“If we avoid the losers, the winners will take care of themselves” Howard Marks

I just read an article “Combining FA and TA” from an investment blog from Singapore here:

http://sgmusicwhiz.blogspot.co.nz/2010/08/combining-fa-and-ta.html

It is an interesting article which gives us some food for thought. The author concluded that:

“I am an advocate on concentrating on either FA or TA in order to excel in either; rather than try to “marry” the two methods together to produce a hybrid. Perhaps one can really come up with such a successful union, but even then it has to be rigorous, consistently applied as well as time-tested. These conditions may sound harsh, but are necessary to prove that a type of method is due to skill and not just luck. “

Let us use V.S Industries as an example. Let’s say the share price is very bullish in term of TA now, but fundamentally you think its intrinsic value from some kind of valuations has been exceeded, would you buy some more based on TA, or would you sell basing on your FA?

Or let’s say, the chart shows it is bearish now, and even if you have bought it higher than its price now earlier based on the good fundamental value versus it price then, would you sell and cut-loss, even though fundamentally, its value is still way ahead of its share price?

So the question is how are you combing FA, which is used by investors, and TA, the province of traders?

Buying undervalue shares with momentum: Evidence from US

A well-known US-based finance professor Josef Lakonishok tried to find under-valued, out-of-favour companies at the point when the market is starting to recognize them – a combination of value and momentum. From a fundamentals perspective, he begins by looking at price-to-book, price to-cash flow, price-earnings and price-to-sales ratios in order to identify unloved stocks. However, identifying a group of out-of-favour stocks is just the beginning. The trick is to ascertain which of them are likely to rebound versus being cheap for a reason, such as being near bankruptcy. So, he then looks for those shares that are showing sign of momentum, either in terms of price momentum (relative strength) or in terms of improving analyst sentiment and earnings surprises.

It turns out that the approach has been a barn- stormer. According to the American Association of Individual Investors, the Lakonishok screen has made a 15.7% CAGR for a number of years since inception, compared with 2.3% for the S&P 500, although its more recent performance has been less impressive – much like most momentum strategies in the face of market volatility!

Lakonishok started with FA first as the core investment strategy, and then add a little TA, and not the other way round. This is also generally true for most other investors using a combination of FA+TA.

The return of pure FA and TA+FA investing strategies in Bursa

Here I base on my little experience on the two sets of comparative results which have a longer record of 2 to 3 years on the two different investing strategies which were posted in i3investor. I compare the return of the portfolios as if they are held for the whole duration. This obviously may not be true for the performance of the portfolios, especially the one which is based on TA+FA, as the player may have entered and exited multiple times on the stocks in the portfolio basing on his charts, or may have taken profit or cut loss and have abandoned the stocks concerned. However, this is the only way I can compare as I do not have his trading records.

The first set was posted in 20^th January which I have discussed briefly in my last article below.

http://klse.i3investor.com/blogs/kcchongnz/78074.jsp

My portfolio, basing on pure FA is shown in the link below.

http://klse.i3investor.com/servlets/pfs/13147.jsp

The TA+FA portfolio belongs to Ooi Teik Bee as shown here.

http://klse.i3investor.com/servlets/pfs/12952.jsp

Table 1 and Table 2 in the Appendix shows the return of the two portfolios, both with 10 stocks each, as at 5^th June 2015, after two and a half years of holding period.

Risks and Returns of portfolios set up on 21^st January 2013

The portfolio of 10 stocks using TA+FA as shown in Table 1 returned an average of 68.2% with a median return of 27.3%, very good for a period of two and a half years, at least according to my standard. There were two losers; Benalec at -50.4%, and Alam at -25.3%. 4 out of 10 stocks under-performed the broad market return of 12% during the same period. Still not bad at all.

Table 2 is the result of the portfolio of 10 stocks using pure FA. It happened to do better with an average return of 120.2% and median return of 74.5%. All stocks made positive returns and there were no loser. Only 2 out of 10 stocks under-performed the broad market, marginally. This may imply the pure FA strategy incurred less risk than that of the TA+FA strategy.

Although the pure FA portfolio out-performed the TA+FA portfolio in the longer term of two and a half years, the TA+FA portfolio did out-performed the FA portfolio in the shorter term of 7 months when an analysis of their returns were made. I have actually made a comparison of the return seven months after the above portfolios were put up.

http://klse.i3investor.com/blogs/kianweiaritcles/33790.jsp

During the seven months period, the TA+FA portfolio returned 55%, out-performed the pure FA portfolio of 38%.

Hence we may conclude that trading stocks basing on TA (plus a little FA) could yield better return in a bull market in the short-term, provided you are really a good technician, but not necessary in the long-term basing on the above comparisons. But how many retail investors are really that good to beat the syndicates, insiders, institutional investors who have all the computer and financial powers?

Risk and return FA Vs TA+FA portfolios set up on 1^st August 2013

One thing we should bear in mind that in investing, it is not just the return we are looking at. We should also concern about the other part of the investment equation, the risk. Let us refer to the other set of portfolios put up in i3investor on 1^st August 2013, again one basing purely on FA , and the other using TA+FA as illustrations as shown in the links below.

http://klse.i3investor.com/servlets/pfs/19386.jsp

http://klse.i3investor.com/servlets/pfs/19385.jsp

The stocks selection processes were properly and fully articulated as shown in the link below:

http://klse.i3investor.com/blogs/stock_pick_challenge_2013_2h/blidx.jsp

My pure FA portfolio of stocks were mostly selected based on Joel Greenblatt’s Magic Formula investing; i.e. buying good companies at cheap price, augmented by healthy balance sheets and cash flow statements. Only one stock, Plenitude was based more on Graham net current asset valuation.

Table 3 and Table 4 tabulated the return of our portfolios of 10 stocks as on 5^th June 2015 after about two years now using the adjusted prices in Yahoo Finance.

Risk and Return of TA+FA portfolio

Table 3 shows the average return of TA+FA portfolio of 68.9% in the 2-year period, as compared to the return of the broad market of just 3%. Not bad at all. However, the Median return is a negative number of minus 9.1%. The standard deviation of the average return is very high at 191%. There were 6 losers out of 10, with quite substantial loss for Pantech warrant (-43.5%), and GOB (-33.6%). There were two multi-baggers in Hapseng warrant at +571% and Lii Hen at 214%. These two outliers made up almost all the returns of the portfolio.

Risk and Return of pure FA portfolio

Table 4 shows the average return of pure FA portfolio of 11 stocks at 85.9% in the 2-year period, as compared to the return of the broad market of just 3%. It is 17% above the return of the above TA+FA portfolio. The standard deviation of average return is 125%. The Median return is also great at 45.2%. The portfolio is clearly to have lower risk with only two losers out of eleven stocks. Moreover, the losses were small with Tien Wah at -14%, and Haio at -6.1%. There were also two multi-baggers outliers in Datasonic at +333% and Homeritz at +327%.  

In a small sample size with outliers, the median provides a measure that is more robust than the average because it is not at the mercy of outliers.

Conclusions

The use of either FA or TA, or TA+FA seem to work well in Bursa from the above analysis. However, bear in mind that the success of each method very much depends on the skill and experience of the individual users. I am not sure if one can successfully combine TA with FA to create a successful hybrid. It may be better to focus on being good at either FA or TA, as it may simply dilute any advantages which each style purports to convey on the practitioner, resulting in sub-par performance over the long-term as opposed to a more “purist” approach.

My experience on the use of pure FA has worked very well for me as shown in the analysis above; not only it provided great returns so far, the risk is also very low. I kind of find it intuitive; buying good companies with high return on capitals when they are cheap, coupled with healthy balance sheets and good cash flows should logically works well. It may not work well for one or two companies in the short term, but surely it should work for a diversified portfolio of stocks in the long term. However, the time frame of the experience of just 2 to 3 years is still short for fundamental value investors, and it may be partly due to the good market conditions thus far, or may be some real skill? It may be still early to tell.

I know this may open up for some fierce argument about the use of FA and TA. But isn’t sharing opposite views useful in our learning? You are hence welcomed to present your arguments, better if they come with facts and records.

For those who are interested to learn pure fundamental analysis in stock investing, please contact me

ckc14invest@gmail.com

K C Chong (14th June 2015)

Appendix

Table 1: OTB portfolio on 21^st January 2013

Table 2: My portfolio set up on 21^st January 2013

Table 3: Return TA+FA portfolio set up on 1^st August 2013

Table 4: Return FA portfolio set up on 1^st August 2013