements that inherently promotes optimism is reporting.  What public company President with stock options wants to report level profitability – or heaven forbid – reduced quarter/quarter profits.  No private company owner I have known over a forty year period measures their progress on their company’s quarterly results to any significant degree – unless their company is in financial difficulty and has to worry about failing to meet its banking covenants.  Quarterly earnings are to me are not close to being as meaningful as a ‘corporate (and hence share) value test’ as are discretionary after-tax cash flows.  Hence I believe that while quarterly reported earnings are relevant to traders, they ought to be very much less relevant to investors than the public equity markets make them.  There is, of course, also the question of how well the analysts who generated the ‘earnings estimates’ against which quarterly profits are measured in a ‘beat test’ did their analysis.  Earnings estimates may very well be given more credibility than they deserve in circumstances where equity market participants take them as very meaningful;

• While the equity markets may very well look to the ‘revenue beat rate’, that is for me a very ‘surface’ test of either value or price.  Detailed questions with respect to whether or not there have been non-recurring revenues in the quarter, whether revenue growth is likely to continue, what gross margins were generated on revenues in the quarter and whether those gross margins are going to hold up, decrease, or improve going forward, and so on, all have to be addressed to make a ‘revenue beat rate’ analysis meaningful.  The same subjective accounting issues arise with revenues as arise with reported earnings.  Were quarter-end cut-offs consistent with prior quarter cut-offs is only one of these.  Based on analyst’s reports I have reviewed to date, I question whether this level of detail is always dealt with when analysts make their quarterly estimates.  That said, I also think this isn’t relevant in the context of the equity markets behavior around analyst estimates, save and except to suggest that the entire process probably in fairness can be described as a ‘best efforts process’; and,

• the so-called ‘guidance spread’ is described in the article as the difference between the % of companies raising versus lowering guidance where slightly less than 50% of all companies across all industry sectors (as I read the article) issue guidance.  The author says that anything above a +1% guidance spread “should be considered bullish”.  I have no idea how this is relevant to anything in terms of the price behavior of specific equities, but presume as an ‘equities markets direction test’ the author adheres to the theory of ‘a rising market raises all boats, and an falling market drops all boats’.

In the end, to the extent the type of thinking exhibited in this article pervades the public equity markets, and I believe it probably does, I believe this is a good reason to step back from them, decide whether you want to participate in them, and if you do want to participate in them think very hard about what I see as the importance of taking ever more responsibility for, and involvement in, the management of your own wealth.  I believe this to be ever more important in the current, and I believe prospective, macro-economic and country-specific economic world we live in.

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Just before 10:00 a.m. ET yesterday the DJIA had fallen to 10,404 (down 251 points in the first 25 minutes of trading).  The index then muddled along in negative territory until about 3:20 p.m. ET, when it magically began recovering from about 10,425 by about 400 points to end the day 40 minutes later at 10,808, up 153 points from the previous day’s close – see yesterday’s DJIA chart here.

An article this morning titled ‘FT Causes Massive Short Squeeze With Mother Of All End Of Day Rumors’ – reading time 1 minute – claims that a Financial Times story on increased co-ordination among the European Central Bank, the European Banking Authority, and the European Commission to convince the financial markets the Europe’s banks could withstand the current debt crisis was the catalyst that resulted in the late day recovery.  I assume at least one person, being the person that wrote the article believes this.  While it seems incredulous to me, given the way the financial markets are behaving anything seems possible, and the article’s author may have it right.

For me it follows, both given the extent of algorithmic trading (see ‘Algorithmic Trading’ (September 30) – reading time 3 minutes) and what appears to be general financial market instantaneous ‘knee-jerk reactions’ to near-term rumour and innuendo, that financial market fundamentals in a public market context ever more take precedent over logic and long-term outlooks.

Think of it this way.  Suppose the author of the referenced article is right in his assertion with respect to yesterday’s Dow recovery.  A European debt crisis is a European debt crisis, and ‘All the King’s Horses and All the King’s Men can’t put Humpty together again’ by talking increasing their co-ordination in communicating how Humpty is teetering rapidly.  They should instead of take that time to build a ‘wind barrier’ against the ever increasing wind velocity Humpty currently is experiencing.

This commentary is all in aid of very simple message.  I am increasingly of the view that anyone who does not take the time to learn, think about, and actively participate in the management of their own wealth simply ought not to participate in the financial markets.  Would you jump into water that was overpopulated by large and vicious sharks if you didn’t know how to swim and didn’t have with you serious ‘anti-shark cage’, and had to depend on an arm’s length third party to hold you up and protect you from multiple shark attacks?  Enough said.

Visit Stock Research Portal for free stock market data, analysis, and research on over 1,600 Mining, Oil & Gas Companies listed on the Toronto and Venture Exchanges. See our Legal Disclaimer.

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Algorithmic Trading is a term used to describe the use of computers to execute trading orders where algorithms decide, without in many cases human intervention, order parameters including timing, price and quantity.  Such automated trading is also referred to as “algo trading”, “black-box trading”, or “robo-trading”.   Algorithmic Trading is not restricted to trading in equity shares, but extends to futures, option, foreign exchange markets, and bond markets.

High-Frequency Trading (‘HFT’) is a term used to describe algorithmic trading executed by computers programmed to make complex trading decisions. Decisions based on information received electronically by those computers and processed faster than humanly possible.  Importantly, there is no investment strategy for which algorithms can’t be programmed.

From what I have read, but not independently verified, it is estimated that by 2009 HFT accounted for 73% of all U.S. equity trading volume, whereas in 2006 it is estimated that about 33% of all EU and US stock trades were driven by automatic programs.

Algorithmic Trading (including HFT) have received increasing focus after the so-called ‘flash crash’ that occurred on May 6, 2010 when the Dow suffered its 2^nd largest intraday point swing up to that date.  Moreover, there is considerable debate as to whether HFT is a driver of the volatility that has recently been experienced in the U.S. equity markets.

Two articles I have read on this are ‘HFT Is Not Responsible for Market Volatility – You Are!’ – reading time 4 minutes, and ‘High-frequency trading a receipt for economic disaster’ – reading time 4 minutes.

You might want to read both articles. I have little doubt that Algorithmic Trading and, in particular, HFT which largely entered the scene in 2007 following a change in U.S. Securities Rules, has changed the face of trading versus investing.

Only two weeks ago it was reported that a large number of global institutional investors are concerned about “the broad ramifications of high-frequency trading and its effect on the stock market” – see ‘Big Investors Cite Concern Over High-Frequency Trading’, reading time 4 minutes.

For the time being, until I study Algorithmic Trading generally and HFT in particular more carefully,  I am of the mind that both clearly have been, and continue to be, ‘game-changers’.  My current thoughts are:

• While computers calculate without emotion, their programs are dependent on the inputs, biases and logic of those who program them – or direct the programming of them.  Accordingly, once programmed, a computer will execute the trades it has been programmed to execute, but that programming may reflect – for but one example – an underlying belief that the U.S.$ is a ‘safe haven’.

  All trades driven by that computer’s program would then be biased toward trades that supported an underlying thesis that irrespective of U.S. economic direction or results, the U.S.$ will always be the favoured fiat currency.  Viewed conceptually, if built into trading program algorithms, such biases (and there could be an infinite number of them) could have short-term effects, and perhaps long-term effects, on financial markets.

• On August 22 and 25 I wrote the following commentaries: ‘When The Market Isn’t The Market’ – reading time 4 minutes, and ‘Computerized Trading’ – reading time 4 minutes.  Intuitively, I would rather participate in markets that are skewed more to an ‘investment model’ than to a ‘trading model’.

• Again, intuitively, while I have never believed in ‘buying the market’ (read ‘diversification’), had I believed in diversification up to 2008, the more I understood about Algorithmic Trading (including HFT) the less interest I would have in conventional large capitalization diversification investing – and the less comfortable I would be having others manage my capital for me.

You might also want to watch two videos, one titled ‘HFT Industry circles the wagons’ and a second titled ‘High-frequency traders transform markets’.

Interestingly, this morning I noted a reappearance of a suggested tax on financial transactions.  See ‘EU’s financial transaction tax is feasible, and if set right, desirable’ – reading time 5 minutes.  I, for one, think the U.S. Federal Government (both Democrats and Republicans) is far too prone to policies that favour what I consider to be a ‘super-profit environment’ for Investment Banks, Hedge Funds, and others in the ‘financial services businesses’.  I think that such taxes on financial transactions – where those taxes are paid by those executing the transactions and not included in money management fees – would only make sense.  That said, I think that is a rather naïve thought on my part, as I can’t imagine a circumstance where financial firms would not reflect a transaction tax in the fees they charges, whether they did that transparently or as a ‘hidden cost’.

Visit Stock Research Portal for free stock market data, analysis, and research on over 1,600 Mining, Oil and Gas Companies listed on the Toronto and Venture Exchanges. See our Legal Disclaimer.

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In a recent 30 minute interview conducted September 9 Doug Casey of Casey Research answers according to the title of the intereview ‘The Hard Questions About Hard Times’.

While I don’t agree with everything Casey says, much of what he says does make sense to me – in some cases ‘toned down a little bit’.  In particular Casey discusses in some detail his views as to where each of gold and the U.S.$ are heading, and discusses the junior resource companies in some rather ‘no holds barred’ terms.  If you participate as an equity investor in the Junior Resource Sector, or for that matter participate in the equity markets generally, I suggest you take the time to watch and think carefully about what Casey says in what I see as current volatile and uncertain financial markets and economic times.

I have heard many people describe Doug Casey as a ‘Libertarian’.  Broadly, a Libertarian is a person that ‘stands strong’ for individual liberty, with particular emphasis on ‘freedom of expression and action’.  Doug Casey comes across in his writings and interviews as someone who says what he thinks, without particular concern about who may or may not like or appreciate his views.  For me, that makes him worth listening to, where ‘listening to’ means considering what he says, weighing it, and deciding for yourself whether you agree, partially agree, or disagree with him.  Again, 30 minutes is a long time, but if you fall into the categories I described in the previous paragraph, I think you will find the referenced interview will give you useful ‘food for thought’.

Visit Stock Research Portal for free stock market data, analysis, and research on over 1,600 Mining, Oil and Gas Companies listed on the Toronto and Venture Exchanges. See our Legal Disclaimer.

Possibly Related Posts:

• Three Types of Investors – and What About Traders?
• Dow Weekly Gains/Losses!
• What Value Do You Give To Your Time?
• Coming Derivatives Crisis?
• The Equity Markets and Value?