Using FA to avoid the big drops in ASX equities

[Gringotts Bank]

I'm looking to incorporate FA somehow.

Was there a [simple] FA way to see that oil stocks were going to get hammered as they did in 2014/15?

What about an FA way to discover the Gunns, Dick Smith, Babcock, Onetel etc before they started to decline?

Thanks.

 

[systematic]

What about an FA way to discover the Gunns, Dick Smith, Babcock, Onetel etc before they started to decline?

Only time for a quick reply, but within the broader 'quality' or 'safety' factors you have a subset of 'red flag' indicators (that's just my ad-hoc categorisation). Bankruptcy indicators are close to what you are looking for (given the stocks you mention).

For examples, look up stuff like Altman Z-score, Ohlson O-score, Montier C-Score or Beneish M-Score. It must contain one letter of the alphabet followed by the word 'score' to be effective (sick joke!).

In the academic papers there are heaps of bankruptcy / red flag / distress type research along the lines of the above.

 

[galumay]

At its simplest level yes! FA would guide you not to invest in cyclical commodity reliant companies, so oil companies would not have been on your watchlist.

I havent run full analysis on any of the companies you mention, probably because they wouldnt even come within my area of interest because of their management, sector, structure, debt or other obvious metrics.

Once a company comes up on a formal or informal scan i add it to a list of companies that might pass muster for detailed analysis, then when I get time I will do a preliminary analysis and if they still look OK I will run a full analysis and if they satisfy all my metrics limits and seem to be priced below their intrinsic value i may decide to take a posiition.

Certainly doesnt gaurantee that there wont be a big drop in price though, something can happen that you had no way of accounting for - regulatory risk, black swan event, or the market can continue to mis-price the company for longer than you can stay solvent (as Keynes famously said.)

If there was an easy way to avoid serious capital loss investing in companies someone would have done it!

EDIT - Systematic put it much more succinctly than I, while I was typing.

 

[Gringotts Bank]

Only time for a quick reply, but within the broader 'quality' or 'safety' factors you have a subset of 'red flag' indicators (that's just my ad-hoc categorisation). Bankruptcy indicators are close to what you are looking for (given the stocks you mention).

For examples, look up stuff like Altman Z-score, Ohlson O-score, Montier C-Score or Beneish M-Score. It must contain one letter of the alphabet followed by the word 'score' to be effective (sick joke!).

In the academic papers there are heaps of bankruptcy / red flag / distress type research along the lines of the above.

Sounds good, thanks systematic. Which one of those scores would be easily accessible, so that I could download it every month or so for each of the top 50-ASX?

 

[Gringotts Bank]

At its simplest level yes! FA would guide you not to invest in cyclical commodity reliant companies, so oil companies would not have been on your watchlist.

I havent run full analysis on any of the companies you mention, probably because they wouldnt even come within my area of interest because of their management, sector, structure, debt or other obvious metrics.

Once a company comes up on a formal or informal scan i add it to a list of companies that might pass muster for detailed analysis, then when I get time I will do a preliminary analysis and if they still look OK I will run a full analysis and if they satisfy all my metrics limits and seem to be priced below their intrinsic value i may decide to take a posiition.

Certainly doesnt gaurantee that there wont be a big drop in price though, something can happen that you had no way of accounting for - regulatory risk, black swan event, or the market can continue to mis-price the company for longer than you can stay solvent (as Keynes famously said.)

If there was an easy way to avoid serious capital loss investing in companies someone would have done it!

EDIT - Systematic put it much more succinctly than I, while I was typing.

Thanks galumay. Could you suggest maybe one or two metrics you'd consider best fit the bill for avoiding sustained big sell offs? I'm interested in ones which are easily accessible so that I can throw them into a backtest.

 

[banco]

Hedge funds etc. have whole teams of guys doing FA all day and they still get hit by big drops. I'm skeptical there's anything you will find that is in any quick/easy/simple with regards to FA.

 

[Trendnomics]

No amount of FA will assist, if disclosure obligations are not met:

https://au.news.yahoo.com/thewest/wa/a/29592803/ex-forge-bosses-back-in-spotlight/

 

[systematic]

I assume this is somewhat of a given, but just in case...please be aware that sharing information does not mean to imply that I advocate the usefulness of any mentioned examples. It was just information to help answer the question.

 

[galumay]

Thanks galumay. Could you suggest maybe one or two metrics you'd consider best fit the bill for avoiding sustained big sell offs? I'm interested in ones which are easily accessible so that I can throw them into a backtest.

I don't think you are going to find them, as systemetic says there are all sorts of calculations out there but none of them are "easily accessible to throw in a backtest". They all require research, extracting data from financial reports and then applying data in formulas.

I am dubious about the benefit of trying to combine FA & TA techniques, the approaches are so strategically and diametrically opposed and you potentially just end up doing a bit of both, badly!

 

[Gringotts Bank]

Thanks for the input everyone.

I agree, it looks difficult. I'll just hope that the price reflects consensus FA opinion amongst the bigger brokers and analysts. It's probably an ok method given that the top 50 are fairly well researched.

 

[luutzu]

Thanks for the input everyone.

I agree, it looks difficult. I'll just hope that the price reflects consensus FA opinion amongst the bigger brokers and analysts. It's probably an ok method given that the top 50 are fairly well researched.

I wouldn't put too much faith into consensus opinions and "analysis".

It could surprise us all how little researched the top 50 or top100 companies could be.

One reason is that it's so big the other guys will surely have studied it; If every analyst think that, that's just asking to be wrong - big time.

Second, big companies aren't that well covered... maybe covered but not studied... because they're big and so difficult to study properly beside rejigging the estimates provided by management. That and since these are blue chips... you can recommend it and would still do as well as the market (because these take up a big part of the market's movement)....

 

[systematic]

Thanks for the input everyone.

I agree, it looks difficult. I'll just hope that the price reflects consensus FA opinion amongst the bigger brokers and analysts. It's probably an ok method given that the top 50 are fairly well researched.

...I wouldn't necessarily throw away the idea!

Regardless, if you are only talking about the top 50 stocks, there is some truth to what you're saying - especially if you are also doing some type of trend following. Both size and price weakness are characteristics of distressed / gone bankrupt firms. So the top 50 and avoiding those that are massively under performing (relatively) could both be considered aspects of attempting to avoid distressed firms. One (Australian) study showed that the effect of price under-performance is significant in eventually bankrupt firms to be clearly evident months and months and months prior. So again, any typically, "TA" / momentum or trend following type trader are already incorporating an appropriate measure. Also an increase in the bid/ask (particularly right at the end, but also often observable up to a year prior). Also, right at the end are massive increases in volatility and volume - but you'd already be out by then (otherwise you'd have already suffered massive losses from the down trend that had been occurring months earlier).

 

[Smurf1976]

I've always considered that there is more than one approach to FA.

One way is looking at specific companies based on their financial and business fundamentals.

Another way is looking at entire industries based on overall prospects and likely future outcomes.

In the case of oil stocks, well if you thought someone was going to start a revolution in Saudi and disrupt supply then you'd be looking to buy oil stocks certainly, the only question then being which specific companies. But if the move's big enough then you'd likely come out a winner if you simply bought a selection of large producers and didn't worry too much about the company specific detail beyond the basics.

On the other hand, if you weren't expecting a jump in the oil price then you need to be a lot more careful to pick companies that will survive and grow since there's no "rising tide lifts all boats" aspect of a surging commodity price to bail out the duds.

 

[shouldaindex]

If you can outsmart millions of other people with the same information, you'd be on a million dollar salary somewhere.

 

[Gringotts Bank]

If you can outsmart millions of other people with the same information, you'd be on a million dollar salary somewhere.

Correct. Such people exist, you know.

 

[Gringotts Bank]

...I wouldn't necessarily throw away the idea!

One (Australian) study showed that the effect of price under-performance is significant in eventually bankrupt firms to be clearly evident months and months and months prior. So again, any typically, "TA" / momentum or trend following type trader are already incorporating an appropriate measure. Also an increase in the bid/ask (particularly right at the end, but also often observable up to a year prior).

Thanks for this - good answer. This is what I ended up doing. Spread isn't something I have access to, but volatility and other simple TA metrics are easily accessible.