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Do fundamentals (still) drive the stock market in 2021?

Like all good business school answers, the answer to this one is that "it depends", in this instance, on your time horizon.


As a general proposition, the stock market follows fundamental laws, grounded in economic growth and returns on investment.


Research conducted over 40 years (between 1960 and 2000) supports the views of the authors Koller, Goedhart and Wessels * that return on capital, growth and free cash flows drive value in the capital markets.


The authors saw the same pattern occur on an industry level. Their research underscored their conclusion that short term earnings do not drive share prices, which are determined by long-term cash flows.


Amazon is a great example of the applicability of this phenomenon, with its financials** showing free cash flows of USD 6,479bn in 2017 increasing by 300% to USD 25,924bn in 2020.


Admittedly, a 4 year period could be argued not to be "long term" but I would be surprised if an analysis of Amazon's cash flows since 1997 did not show similar spectacular growth.


*Taken from their work titled: VALUATION: Measuring and Managing the Value of Companies, 4th edition, 2005 McKinsey and Co at pages 69-78


**https://lnkd.in/eDvUxmK


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