Technology and the Stock Market: A Winning Combination

Individuals who cannot master their emotions are ill-suited to profit from the investment process.

Benjamin Graham

How to profit in the stock market has deviled investors since the days under the Buttonwood Agreement in New York City. For most of history, those brave enough to consider investing in a publicly-traded common stock were sheep to be shorn, victimized by Wall Street insiders and unscrupulous tycoons. Laws enacted after the Crash of 1929 finally leveled the playing field, ensuring that everyone had access to the same information. Nonetheless, the Dow Jones Industrial Average (DJIA) did not return to its 1929 high for twenty-five years.

Today, more than one-half of Americans own stocks, according to a 2019 Gallup Poll. As ownership in stocks increased, multiple systems appeared, each claiming to be the best system to make money in the market. Amazon, the online bookseller, lists over 10,000 titles with financial advice. There are dozens of TV series and YouTube channels dedicated to investing and the stock market. Almost 13,000 Registered Investment Advisors (RIAs) and 83,000 Certified Financial Planners (CFPs) anxious to guide their clients to perpetual, superior profits.

The Real Deal: Fundamental Analysis

Investing professionals from Warren Buffett to Peter Lynch have long recognized that investment success requires the ability to identify and buy companies with compelling products, excellent management, and competitive advantage for prices below their value. Charlie Munger, Buffett’s long-term investment partner, explains the theory of fundamental investing best: “All intelligent investing is value investing. Acquiring more that you are paying for. You must value the business in order to value the stock.”

Fundamental analysis is a system focused on determining the intrinsic, i.e., “real,” value of a company (and its securities) by a detailed analysis of macro- and microeconomic factors that affect value. The research — a top/down approach — includes three distinct components:

• Economic. The environment in which a company operates is a significant factor, essentially encouraging growth or erecting barriers. The measures to review include trends and details of Gross Domestic Product (GDP), retail sales, unemployment, interest rates, and government policies for trade and taxes.
• Industry. Industries function as a sub-section of the economy, specifically by inter- and intra-competitive factors that might affect the industry’s companies. Demand-supply statistics, technological change, and future prospects are among the factors considered. Harvard Business School Professor Michael Porter developed the 5 Forces Model commonly used to illustrate an industry’s position.
• Company. Criteria to be reviewed include financial information such as revenues, assets, and employees characterized by analytics (earnings growth, cash flows, capitalization, financial leverage) compared to other industry companies. The analysis intends to determine the company’s real value and potential for future growth.

After significant effort, the analyst compares the calculated intrinsic value with the market price, thereby determining whether the company Is over- or undervalued compared to its peers and other potential investments. The decision to act on the result, i.e., buying or selling a position, depends on the analyst’s confidence in his work and the size of the discrepancy between the two values.

Obstacles to the Application of Fundamental Analysis

Though the value of fundamental analysis in making stock investments is undisputed, few investors have the time or expertise to conduct a thorough investigation. Wall Street firms and mutual fund managers spend millions of dollars each year to hire MBAs and PhDs to research companies. Many follow a single industry or the two or three industry leaders for their careers. Robust IT systems, online access to information sources worldwide, and continuous feedback from peers are readily available to assist. Even then, advice and recommendations are often biased to support their employer’s purpose. (When was the last time your broker told you to sell a stock his firm had underwritten?)

Over the years, computers and software programs have assumed much of the physical work — information gathering, financial statement ratio analysis, competitor details — of research. Anyone with a computer and internet access can visit websites like Yahoo Finance or MSN Money for no cost and be bewildered by a cacophony of data.

Rushing to fill the void of actionable information, multiple financial websites offer financial information and recommendations for a small fee. One site recommends, “Buy a security,” while another says, “Sell the same security.” In frustration, droves of investors turn to index funds and their average returns, abandoning the possibility of identifying an undervalued company with growth appeal.

The Melding of AI and Fundamental Analysis

Artificial intelligence (AI) is transforming the investment industry, according to Deloitte. The computer’s ability to review thousands of historical chess games, forecast possible game scenarios, analyze future moves, and instantly implement a new strategy enabled IBM’s Big Blue to defeat world champion chess master Gerry Kasparov in 1997.

It’s going to be interesting to see how society deals with artificial intelligence, but it will definitely be cool.

Colin Angle, CEO and Founder of iRobot

In the decades since, scientists have produced tremendous leaps in computer processing abilities, specifically to handle enormous volumes of data. Combined with their predictive power and complex algorithms, AI-enhanced computers are moving quickly to assume decisions previously made by humans:

• Man Group Plc., a hedge fund, uses AI to manage its $12.3 billion of funds, executing trades and “betting on market momentum.”
• New York Life Investments uses “machine learning,” a component of AI, to analyze economic cycles and predict markets as part of their asset allocation strategy.
• Citigroup uses AI to make portfolio recommendations to clients through tailored research reports, solutions, and real-time alerts.

These capabilities are available to the man-on-the-street seeking to achieve high returns without taking abnormal risks. Companies like wealthX have applied the power of AI to personal portfolio management. Using proprietary algorithms, the company continuously monitors thousands of publicly traded stock datum, industry developments, and economic reports to determine which companies are undervalued in the market at any time. Their service includes weekly email updates, freeing their clients from worry and sleepless nights.

Final Thoughts

Protecting your future with a growing investment portfolio need not be difficult or time-consuming. Rather than viewing screen after screen of voluminous data trying to determine what is meaningful and what is not, an investor — beginner or old pro — can leave the heavy lifting to wealthX. Clients track their individualized portfolios online with buy, sell, and hold recommendations for a fee less than the cost of a monthly print subscription to the Wall Street Journal.