Here’s Proof that Fundamentals Matter When Investing in the Stock Market

Technical analysis can be effective when swing trading — but is virtually worthless when constructing portfolios for wealth generation. This isn’t meant to be a sale pitch for Exodus — but it might end up sounding like one because I am going to demonstrate a way to use it to easily gain an edge in the market.

For those who don’t know, I had Exodus built in 2007-2008 to help me with my business. I used to spend countless hours scouring quarterly reports, working Excel spreadsheets. Then I came up with the idea to have a program do it for me — ranking fundamentals on a 1-5 scale. After that, I added technicals and then married them together, producing a ‘hybrid score’, which is a combination of both — leaning more to the technicals since it’s helpful when trading.

Technical analysis larpers will tell you that fundamentals don’t matter. I can prove to you they do.

Here are the year to date passive median returns using our fundamentals screener. We grade fundamentals by debt/eq ratios, PEG ratios, price to book, price to sales, and profit margins.

Over 4.5: +14.14%

4-4.5: +13.11%

3.5-4: +12.5%

3-3.5: +7.44%

2.5-3: +3.23%

The returns literally decrease with each rung lower in fundamentals — clear and concise proof that investing in well run companies really does make a difference. Then something interesting happened on our way into the sewers: returns exploded. The very lowest scores are filled with money losing Biotechs and Crypto-proxies, all of the wild small capped stocks that made outrageous runs towards the end of the year. The median market cap is just $345 million for this quintile. And I think it’s fair to say no one in their right mind would construct a portfolio with these type of stocks.

Under 2.5: +16.68%

How else can we use this data? Well, I use it just fine in my Quant portfolio. I take the highest returning stocks and profile them, reverse engineering their data to find stocks just like them — and it works. In other words, if value is working now and companies with PEs less than 15, dividends of 3%+, are running higher — I will know about it and can easily find a basket of stocks to match that criteria. This is top down analysis that is constantly searching for Alpha. This is just one layer of the onion, finding out that good fundamentals matter. After this, I’ll dig a lot deeper and eventually come up with a group of stocks that is superior to all others — using only quantitative means to guide my portfolio decisions.

This will be the only method by which I will manage money in 2018, using big data, predictive algorithms, and AI learning to give me a discernible edge over my competitors.