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Why Value Investors Have The Edge In The Short Term

Why Value Investors Have The Edge In The Short Term via George Athanassakos, The Globe And Mail

Are markets efficient? Do stock prices discount all publicly available information, correctly and accurately? Is the only way to earn higher returns to take higher risk? It all depends who you ask. Academics who study and teach modern portfolio theory will say, “Of course markets are efficient.” But practitioners who put their money where their mouths are and make a living this way, they will say, “Of course markets are not efficient.”

If you side with academics, you must invest in index funds, and if you side with practitioners, you should invest in stock pickers and actively managed portfolios managed by portfolio managers who aspire to beat the index.

But are academics that different from, say, value investors? In fact, they are not. They both believe that markets are efficient in the long run. Where they disagree is whether the market is efficient in the short run. And if you look at it this way, one cannot seriously think that markets are efficient in the shorter term.

Market efficiency originated at the University of Chicago, where academics in the 1970s produced research which demonstrated that markets were efficient. Stock picking at that point started to lose its lustre. But fortunately for stock pickers, other academics in the 1980s started to produce research which showed that there were predictable patterns in stock prices, such as the January Effect and the “sell in May and go away” effect, and that different strategies produced unusually high returns even after adjusting for risk, such as the size effect, the value effect, the volatility effect and so on.

At the same time, other market participants also started to become vocal against market efficiency.

Respected value investor Martin Whitman of Third Avenue penned recently: “There is a belief that securities markets reflect price equilibrium … and prices of securities are right. What nonsense!”

Warren Buffett has indicated that he is willing to endow chairs to academics to teach market efficiency so that “more people would sell what he buys and buy what he sells.” Nobel Prize winner Robert Shiller once called market efficiency “one of the most remarkable errors in the history of economic thought.”

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Why Value Investors Have The Edge In The Short Term

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  • Serenity Stocks

    Benjamin Graham was a scholar and professional investor who mentored investing legends such as Warren Buffett, William J. Ruane, Irving Kahn and Walter J. Schloss.

    Warren Buffett wrote the preface to Graham’s book – The Intelligent Investor – in which he calls it “by far the best book about investing ever written.”

    Graham’s first recommended strategy – for novice investors – was to invest in Index stocks.

    For more serious investors, Graham recommended three different categories of stocks – Defensive, Enterprising and NCAV – and 17 qualitative and quantitative rules for identifying them.

    For professional investors, Graham described various special situations or “workouts”.

    The first requires almost no analysis, and is easily accomplished today with a good S&P500 Index fund.

    The last requires more than the average level of ability and experience. Such stocks are also not amenable to impartial algorithmic analysis, and require a case-specific approach.

    But Defensive, Enterprising and NCAV stocks can be reliably detected by today’s data-mining software, and offer a great avenue for accurate automated analysis and profitable investment.

    Most of Buffett’s investments are what Graham defined as Special Situations.

    Warren Buffett once gave a speech at Columbia Business School describing how Graham’s record of creating exceptional investors (such as Buffett himself) is unquestionable, and how Graham’s principles are everlasting. The speech is now known as “The Superinvestors of Graham-and-Doddsville”.

    August 12, 2015 at 2:48 pm


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