Forgotten (or Irrelevant?) Fundamentals

As is common in times of financial stress, correlations have risen— especially in the last few days, and especially in Europe. Taking a look at the factors driving developed market returns over the last week, we find the correlations to currencies, yields, and even commodities (oil) at the top of the list.

GKCI DM (sorted by 1 week column)

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This phenomenon is not unique to just the last several days, however, as those ‘correlation’ factors have dominated investment returns over the last one and three-month time frames as well. In contrast, if we sort the table by the factors that have been the most important over the last year, we find variables like earnings growth and changes in estimates– factors (presumably) somewhat influenced by the fundamentals of the underlying companies.

GKCI DM (sorted by 1 year column)

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Interestingly, though, fundamental factors such as margins, debt, and companies’ relative cash levels are mostly absent from having any meaningful impact on returns no matter what time period we consider. This is illustrative of a longer-term trend with broad implications for the investment community in general. The question of how meaningful financial statements are these days is an important one. Baruch Lev (a familiar name to those familiar with our Knowledge Leaders screening process) and Feng Gu are of the mind that the relevance of GAAP accounting has diminished over time, as investments in tangible assets have been supplanted by investments in intangibles. Stay tuned for details from our in-depth interview with Mr. Lev in the coming weeks. In the meantime, feel free to review our work on the Knowledge Effect and why pursuing a strategy based on Knowledge Leaders is so important in the face of the seismic shift in how companies generate returns.