Essence of Trading: The Peculiar Practice Of Financial Analysis

Financial analysts often make a big fuss with very detailed analysis of the financial data reported by the exchange listed corporations. And then as an after thought, a chart or two would be thrown in at the end of their report to provide a technical excuse that the price should go the way they claimed. This ill-practice can be seen everywhere in the financial world.

Even more interesting though, people loves this kind of analysis.

Why?

Financial Analysis Metrics Are Relative And Non-Scientific

No one can agree on what Price Earning Ratio (PE Ratio) is considered as cheap. No one can give you a number that can be considered as too high either. They are all relative.

Someone can say stock XYZ is cheap because its PE Ratio or whatever metric is lower than its peers in the same industry. The argument will then jump to the conclusion that it is a buy. Obviously the logical inference in use is that this company should eventually trade at a similar PE ratio like its peers. However, I never see these analysis properly justify their claims with statistics on such inference.

Is it 80% chance that this company will trade at a similar PE ratio in 2 years?

Or is it really just 50% chance?

My guess is that majority of those writers who produced their analysis do not even know what probability is.

Same low PE ratio condition is often used as an argument to justify selling the same stock because it is not performing. Again, scientific method is not employed to tell you how likely the stock will not perform based on historical performance on other companies under similar conditions.

There are many financial articles out there sharing the same argument with completely opposite conclusions. It is common sense that we cannot have both sides being correct at the same time. Since this kind of financial analysis has been flooding the media daily, we have to wonder how scientific the financial industry really is.

Is the financial industry really lagging behind or could there be something more to this phenomenon?

Real Purpose Of Financial Analysis From The Financial Industry

The main purpose of these analysis are not there to assist the market participants. They are created because the financial industry needs you. They need people to notice the existence of these stocks. It does not matter what you do with the stocks. As long as you do something about them, someone in the industry wins.

• If you go ahead to trade them, someone from the industry make money from at least the commission angle
• If you discuss these stocks with your peers, you spread the word to more potential targets
• If you start to follow the analysts, they get to not being fired
• If you like the work from a particular analyst so much, you open an account with the firm this person works for, the firm wins

It does not matter if you win or lose at the end with the particular stock. It only matters if you act on the information. That’s why they have to dump as much information onto you as possible. One of these hot tips will stir your interest. One of these bargain hunting picks will trigger your internal desire to beat the market.

Once you are hooked they win.

Adding Something Colourful Helps

Plain old good analysis of a company based on sound analytics of the financial strength of a company are useful in determining the health of the company. Unluckily that does not promote trading of the said company. If you want people to take actions, you need to get them excited. You need to exaggerate.

Good graphics can get the job done. You can turn a simple comparison of year to year earning improvement into a pretty picture with 3-D effects. People are more likely to look at the picture than what is written in the article anyway. Most important of all, majority of the readers of financial articles do not even understand half of the financial jargons used in them.

The content of these analysis does not matter. The readers will form their own opinions anyway.

Adding Price Charts Is Even Better

The problem with charts on fundamental data on a company is that it has limited ways to express them. It is very hard to promote sophistication with a simple chart even though it is good looking. Sense of sophistication often leads to blind following. It is a very useful tactic when the goal is just generating interest in a particular stock.

The price charts can drive home this goal.

Price charts can be formatted with stunning effects and graphics. Lines drawn on the chart promote sense of mystic and sophistications. Both means nothing when it comes down to proper analysis of a price chart. But it is pretty and can attract people to at least browse the subtitle of the chart.

Again, It does not matter if the authors of these articles make no sense at all in what they write about the charts. Majority of the readers do not understand price charts. The conclusion of the analysis does not even need to make any sense. A non-sense piece of analysis can still get the job done because the readers will make it a talking point with their friends. The words are spread and mission accomplished.

The Truth

People love these half baked financial analysis because they are not really studying them. They are just looking for ideas. The financial industry knows and happily supply their potential clients with lots of reading materials. The goal is to get these potential clients excited and act on the information. Any action taken by the potential clients will be beneficial to the industry.

So how do we tell the good analysis from the bad ones?

I find fundamental analysts who love to end their analysis with pretty price charts and random comments of the charts supporting their buy or sell ideas are likely the ones whose analysis are bad. A quick look at the end of a multi-page analysis to see if the author is wasting your time with nonsense on the price charts can help you identify the quality of the analysis quickly. Simply skip these bad ones and your time is saved.

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