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August 2 - August 18, 2022
you remember not the current exceptions, but rather the rule: Many in Wall Street refuse to accept the fact that no reliable pattern can be discerned from past records to aid the analyst in predicting future growth.
Analysts can’t predict consistent long-run growth, because it does not exist.
Security analysts have enormous difficulty in performing their basic function of forecasting company earnings prospects.
Investors who put blind faith in such forecasts in making their investment selections are in for some rude disappointments.
The point is that we should not take for granted the reliability and accuracy of any judge, no matter how expert.
Pro forma earnings are often called “earnings before all the bad stuff,” and give firms license to exclude any expenses they deem to be “special,” “extraordinary,” and “non-recurring.”
“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
Simply buying and holding the stocks in a broad market index is a strategy that is very hard for the professional portfolio manager to beat.
The problem is that there is no consistency to performance.
Just as past earnings growth cannot predict future earnings, neither can past fund performance predict future results.
The evidence in favor of index investing grows stronger over time.
Index investing is smart investing.
A strategy far more likely to be optimal is to buy the haystack itself: that is, buy an index fund—a fund that simply buys and holds all the stocks in a broad stock-market index.
The “semi-strong” form says that no public information will help the analyst select undervalued securities.
The “strong” form says that absolutely nothing that is known or even knowable about a company will benefit the fundamental analyst.
What EMH implies is that no one knows for sure if stock prices are too high or too low.
The market is so efficient—prices move so quickly when information arises—that no one can buy or sell fast enough to benefit. And real news develops randomly, that is, unpredictably. It cannot be predicted by studying either past technical or fundamental information.
Investment risk, then, is the chance that expected security returns will not materialize and, in particular, that the securities you hold will fall in price.
A security whose returns are not likely to depart much, if at all, from its average (or expected) return is said to carry little or no risk. A security whose returns from year to year are likely to be quite volatile (and for which sharp losses occur in some years) is said to be risky.
One of the best-documented propositions in the field of finance is that, on average, investors have received higher rates of return for bearing greater risk.
to get the total risk elimination just shown. Nevertheless, because company fortunes don’t always move completely in parallel, investment in a diversified portfolio of stocks is likely to be less risky than investment in one or two single securities.
In general, diversification will not help much if there is a high covariance (high correlation) between the returns of the two companies.
some stocks and some classes of assets do move against the market; that is, they have negative covariance or (and this is the same thing) they are negatively correlated with each other.
contribution to investors’ wallets was his demonstration that anything less than perfect positive correlation can potentially reduce risk.
The paradoxical result of this analysis is that overall portfolio risk is reduced by the addition of a small amount of riskier foreign securities.
When higher returns can be achieved with lower risk by adding international stocks, no investor should fail to take notice.
But note that even though correlations between markets have risen, they are still far from perfectly correlated, and broad diversification will still tend to reduce the volatility of a portfolio.
Systematic risk, also called market risk, captures the reaction of individual stocks (or portfolios) to general market swings.
beta is the numerical description of systematic risk.
The beta calculation is essentially a comparison between the movements of an individual stock (or portfolio) and the movements of the market as a whole.
The calculation begins by assigning a beta of 1 to a broad market index. If a stock has a beta of 2, then on average it swings twice as far as the market. If the market goes up 10 percent, the stock tends to rise 20 percent.
Unsystematic risk (also called specific risk) is the variability in stock prices (and, therefore, in returns from stocks) that results from factors peculiar to an individual company.
The only part of total risk that investors will get paid for bearing is systematic risk, the risk that diversification
cannot help.
The new theory says that the total risk of each individual security is irrelevant. It is only the systematic component that counts as far as extra rewards go.
Because stocks can be combined in portfolios to eliminate specific risk, only the undiversifiable or systematic risk will command a risk premium. Investors will not get paid for bearing risks that can be diversified away. This is the basic logic behind the capital-asset pricing model.
people are not as rational as economic models assume.
that it is possible to quantify or classify such irrational behavior. Basically, there are four factors that create irrational market behavior: overconfidence, biased judgments, herd mentality, and loss aversion.
History does not move us as much as a couple of anecdotes of success.
Overoptimism in forecasting the growth for exciting companies could then be one explanation for the tendency of “growth” stocks to underperform “value” stocks.
Psychologists have long identified a tendency for individuals to be fooled by the illusion that they have some control over situations where, in fact, none exists.
illusion of control that can lead investors to see trends that do not exist or to believe that they can spot a stock-price pattern that will predict future prices.
One cardinal rule of probability (Bayes’ law) tells us that our assessment of the likelihood that someone belongs to a particular group should combine “representativeness” with base rates (the percentage of the population falling into various groups).
In everyday English, this means that if we see somebody who looks like a criminal (seems to represent our idea of a criminal type), our assessment of the probability that he is a criminal also requires knowledge about base rates—that is, the percentage of people who are criminals.
People’s choices are motivated instead by the values they assign to gains and losses. Losses are considered far more undesirable than equivalent gains are desirable.
Kahneman and Tversky concluded that losses were 2½ times as undesirable as equivalent gains were desirable. In other words, a dollar loss is 2½ times as painful as a dollar gain is pleasurable.
An understanding of how vulnerable we are to our own psychology can help us avoid the stupid investor delusions that can screw up our financial security. There is an old adage about the game of poker: If you sit down at the table and can’t figure out who the sucker is, get up and leave because it’s you.
Any investment that has become a topic of widespread conversation is likely to be hazardous to your wealth.
Invariably, the hottest stocks or funds in one period are the worst performers in the next.
Chasing today’s hot investment usually leads to tomorrow’s investment freeze.
