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Investment Fables: Exposing the Myths of "Can't Miss" Investment Strategies

by Aswath Damodaran

March 2004

Beginner

576 pages

11h 55m

English

Pearson

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Dedication
The Power of the StoryCategorizing Investment StoriesStories for the Risk AverseHigh Dividend StocksStocks with Low Price-Earnings RatiosStocks That Trade at Less Than Book ValueStable Earnings CompaniesStories for the Risk SeekerGreat CompaniesGrowth StocksLoser StocksHidden BargainsStories for the GreedyGet on the Fast TrackNo Money Down, No Risk, Big ProfitsGo with the Flow: Momentum StrategiesStories for the HopefulJust Follow the ExpertsStocks Always Win in the Long TermDeconstructing an Investment StoryI. Theoretical Roots: Isolating the Kernel of TruthII. Looking at the Evidence: Getting the Full PictureIII. Crunching the Numbers: Developing a Frame of ReferenceIV. More to the Story: Probing for WeaknessesV. Lessons for InvestorsConclusionEndnotes
Core of the StoryTheoretical Roots: Dividends and ValueDividends Do Not Matter: The Miller-Modigliani TheoremDividends Are Bad: The Tax ArgumentDividends Are Good: The Clientele and Signaling StoriesLooking at the EvidenceDo Higher Yield Stocks Earn Higher Returns?The Dividend DogsDividend IncreasesCrunching the NumbersDividend Yields: Across Companies and Over TimeSector Differences in Dividend PolicyA Portfolio of High Dividend StocksMore to the StoryUnsustainable DividendsComparisons to Actual or Normalized EarningsComparisons to Potential DividendsLow GrowthTaxesLessons for InvestorsConclusionAppendix: Firms That Pass the Dividend Screens: October 2002Endnotes
Core of the StoryTheoretical Roots: Determinants of PE RatioWhat Is the PE Ratio?A Primer on Accounting EarningsDeterminants of PE RatiosLooking at the EvidenceBen Graham and Value ScreeningLow PE Stocks versus the Rest of the MarketCrunching the NumbersPE Ratios Across the MarketPE Ratios Across SectorsPE Ratio Across TimeA Low PE PortfolioMore to the StoryRisk and PE RatiosLow Growth and PE RatiosEarnings Quality and PE RatiosLessons for InvestorsConclusionAppendix: Companies That Pass PE Tests in the United States: October 2002Endnotes
Core of the StoryTheoretical Roots: Price to Book Ratios and FundamentalsDefining the Price-to-Book RatioHow Accountants Measure Book ValueDeterminants of PBV RatiosLooking at the EvidenceEvidence from the United StatesEvidence from Outside the United StatesCrunching the NumbersDistribution of Price-to-Book Ratios Across the MarketPrice-to-Book Ratios by SectorA Low Price-to-Book PortfolioMore to the StoryHigh-Risk StocksLow-Priced StocksPoor Projects: Low Return on EquityLessons for InvestorsConclusionAppendix: Undervalued Stocks with Price-to-Book ScreensEndnotes
Core of the StoryMeasurement of Earnings StabilityTheoretical Roots: Earnings Stability and ValueDiversification and RiskStable Earnings, Risk and ValueLooking at the EvidenceStable Businesses with No CompetitionDiversified Business Mix: The Allure of ConglomeratesGlobal DiversificationRisk HedgersShould Project Risk Be Managed?How Do You Manage Project Risk?The Payoff to Risk ManagementEarnings SmoothersThe Phenomenon of Managed EarningsTechniques for Managing EarningsIs There a Payoff to Managing Earnings?Crunching the NumbersEarnings Volatility Across the MarketA Portfolio of Stable Earnings CompaniesMore to the StoryStable Earnings, Risky Investment?Giving Up on Growth OpportunitiesPriced Right?Earnings QualityLessons for InvestorsConclusionAppendix: Stable Earnings, Growth Potential and Low RiskEndnotes

Core of the StoryWhat Is a Good Company?Financial PerformanceCorporate GovernanceSocial ResponsibilityTheoretical Roots: Building Quality into ValueInputs in a DCF ValuationEVA and Excess Return ModelsLooking at the EvidenceProject Quality and Stock ReturnsThe Payoff to Corporate GovernanceThe Payoff to Social ResponsibilityBroader Definitions of Good CompaniesInvesting in Excellent CompaniesS&P Stock RatingsFortune RankingsCrunching the NumbersAcross the MarketA Superior Company ListMore to the StoryFailing the Expectations GameReverting to the “Norm”Lessons for InvestorsConclusionAppendix: Good Companies with Reasonable PricingEndnotes
Core of the StoryThe Theory: Growth and ValueGrowth in a Discounted Cash Flow ValuationDeterminants of GrowthThe Value of Growth in a Discounted Cash Flow ModelThe Value of Growth in a Relative ValuationLooking at the EvidenceHigh PE StrategyThe Overall EvidenceThe Growth Investors' CaseGrowth at a Reasonable Price (GARP) StrategiesPE Less Than Growth RatePEG RatiosDefining the PEG RatioUsing the PEG RatioCrunching the NumbersAcross the MarketThe Value of GrowthA High Growth PortfolioMore to the StoryIdentifying Growth CompaniesPast and Future Growth in EarningsAnalyst Estimates of GrowthScreening for RiskPoor-Quality GrowthLessons for InvestorsConclusionAppendix: High Growth Companies with Sustainable, High-Quality Growth, Low Risk and Low PricingEndnotes
Core of the StoryTheoretical Roots: The Contrarian StoryInformation and PriceThe Random-Walk WorldThe Basis for Contrarian InvestingLooking at the EvidenceSerial CorrelationLoser StocksCrunching the NumbersAcross the MarketThe Sector EffectA Portfolio of LosersMore to the StoryTransactions CostsVolatility and Default RiskCatalysts for ImprovementLessons for InvestorsConclusionAppendix: Loser Stocks Trading at More Than $5 and with Limited Exposure to Risk and DefaultEndnotes
Core of the StoryTheoretical Roots: Risk and Potential GrowthAdditional RiskInformation RiskGrowth RiskMarketability and LiquidityPotential for Excess ReturnLooking at the EvidenceSmall CompaniesInitial Public OfferingsProcess of an Initial Public OfferingInitial Public Offerings: Pricing and Investment StrategiesPrivate CompaniesMarket for Private Equity and Venture CapitalPayoff to Venture Capital and Private Equity InvestingCrunching the NumbersMarket CapitalizationInitial Public OfferingsPrivate Equity InvestmentsA Portfolio of Small-Cap, Lightly Followed StocksMore to the StorySmall and Lightly Followed StocksCosts of TransactionsFailure to Consider Liquidity and Estimation RiskExposure to Information RiskInitial Public OfferingsAllotment ProcessThe IPO CyclePrivate CompaniesLessons for InvestorsConclusionAppendix: Small-Cap Companies That Are Lightly Followed: January 2003Endnotes
Core of the StoryTheoretical Roots: Acquisitions and ValueAcquisitions and Value CreationAcquire Undervalued FirmsCreate Operating or Financial SynergyTake Over Poorly Managed Firms and Change ManagementAcquisitions and Value DivisionLooking at the EvidenceAcquisition DateTarget FirmsBidding FirmsDoes the Market Value Synergy?From Announcement to ActionMultiple BiddersFailed BidsMerger or Risk ArbitrageAfter the AcquisitionCrunching the NumbersAcquiring and Acquired FirmsAcquiring FirmsTarget FirmsCreating PortfoliosPortfolio of Acquiring FirmsPortfolio of Potential TargetsMore to the StoryInvesting in Acquiring FirmsOverpaying on AcquisitionsAccounting ComplexityDebt and DilutionLack of FocusInvesting in Target FirmsEntrenched ManagementMarket MoodRiskLessons for InvestorsConclusionAppendix: Potential Takeover Targets Among U.S. Companies: March 2003Endnotes
Core of the StoryTheoretical Roots of ArbitragePure ArbitrageFutures ArbitrageOptions ArbitrageNear ArbitragePseudo or Speculative ArbitrageLooking at the EvidencePure ArbitrageFutures and Option MarketsFixed Income ArbitrageNear ArbitrageSame Security, Multiple MarketsClosed-End FundsConvertible ArbitragePseudo or Speculative ArbitrageCrunching the NumbersFutures and Options ArbitrageDepository ReceiptsClosed-End FundsMore to the StoryPure ArbitrageNear ArbitrageNot Perfectly Identical AssetsAbsence of Convergence MechanismsSpeculative ArbitrageToo Much Leverage (Borrowing)Price ImpactSmall Upside, Big DownsideThe Long Term Capital Management SagaLessons for InvestorsConclusionEndnotes
Core of the StoryTheoretical Roots of Momentum InvestingMeasures Used by Momentum InvestorsModels for MomentumInformation-Based ModelTrading-Volume ModelLooking for the EvidenceSerial Correlation in Stock Price DriftsInformation AnnouncementsEarnings AnnouncementsStock SplitsDividend ChangesThe Confounding Effect of Trading VolumeMomentum in Mutual FundsCrunching the NumbersMomentum MeasuresPrice MomentumTrading VolumeEarnings SurprisesConstructing a Momentum PortfolioPrice/Volume MomentumInformation MomentumMore to the StoryRiskMomentum Shifts (When Do You Sell?)Execution CostsLessons for InvestorsConclusionAppendix 1: Stocks with Price and Volume Momentum, Low risk and Low PEAppendix 2: Stocks with Positive Earnings Surprises and Consensus on Expected EarningsEndnotes
Core of the StoryTheoretical Roots: The Value of Expert OpinionLooking at the EvidenceInsidersInsider Trading and Stock PricesIllegal Insider TradingUsing Insider Trading in Investment DecisionsAnalystsEarnings ForecastsInformation in Analyst ForecastsQuality of Earnings Forecasts[9]Market Reaction to Revisions of Earnings ForecastAnalyst RecommendationsThe Recommendation GameMarket Reaction to RecommendationsInvestment Advisors and Other ExpertsCrunching the NumbersInsider TradingAnalyst Recommendations and RevisionsWhat Firms Do Analysts Follow?Bias in Analyst RecommendationsAnalyst Earnings EstimatesPortfolio of “Expert” StocksMore to the StoryFollowing Insiders: Timing Is EverythingEarnings RevisionsAnalyst RecommendationsLessons for InvestorsConclusionEndnotes
Core of the StoryStocks Always Win in the Long TermTheoretical Roots: Market TimingMarket Timing Trumps Stock SelectionMarket Timing WorksLooking at the EvidenceDo Stocks Always Win in the Long Term?Market Timing IndicatorsNonfinancial IndicatorsSpurious IndicatorsFeel-Good IndicatorsHype IndicatorsTechnical IndicatorsPast PricesTrading VolumeVolatilityOther Technical IndicatorsNormal Ranges (Mean Reversion)Market Fundamentals as IndicatorsShort-Term Interest RatesLong-Term Interest RatesBusiness CyclesMarket TimersMutual Fund ManagersTactical Asset Allocation Funds and Other Market-Timing Funds.Investment NewslettersMarket StrategistsMore to the StoryStocks Are Not Riskless in the Long TermSurvivor Market BiasHow Long Term Is Long Term?Market Timing Works Only InfrequentlyHindsight BiasTiming of InformationNoise in ForecastLack of ConsistencyCosts in Transactions, Opportunities, and TaxesLessons for InvestorsConclusionEndnotes
Lesson 1: The more things change, the more they stay the sameLesson 2: If you want guarantees, don't invest in stocksLesson 3: No pain, no gainLesson 4: Remember the fundamentalsLesson 5: Most stocks that look cheap are cheap for a reasonLesson 6: Everything has a priceLesson 7: Numbers can be deceptiveLesson 8: Respect the marketLesson 9: Know yourselfLesson 10: Luck overwhelms skill (at least in the short term)Conclusion

Content preview from Investment Fables: Exposing the Myths of "Can't Miss" Investment Strategies

Investment Fables: Tall Tales about Stocks

As investors, you have all been on the receiving end of sales pitches from brokers, friends and investment advisors about stocks that they claim will deliver spectacular returns. These stories not only sound persuasive and reasonable but are also backed up by evidence—anecdotal, in some cases, and statistical, in others—that the strategies work. When you try to implement them for your investments, though, you seldom can match their success on paper. All too often, you end up with buyer's remorse, poorer for the experience and promising yourselves that you will not fall for the allure of these stories again. All too often, you forget the lessons of past mistakes and are easy prey for the next big stock ...

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