The inefficient market makes
many mistakes in pricing stocks. These mistakes result in tendencies. Stocks with
particular characteristics tend to produce premium returns.
The market has a map with
topography measured in expected return. There are places to go on that map that are evil.
If you go there, you will underperform badly in the long run. There are good places, too.
Go there and you will be rewarded.
In this book, you will learn
how to measure the payoffs to stock characteristics (factors). My book The New Finance:
The Case for an Over-reactive Stock Market22 is about the positive payoff to cheapness. In
this book, we will reconfirm the critical importance of cheapness. However, we will also
discuss, among other things, the payoffs to risk, liquidity, profitability, and a stock's
performance in past periods.
And, in the tradition of The
New Finance, we shall seek reasonable explanations for these payoffs. Some of these
explanations are consistent with rational behavior. However, the contractual environment
in which this behavior takes place is, itself, irrational, creating agency problems that
induce the behavior. Some payoffs are rooted in purely irrational human behavior. For
these, we look toward the field of psychology.
You will also discover a new
kind of stock.
You've probably heard of
growth stocks and value stocks. Both reside at different places on the market's map. But
there are other places on the map where few have ever gone.
Such as the land of Super
Stocks.
A Super Stock portfolio has
the following characteristics: The companies in the portfolio are, on average, big,
liquid, and well-known. They have low risk, and they are financially sound. They are
highly profitable in all dimensions. And while they have had strong relative performance
over the past year, they are still selling at dirt-cheap prices relative to their cash
flow, earnings, and dividends.
This is a dream profile. It
is the profile of a portfolio that can be expected to produce the best returns in the
future.
No individual stock has the
complete profile. If a stock were complete, the inefficient market would price it up until
it was expensive rather than cheap.
Nevertheless, it is easy to
construct a complete portfolio by assembling incomplete stocks that have components of the
complete profile.
Want to learn how to build
such a portfolio?
Want to learn what pays off
and why?
Keep reading.
137 STR.
ISBN 0-13-032366-7