Advantages of Economic, Cash-Based Modeling
We believe that our modeling process, focusing on cash flow as the best measure of a company's economic performance, serves to encourage investors to hold stocks longer. Holding stocks longer improves their opportunity to achieve higher returns by reducing turnover costs of brokerage commissions and price impacts. Good decisions, built from understanding a company's intrinsic value from its cash flow fundamentals, generate optimal longer-term gains.
Investors with longer-term outlooks contribute to a more efficient market. Our ongoing study and analysis of our value charts (please see Chapter 27, beginning with “Starting with a Baseline Model”) shows whether a market is behaving more or less efficiently. When the market is getting systemically more efficient, the dispersion of market prices around the intrinsic values of companies contracts.1 Also, the rational range of high and low market prices contracts. We call these Rawley ranges of bounded rationality (described around Figure 16.5). These empirical insights can be shown statistically.
Instead, what seems to be occurring is a predominant use of modeling techniques that are more short-term driven. Quantitative and multifactor models today are mostly of a short-term nature. They are generating trading and what the market calls “noise trading,” instead of a sane market operating at a high level of control with investors making decisions on good analysis of fundamentals and ...