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Chapter 5. Fundamental Volatility > Fundamentals as the Basis of Market Risk

Fundamentals as the Basis of Market Risk

Revising the methods used to perform price analysis is a helpful exercise, especially if it leads to a more realistic conclusion about risk and volatility. Statisticians recognize the importance of removing exceptional data from a field of results; one method calls for eliminating the highest and lowest responses or outcomes as an automatic step. In the case of price analysis, we simply want to ensure that we are using typical data rather than all data. Even so, limiting our tests to price alone—the purely technical approach—does not address the problems of core earnings adjustments. When such adjustments are significant, we have to wonder how market risk is affected over the long term. Our interpretation of data when adjustments are significant raises some troubling questions, and the resulting uncertainty increases risk. For example, if you have to deal with a high level of core earnings adjustments, does that mean that market price and PE ratio are unreliable or inaccurate? If this is the case, then we cannot use those short-term indicators to measure long-term investment value.

Key Point: There may be a direct correlation between high levels of core earnings adjustments and market risk. To err on the side of caution, this conclusion should be based on study and observation.



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