Friday, February 28, 2014

The Fundamental Analyst's Comparative Advantage

This is good advice from Stephen H. Penman. As he sees it, there are five steps in the fundamental analysis of a company:

1) Knowing the business
2) Analyzing information
3) Developing forecasts
4) Converting the forecast to a valuation
5) The investment decision: Trading on the valuation

Here's the part I find really interesting:

"An analyst can specialize in any one of these steps or a combination of them. The analyst needs to get a sense of where in the process his comparative advantage lies, where he can get an edge on his competition. When buying advice from an analyst, the investor needs to know just what the analyst's particular skill is."

Buffett's concept of a "circle of competence" only addresses Penman's point (1), but of course it is virtually impossible to be expert in points 2-5 if you fall short on (1).

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