Value Investing: Tools and Techniques for Intelligent Investment

Preface

Part I: Why everything you learned in business school is wrong

In fairness I should have entitled Part I 'Why Everything you Learned in Business School is Wrong (unless you went to Columbia)'. Equally well I could have used the title 'Six Impossible Things Before Breakfast'.

The seductive elegance of classical finance theory is powerful, yet value investing requires that we reject both the precepts of modern portfolio theory (MPT) and almost all of its tools and techniques. The existence of MPT wouldn't bother me nearly as much as it does, if real-world investors didn't take its conclusions into investment practice. Sadly, all too often this is exactly what happens. Unfortunately, the prescriptions of MPT end up thwarting the investor. They lead us astray from the things on which we really should be concentrating.

Milton Freidman argued that a model shouldn't be judged by its assumptions but rather by the accuracy of its predictions. The chapters in Part I attempt to demonstrate that the basic edicts of MPT are empirically flawed. The capital asset pricing model (CAPM), so beloved of MPT, leads investors to try to separate alpha and beta, rather than concentrate upon maximum after tax total real return (the true object of investment). The concept that risk can be measured by price fluctuations leads investors to focus upon tracking error and excessive diversification, rather than the risk of permanent loss of capital. The prevalent use of discounted cash flow models leads the ...