Q: What is the intuition of the Warren Machine?
A: Stock prices rise steadily if either the fundamentals are sound or the business model of a firm sparks enough fantasy for future profitability. On the contrary, if a steadily rising stock price can be measured, it can be assumed that the fundamentals are sound or the prices are driven exclusively by future expectations. In order to avoid investment in the latter, the longevity of a firm is taken into account so that essentially only fundamentally sound companies are identified.
Q: Why is the Warren Machine a new concept?
A: The algorithm to quantify a steadily rising time series in relation to its volatility is new. Each data point is evaluated in relation to all other data points of the entire time series. This is why the analysis is very precise in the measurement of overall return to overall modified semi-volatility. The drawback of standard statistical analysis is the evaluation of data points only in relation to averages or thresholds.
Q: I am into fundamental research, what is the goal of my work?
A: Analyzing balance sheets, the economic situation and interviewing managers has three purposes: 1. finding undervalued stocks as buying candidates, 2. getting affirmation of growth continuity and 3. identifying warning signals of future weakness. Mastering all three skills is close to becoming a super-investor like Warren Buffett.
Q: If my fundamental research of a company doesn't raise a red flag, what is my expectation of stock price evolution?
A: Considering a regular and steady dividend payout, a sound return on equity and low equity to debt ratios, rising sales and smart management, the stock price should move up in a stable fashion, bar of sudden negative surprises.
Q: I don't see how the Warren Machine contributes to my fundamental knowledge!
A: The Warren Machine measures three factors: steadiness, longevity and momentum of a time series. Steadiness is measured very precisely: performance of a stock relative to its fluctuating path. Longevity takes into account the maturity of a company in order to observe some reliability in the stock's history. And momentum measures short to medium term weakness of a stock as a trigger to sell. This is also exactly what fundamental research is trying to achieve: getting confirmation of long-term continuity and identifying imminent weakness.
Q: Can the Warren Machine identify undervalued stocks?
A: The Warren Machine does not identify turnaround stocks. Since the whole history of a stock is taken into account, the weak performance before the turnaround drags the Warren Machine measure down.