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Fundamentals Trump Technical Analysis Long-Term, but Sentiment Trumps All
By Kevin Hurley
I am a fundamental trader for many reasons, the most pragmatic being the tax liability on long-term vs. short-term investing. But, there are, as there always are, more reasons for my loyalty to fundamental analysis.
In addition to be a fundamental trader, I am an options trader. I use options to protect the stock. There are specific reasons to use this strategy. Protective puts or collar strategies are good ideas when a stock has bad news or a less than impressive earnings event; or when technical crossovers occur to the bearish side or something unexpected occurs. The goal is to make up some of the downside risk in the stock price.
Fundamentalanalysis, defined by Investopedia, is a method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors.
In reality the data are just numbers or ratios to value the strength of the company against the sector, another company or an index like the S&P 500. There are certain ratios that traders, we will value more than others in order to justify our purchase of the equity in our portfolio.
Which ones? For me they are P/E ratios, profit margin, and revenues. These numbers give us the intestinal fortitude to keep the equity in our portfolio even when the stock starts a downward trend. We know through fundamental analysis that the stock should come back or move higher from the purchase price.
Here is an example. Baidu (BIDU) has impressive fundamentals across the board. Baidu fundamentals are above the industry average in many areas and below the industry averages in the areas that benefit the strength of the company. The fundamentals look good, but there is a small internet company called Qihoo360 that has changed the way we evaluate Baidu.
Enter sentimental analysis. Qihoo360 had a Q2, 2012 increase in revenues (107.4 %) with total revenue coming in at $72.8 million U.S. dollars. BIDU, in the same quarter, had revenues of $858.8 million U.S. dollars. BIDU has a more realistic P/E ratio of 28.56 (trailing 12 months) while QIHOO has a higher than normal sector P/E ratio of 65.62. Recently an article claimed that Qihoo360 took 4% – 9% of the internet market advertising from BIDU.
However, the fundamentals do not support that claim. Fundamentally Baidu is the stronger candidate. Sentiment points to QIHOO and the technicals indicate that BIDU is bearish and QIHOO360 is bullish. So what to do with your portfolio? Is it time to sell BIDU and jump into Qihoo360?
In my humble opinion, definitely NOT! I like proven companies with strong fundamentals.
Qihoo360, has delivered back to back quarters that show improving fundamentals. It doesn’t mean they will continue to do so into the future. The news article that started BIDU’s fall and Qihoo360 rise was not fundamentally correct.
If it had been reported that they increased profits in the mobile marketing side of the industry it would have been accurate, but the claims were not accurate. Qihoo360 is a software company while BIDU is a search engine, mobile search with AAPL using their website, cloud investors with many other internet related revenue streams. This is a flawed comparison, and exactly why, sentiment alone cannot be trusted to guide your investment choices.
Doing fundamental research is the homework of trading. It is the pencil, paper, and calculator work that can bring us to a correct conclusion on these two companies. It is a fad company vs. a proven company. There are plenty of times that a fad can make you money. Maybe Qihoo360 can be the next Baidu, but my portfolio will remain with the original, and BIDU is fundamentally a buying opportunity!
Disclosure: I am long on BIDU shares