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  #21  
Old 15-04-2011, 10:02 AM
Chris Chris is offline
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The end result is that the price of the stock is usually a good estimate of its intrinsic value.
Not a good estimate or even a right estimate, but just an estimate. As I said before this is where I believe EMH takes a leap of faith.

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Critics often challenge the notion that investors on the whole are informed enough to price stocks correctly by consensus. Most investors can't possibly know that much about any given stock. But market efficiency doesn't require that most investors have information. It only requires that "many intelligent participants" have information. In fact, no single investor has that much information. Even the smartest, most savvy guy has only a tiny fraction of all the information out there. Information isn't a big secret squirreled away somewhere; it is widely distributed in little pieces. The market functions as a mechanism that gathers the information, evaluates it, and builds it into prices.
I would certainly agree with this, but I think this highlights precisely why a majority of market participants can end up being incredibly wrong. During the dot com boom everyone had the same information available, but suddenly the majority of investors ignored earnings and started looking at fancy things like potential clicks per second. I don't disagree that the market shows the current sentiment of all participants in a more or less instant manner, that is precisely what a market is. But I just do not believe that people are rational and therefore markets efficient.

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This is what it means to say prices are a consensus view of a stock's value. At some level every investor includes (or doesn't include) a security in his or her portfolio until the stock's value to the investor is about equal to its market price. Since the price is the same for everyone, so is the value. Now granted, if everybody investing is wrong, prices might conceivably be poor estimates of value. For this to happen on any scale, the ignorant investors would have to be overly optimistic or overly pessimistic as a group. Otherwise, the optimists will cancel out the pessimists and the price struck will be rational. Since stocks are more likely to trade when the person selling is pessimistic and the person buying is optimistic, prices on average are more likely to represent rational consensus.
This is the crux, EMH believes that buyers and sellers are much more rational than they actually are. Large scale irrationalities like the dot com and housing boom are common enough, and so are individual undervalued securities.

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Admittedly, sometimes it can be hard to view prices as rational. We see stocks with no assets other than a website and with little or no profit suddenly become bigger than General Motors only to melt down a year later. How can such prices be good estimates of value? They seem so illogical, possibly the consensus view of ignorant day traders.

Let's suppose for the sake of argument that investors behave like lemmings and that the market systematically misprices stocks. Such a market would surely be child's play for a smart investor with real analytical skills. The reason such successes are hard to identify is that there's more than just one or two smart investors out there. There are thousands of savvy analysts looking for over- or under-valued securities. The opportunities to generate excess profit are diminished when these investors trade away disparities between a stock's price and its intrinsic value.
I think that value investing is often over simplified when it comes to the work involved. I also think that just looking at institutional investors is a poor yardstick, even if it is the only practical one really. My personal portfolio has at times been very un-diverse and an institutional investor would probably never be able to sell such a portfolio as a fund. But taking the value investment approach to choose stocks has given me an above average return in 9 out of 10 years. Now of course this is a pretty short time period, and that theoretically could reverse. But applying the same rules my dad has "beat the market" in 26 or 27 out of 30 years.
Without a doubt, there are thousands of institutional investors out there, but I do not believe that value investing makes up a large portion of them. Generally I find they are way to over analytical and fancy in their ideas and often stray way too far from the basics.

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Originally Posted by Marc View Post
The EMH does not claim markets are always perfectly rational or that the information reflected in prices is always correct. The consensus view of investors can temporarily result in prices well above or well below a stock's intrinsic value. The only condition efficient markets require is that a disproportionate number of market participants does not consistently profit over other participants.
I think EMH and its most public proponents are extremely vague and even dismissive when it comes to rationality. While the information reflected in the prices certainly is correct, to a large extent, the prices are quite often not a correct reflection of that information. But this is something that EMH seems to largely dismiss as a rare occasion.

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After taking risk into account, do more managers than you'd see by chance outperform with persistence? Virtually every economist who studied this question answers with a resounding "no." Mike Jensen in the Sixties and Mark Carhart in the Nineties both conduct exhaustive studies of professional investors. They each conclude that in general a manager's fee, and not his skill, plays the biggest role in performance. Since mutual funds report performance after deducting fees, the bigger the fee, the worse the performance. Aside from that, expert investors with nearly unlimited resources working around the clock can't seem to outpredict the market.

This means investors are better off avoiding active managers—especially pricey active managers. History shows that in the long run a thoughtfully designed, diversified strategy of "passive" funds typically beats all but a few active managers. It's not easy to structure and maintain such a strategy. It requires some initial research and discipline to stay the course. But it's much easier than predicting which active managers will randomly beat this approach.
I wouldn't disagree that most fund managers make most of their money on their fees, but that doesn't mean that you cannot assess the success of their stock picking. Yes, looking at just the fund performance will often reveal a below market performance because of the fees. But we are not just talking about people investing in funds. A more accurate assessment would be an evaluation of the underlying asset values of value funds or investors.

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Chris

Your comments point to Ben Graham's margin of safety concept.

Basically if you buy a stock that is cheap you build in a margin of safety and so the investment is less risky.

The problem with this logic is that it doesn't discuss why the stocks got to the price they are now.

One camp says that these stocks are unloved, ignored by the Market and are trading at a discount to their true value. Seek out these stocks that are mis priced and you can make money.

This suggests that there is money on the table. The Market has screwed up and left the prospect of a higher expected return for no more risk.

The informed investor doesnt buy this argument. There is no free lunch in economics.

If the price of a stock is down then it is some manifestation of risk that is being priced by the market and typically associated with distress (but not always).

So we say compared to growth stocks these unloved stocks or value stocks must carry more risk otherwise why would an investor expect a higher return? Risk and return are related. Value stocks on average do better therefore on average they must be more risky.
Risk is always a subjective assessment and I think it is not very sensible to generalise risk in this way. The majority of people would argue that my current portfolio is way too risky, but in my interpretation of the available information I have reduced my risk. When I find an undervalued stock, I look at it in the same way. I do not see myself taking more risk than others.
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  #22  
Old 15-04-2011, 11:17 AM
ringledman ringledman is offline
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Originally Posted by Marc View Post
This means investors are better off avoiding active managers—especially pricey active managers. History shows that in the long run a thoughtfully designed, diversified strategy of "passive" funds typically beats all but a few active managers. It's not easy to structure and maintain such a strategy. It requires some initial research and discipline to stay the course. But it's much easier than predicting which active managers will randomly beat this approach.
Marc, investing in index funds mid way through a secular bear market will produce below average and likely below inflation returns.

We are many years away from entering a new secular bull market for the West based on emperical evidence. You only want to own index trackers during secular bulls.

Also invest on the basis of dividend. In a world lacking real growth (not QE binge growth) and in a negative interest rate world dividends are king.

Agree on fund management, 95% are a complete waste of money and fees are usually 1-2% over the TER as they unfortunatey dont tell you all their hidden costs.

I think the way to proceed in today's market is selectively owning value stocks in defensive industries that have been ignored by the market for a while. Those with excellent fundamentals and won't collapse as much as cyclical growth stocks once the tightening begins.

In today's market it is as much about 'return of capital' than 'return on capital'. I agree with Chris and the works of Montier and Grantham that say risk decreases the lower tha valuation (still doesn't mean you wont buy value traps occassionally).

So firms paying a dividend are lower risk than those that don't, firms that have a high dividend cover are lower risk than those that don't, firms that are on low P/Es are lower risk than those on lofty P/Es based on a mere promise of future growth. Usually value stocks have higher cash reserves and better ROCE than growth stocks.

In today's volotile globally imbalanced world these sort of fundamentals matter. Reducing risk through value is a way of preserving capital which I believe to be the number one issue at present. Over time value should outwin growth due to the lower risk profile in general and better/quicker return of capital to shareholders.

Rather than buy trackers that buy into the whole secular bear market, I believe a better approach is to selectively buy ETFs investing in core secular bull markets is the better choice. I.e. commodities, energy, and I think soon to join this secular bull - pharmaceutical.
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  #23  
Old 15-04-2011, 12:05 PM
ringledman ringledman is offline
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Originally Posted by Chris View Post
I think that value investing is often over simplified when it comes to the work involved. I also think that just looking at institutional investors is a poor yardstick, even if it is the only practical one really. My personal portfolio has at times been very un-diverse and an institutional investor would probably never be able to sell such a portfolio as a fund. But taking the value investment approach to choose stocks has given me an above average return in 9 out of 10 years. Now of course this is a pretty short time period, and that theoretically could reverse. But applying the same rules my dad has "beat the market" in 26 or 27 out of 30 years.
Chris, what is your value approach currently - sectors, fundamentals that you buy on, countries, etc?

Cheers.
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  #24  
Old 18-04-2011, 11:28 AM
Chris Chris is offline
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Chris, what is your value approach currently - sectors, fundamentals that you buy on, countries, etc?
First things I look at are price/earnings and price/book along with the level of debt. Obviously the lower these are the better. Dividends factor significantly in my assessment, especially fluctuations in dividend history and the dividend to net earnings rate.
Geography: heavily focused on Asia directly and indirectly; I generally like large European companies with significant export revenue to Asia; I don't have direct investments in Japan, but I am looking.
Industries: pharmaceutical, precious metals, industrial materials (steel, chemicals, plastics), gas and oil; no financials at all; on the cyclical side I do own a luxury car manfuacturer with very big growth in China.

As already mentioned I am currently looking for exposure to Japan but will probably wait until mid year to see how things turn out there. Rushing a decision has cost me more than any other mistakes.
I am also looking at increasing small to mid cap gold/silver mining stocks, which is proving quite difficult on a traditional value approach. Agriculture is also something I want to increase my exposure in.
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  #25  
Old 28-05-2011, 02:08 PM
davegaa
 
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No matter how much is pumped into Irish banks, I still think the markets will be overly cautious in the future.
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  #26  
Old 17-11-2012, 08:29 AM
Marc Marc is offline
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http://www.sensibleinvesting.tv/Default.aspx
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