Sunday, 2 November 2008

Fundamentals and valuations

(By Anthony Miller) The FT Lex article on equity research last Friday really struck a chord. Having recently spent four years on the ‘dark side’ as a tech stock equity analyst, the comment that “Markets manipulated by spasmodic state interventions, and distorted by the sin-binning of short-sellers, have made a mockery of rigorous, bottom-up analysis” rang oh so true. Lex referred to a broker note which admitted that aligning market movements with fundamentals “is virtually impossible.” We have made that very point in UKHotViews many times in recent weeks.

When I worked at Arete Research, a ‘pure-play’ independent research boutique, we always based our calls on bottom-up, fundamental analysis, tempered with a deep knowledge of the industry. Our calls were frequently ‘contrarian’ and I’d like to think we got them right far more frequently than many investment bank sell-side analysts. The problem today is indeed the decoupling of company fundamentals from stock valuations, which makes a ‘long’ call a brave one. There are now many ‘quality’ stocks fundamentally undervalued, but unfortunately I am no longer permitted to tell you which ones and by how much. I can only say what we have been saying for as many years as we have been in the research business. Long-term contracts for ‘boring’ non-discretionary products and services, with deep, lasting client relationships, speak volumes.

So let me repeat our message for business leaders. As difficult as it is, (especially when your options are so far under water they’d need a decompression tank to resurface) you have to forget about trying to manage your share price and focus on managing the business. No one can yet say when markets will stabilise and share prices recover. But ‘quality’ stocks based on ‘quality’ businesses should be at the head of the queue.

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