Blogs & Comment

Some thoughts on (critical) thinking

Don't overdo fundamental analysis in your investment decisions.

(Photo: Kelvin Murray/Getty)

Do-it-yourself investors take on full responsibility for their investments. This includes but is not limited to security selection, market timing, asset allocation, tax consequences and fundamental analysis. This last one can take a great deal of time if one allows it to.

However, a DIY investor’s fundamental analysis of economies, industries and individual companies need not go overboard if they keep their focus on a single objective: simply answering whether this is an economy I want to be invested in right now; if this is a good industry to be in; if this stock deserves some of my capital right now.

The problem is fundamental analysis can be endless. If you’re assessing a balance sheet or an income statement, there is no end to the ratios you can apply to it, or to years of past data if it’s available, and trend lines and so forth. Further, there is no one key ratio or group of ratios that is universally critical. Sometimes the working capital ratio matters, sometimes the debt-equity ratio and sometimes neither.

Here’s a suggestion: Do some fundamental analysis, but complement it with some objective critical thinking. The ability to think critically is declining rapidly today because access to information is greater than the general will to question that information. So the DIY investor who sets aside some time for some simple, objective critical thinking may be at an advantage.

Here are some examples. Do you seriously think the U.S. federal government won’t raise the debt ceiling? That it will default on social security cheques? That it will let its credit rating with the rating agencies get cut, costing it untold billions in higher interest payments? Or will it in fact raise the ceiling, subject to this or that concession? Mulling that over for a few minutes could save you oodles of time doing ratios on the U.S. economy.

As for stocks, is Yellow Media Inc. (TSX:YLO) really in as much trouble as some reports suggest? Or are some short sellers having success in getting rumours circulated? And if YLO did cut its dividend, would its stock price fall further than it already has?

The investment markets are not immune to ‘information’ that isn’t information at all. Last week, for example, a pure dividend mutual fund that billed itself as such was revealed to be not paying any dividends.

Critical thinking, friends. It’s increasingly necessary these days, and it just might make you a better and more efficient investor.