5. Fundamental Indexing

Rob Arnott of Research Affiliates (RA) does not believe that markets are wholly efficient or that markets are entirely rational, and he says that his conclusions are supported by strong empirical evidence and the growing body of work in behavioral finance.

He asks a question about the validity of cap-weighted methodology: “Cap-weighting claims that the market price is accurate, but if market price does not equal fair market value, how big is the difference?” Arnott says that analysts try to analyze the next quarter sales and earnings and are often off the mark. If they cannot accurately judge the next quarter’s earnings, how can they judge what earnings will be two or three years out? The fair market value of a company ...

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