I don’t think you’ll like L3 very much. Very little on valuation. And it’s a lot of studying too.
“CAPM seems all too confusing and complicated as I try and seek a precise rate based on invalid assumptions, i.e. historical price movements. If prices head deep south volatility goes up (and thus, the beta) rendering the stock MORE risky - albeit they may be now considerably LESS risky than before (given the core fundamentals have not changed). Add to that the cost of debt and calculate the WACC given some fancy forecasting for the target cap structure - and the rate becomes a blur.”
Lol, tell me why a stock’s price would plummet and be less risky? The whole reason why investors are paying less for it today, is because it’s riskier than it was yesterday. When something becomes less risky, people are willing to pay more for it. I can’t believe you would even think that way.
Note: I thought about telling you about all the problems in your posts above… but it isnt worth it. You lack a lot of the basic understanding about risk, reward, and a prices roll in a functioning market. You can only convience people who believe that they can benefit from being convienced, you obviously do not.
Btw, Markowitz uses stdev as a measure of risk, not beta. And quoting WB is so cliche, its laughable.
Well, I think he’s talking about the idea that if the fundamentals are unchanged, and the price drops, the valuation is improved, and so it is less risky to invest in the stock, because the margin of safety (if any) has improved. This is a Buffet maxim, and I don’t necessarily disagree with it, but it is context-determined, and it makes a lot more sense when you are in a long-term bull market like 1982-2000 (or arguably 2007), because beta never hurt you over the long term, so it’s easy to say silly things like “beta isn’t risk.”
What this misses is that when all stocks plummet simultaneously, the fundamentals are almost always in serious doubt and dramatically changed from earlier assumptions (often revenues and growth, but sometimes input or capital costs). What beta captures is the degree to which you’ll be doing badly when everything is doing badly, and the degree to which you’ll be doing well when everything is doing well. That’s why it’s called “systemic” risk.
Sure, markets will typically overshoot in a panic, but it can still take years to recover the capital losses from these events. And if your cash cushion is too small, then you have no way to take advantage of improved valuations at the bottom (to the extent you even know where that might be). And so it makes sense to consider this risk when managing portfolios - unless your mandate specifically tells you not to (which is usually because someone else is taking the responsibility for systemic risk). It takes a 25% gain to recover from a 20% loss; a 100% gain to recover from a 50% loss. Make no mistake, beta represents risk and it can hurt you. Just ask Bill Miller.
None of that means that value isn’t a sensible investing philosophy. It just means some people get too dogmatic about things. But the investment profession attracts obsessive types more than many others, because they are useful employees to have (get that earnings projection down to the last cent!), provided their obsessions are correctly aligned.
As a clarification: CAPM assumes Markowitz MVO, but Markowitz does not require you to assume CAPM. Markowitz doen’t even require you to measure risk as standard deviation, although that’s the most common implementation. All he’s really saying is that risks don’t add up in the same way as returns do, and therefore the portfolio’s risk-return ratio is not just a weighted average of the asset risk-return ratios. And that’s a useful insight that most people don’t have.
Of late I get the feeling that value investing is a ‘backward rationalising technique’ of explaining good stock picks. And use the same techniques going forward with little success. But when it hits jackpot, cryout really loud about your success by appearing on TV interviews or preferably writing books (the latter appeals to urban people). Then you grow in size and use the clout and contact to make some really sensible investment. You will tell the world how you made your money - by understanding value investing. Now, the common man will hail this hero and fall into many traps. He wil rationalise his losses by saying he is on the path to the next WB (somehow he thinks God owes it to him). After a decade he (the common man) will try to figure out from his friends and family on what is asset allocation…
B-chad, I’m going to have to disagree with you, price doesn’t drop all-else held constant. If price drops, it’s inorder to restore a risk-appropiate expected return going forward (with today’s information and expected future changes). I think the OP says thinks “IBM fell 2% on macro news but nothing has changed internally at IBM, hence there’s no reason for the change”, maybe he feels macro news has too large of an impact on prices, hence his logic.
Price is an aggregator of all types of risks/information.
I wasn’t saying that price drops “all else constant.” I was simply saying that there is a perspective that says “if the price drops, all else held constant,” then you could see buying it as less risky.
The rest of my post basically said that when prices drop substantially, “all else” is almost never “constant.”
As for whether price drops are there to restore a more-risk appropriate expected return going forward, I mostly agree, but I don’t think short term price movements are always that way (maybe someone with a large position just decided to sell a bunch in a hurry), and it starts to get muddy about whether expectations about cash flows have changed (due to economic conditions) or the demand for risk premia have changed (people panicing). Panics can be thought of as temporary increases in risk premia based triggered by some kind of fundamental or technical event that scares people into valuing current cash more highly. As long as the panic is unjustified by fundamental events, people with longer time horizons can take advantage of them. The challenge, of course, is that panics are often partly justified, but overdone, and feeling that out seems to be much more art than science.
But I think we’re mostly on the same page here.
I hope Trekker keeps asserting his preconceived notions, just so I get to read more good posts from BChadwick.
Personally, I have come to the conclusion that Buffett’s maxims are non-actionable. Not wrong, but not black-and-white helpful in investing. It’s far better to buy BRK shares and let him do his magic.
I am a value investor at heart, in that when I see a stock selling at 30 P/E, I don’t think of how high it would go but rather how easily it could fall. (To quote Buffett: #1. Never lose money. #2: Don’t forget #1.) Having said that, I have not heard value investors explain how to distinguish value traps from real mispricings. BChad is on the money on this one.
Buffett has said there are no called strike-outs (if you fail to invest in a mispriced stock, you pay no penalty) but has not explained what makes stocks like BNSF or IBM “fat pitches” Going by metrics like P/E, P/B (accounting for effects of buybacks) etc, these are/were not value stocks, yet he bought them. And now he is buying debt-ridden newspapers. I can’t begin to think how I could emulate him.
As for CFA, I’d have no clue how swaps were priced were it not for the curriculum. Same with Nash equilibrium (alas, an optional segment), rent-seeking, covered interest parity, and a million other broad areas that working towards a goal (achieving CFA designation) makes you pay attention to. That is valuable to me.
Agreed, from the view of a price’s role in a functioning market, I dont think we’re disagreeing.
Yes, we think that soft skills are definitely not frowned upon.
Respect, they do. Not arguing that. B Gross is a PIMCO bond man though (I’m sure you knew that).
Valid points - I’m not bashing the program at all. I’m just questioning the inner workings of certain tools - similar to the way not all MBA courses at HBS is beneficial to everyone. And it just happens that these tools differ to a large degree of how I make my investment decisions. I just do not see the value of it in that sense - however, there is no argument that the charter is an intellectual feat albeit it’s very academically driven.
To be able to earn it while juggling work, family, and social life is a charter *truly* earned. I am not arguing that. And I think the recruiters at an IM, especially at an entry level, will give a lot weight to that sort of commitment. Not because they feel comfortable enough to have you manage their portfolios at the onset but - because they know you are most likely someone who is easy to train/teach given the academic knowledge of breadth.
And what I find interesting is that once you start working, *most* of what you have learned while earning the charter, it seems, is thrown out of the window - quite a few charter holders are up front about this experience. If you get to converse with some of the members during monthly local chapter meetings - I’d be surprised if they say they use more than 10% of the actual contents in any role. I’m still a candidate but I’ve already figured out that I don’t have use for most of the contents - obviously that does not mean they are useless for others, especially some of the ‘must know’ foundational underpinnings. So, while others pursue the charter I’m contemplating whether my time is better utilized honing my own tools. I can only imagine the difficulty of the concepts while sitting for the exams, for a non-finance major such as yourself, are probably synonymous to the level it takes to understand thermodynamics (if you are not, say, a mechanical engineer) or differential equations (if you are not a mathematician). So, I see nothing but respect on your achievements.
Great. Any thoughts on the connection between their investment ideology and the charter.
I’d say it’s definitely more bottom up than a top down - however, the program does not specifically promote *true* value investing in the classical sense. And I think this is due to a lot of theories (albeit conflicting at times) that are part of the curriculum that CFA administrators feel should be part of the candidate’s knowledge base. And I agree with this approach GIVEN that the candidates come from an array of non-finance background. If you are into value investing you will dislike most of it though - BUT you will have gained knowledge on what it is and WHY it does not work.
I’ve had similar thoughts several years ago and I came to the realization that there’s a great deal of difficulty in trying to become an expert in more than one area, let alone several. Most super investors I’ve known in any one area are specialists - they have this really vast deep knowledge in their area of expertise and they tend NOT to switch or sway away from their investing style even when the times are rough. This is my belief. And there are professional investors who do make bets on areas of varying degree - but they’ve also been known to get burnt more than once. Financials are something I’m working towards since the valuation requires a slightly different set of tools. I’ve got a bit of step-up on this because I’ve done somewhat similar analysis before which includes few M&A due diligence work, many business cases and several SVA’s (shareholder value analysis) as part of my consulting work for FS firms. And I think that part of work is a complement to my investing style because (i) I see day in and day out not only how capital budgeting projects (source of value creation) is initially proposed but also its implementation and execution (ii) I deal mostly with client senior mgrs (have been on call with C level execs on a few occasions) – this tremendously helps in better understanding management’s thought processes.
Agree with this one - hedging makes sense to the point where the hedge is not too expensive in relation to your overall position. At times, I stay unhedged if my margin of safety is really huge and the hedge is relatively expensive. And my use of derivatives (if I ever use them) is limited to hedging only (downside protection). I don’t know enough about speculative or arbitrage plays on derivatives to make anything close to a profitable bet, so I stay away.
His stuff isn’t bad - but I don’t use DCF as part of my valuation. I think Graham mentioned along the lines that the concept of margin of safety is such that it renders forecasting unnecessary.
In terms of how much the charter is valued, I think this is similar to Palantir’s post above.
It’s either that or maybe value guys don’t really see ‘value’ in it - hard to tell. Greenblatt has said many times that he’s embarrassed to have gone to Wharton because all he got there was a theoretical academic mumbo jumbo - and what they teach at Wharton is the same stuff that’s all over the CFA curriculum. The only exception I’ve seen is Greenwald’s teaching at Columbia where Greenblatt is an adjunct lecturer.
Agreed, entirely.
Thank you. And if he is also a charter holder it would be very interesting to see what his views on this would be.
Appreciate your long response and lots of encouraging words. I think the quitting part really hits it home for me - having come this far and not finishing does not look too good - but I’ve also got to think about the cost-benefit aspect of it from an opportunity cost point of view.
Well, my comment was a hint that mispricing does occur for many reasons and when it does paying a LOWER price entails less risk.
I understand your academic reasoning behind this - but the statement is not always true and what this implicitly implies is that there is no room for mispricing in the market place - and this notion is the theme of Malkiel’s random walk theory and EMH - to me, this is purely academic hogwash (no pun intended).
Take a look at the events of March 2009 - fundamentals of handful of firms in certain industries did not change but they all declined to a significant degree (due to macro herd mentality aka mania). My risk premium did not need to be adjusted upwards for that! I paid bargain prices and any unsystematic risk associated with the purchase went down tremendously.
You are absolutely right. But in industry it’s commonly known as Markowitz’s risk and return. In theory we both know that SML (which uses beta) is the correct lingo and that SML is partly derived using Markowitz’s efficient frontier.
Aside from the view that most value investors tend not to use beta at all, beta also does not hurt in the short run because they have a much longer term outlook. While it is true that bull markets thirsts the tail wind of value guys – also have a look at their track record during recessions (they tend to do relatively better).
Macro perspectives are non-existent in the value world. And because that is one of the implications of beta, we avoid it. To clarify though, I think you meant fundamentals of the ‘overall economy’ - a macro even of sorts. If that occurs then fundamentals of ALL business do not necessarily change - it depends on the type of macro event which might have an immediate impact on only certain industries, but not all. One of the best buying opportunities (for us) was during the events of March 2009.
You are right. It’s a conspiracy. A big scam. Puts a Rothschild to shame. Madoff in the making. Stay away.
(If you were a L1 candidate we would’ve let you go but as a charter holder we expect a bit more from you. How about some transparency - an in-depth analysis on WB’s talk given in 1984 on the 50th anniversary of Security Analysis at Columbia - take a stab at it because THAT talk was targeted towards the skeptics with similar comments at the time. I call it the common misconception - but the overwhelming evidence is pretty difficult to ignore, even more so with 28+ yrs of post speech *transparent* investing track record.)
Trekker - I admire your perfect knowledge of everything. I think I made a lot of sense, especially after reading your response which had a touch of personal-attack!! I think I know better what the program has done to me and I don’t need your word of approval. Thanks for setting up bar of expectations here. No one other than you could do it.
It all revolves around WB isn’t it. Somehow I have to find peace with what I do and what WB does. I wake up everyday and ask myself this question, again and again. I don’t get sleep until I solve the triangle of complexity which is WAIGUY-WB-MARKOWITZ.
Trekker, if you care for your investor’s hard-earned money and not bury your head entirely only in mumbo-jumbo academic debate life would be better. How many of your perfect value investors predicated any of the crisis that happended or protected client-money with the help of those crystal-balls that you and your friends use?
What the money managent profession needs is ethics and empathy. Not arrogance because you figured out what SML does. People’s trust on advisors, analysts, fund managers is eroding everyday. Do you read that?
And now active money management is under threat of ETFs and simply Cash because investors are dissapointed with active managers. Value investing is ‘Ok’ to me. But when I talk to value fund managers I worry when they say things like they don’t care about macro-risks. And somehow they think they are not allocated enough capital by asset-allocators!! How could I? (btw my work involves AA)
For me, value fund managers are an ‘expensive’ choice within my asset allocation framework. They are just another style- like anyother equity style and I don’t attach more merit to it than it deserves. I say expensive because a) given equity conditions they most definitely don’t work b) their fund management fee as a proportion of alpha is astonishingly high. I don’t look at expense ratio as a percent of asset under management, but as a proportion of return-above-passive strategy. It is just too high and it makes me cry when I see those numbers. Honestly what I like about value fund managers is only their reading-list.
I see the confirmatory-bias in your approach. You have picked up the oldest WB speech so you could say it worked for a longtime!! Either you haven’t read all of WB’s letters/speeches or you are being dishonest enough just to appear pure and upright in this forum (I think other readers would know what I am talking about here).
So it all comes back to WB isn’t it. My bad, I shouldn’t have done that.
Trekker - What I practise in my real life is what I learned in L3, mostly. But no point explaining that to you because I am not sure how much you will appreciate it. For one, you too stuck on the price debate from a narrow perspective.And two, It could be because of your fresh-L2 mind. I rather you read L3 entirely from scheweser or CFA (someone else recommended this in this thread). You are an avid reader. So sparing your time for L3 is not a sin. Don’t judge a book half-way!! By the way, are you an L2 candidate or did you just clear L2 in June 2012?
This is simple, really. All I am looking for is an explanation why you think buying equities for 50 cents on the dollar is a ‘backward rationalising technique’. Let’s keep it constructive and objective with real facts and/or examples. Refer to your earlier comments below:
No macro impacts. Well, the definition of price is correct if you are a fan of EMH.