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Target Based Strategies
Preannouncement investing invest in target after announcement, but before completion invest in good mergers and short value destroying ones
Earnings forecast quality
Predicting the future Short term (next quarter) better than long term (5 years) Trend is your friend bias Errors caused by difficult to forecast macro events Top Analysts (consistency, conflicts of interest, celebrity, and hedge fund recruitment)
Activist Investing: Mechanisms for Change
Proxy contests: Investors contest incumbent managers for proxies they then use to elect their nominees for directors and change policy. Hostile acquisitions: Hostile acquisitions are more likely to be mounted on poorly managed, poorly run firms and are far more likely to be successful.
13F Filings
SEC Form 13F is a quarterly report that is filed by institutional investment managers with $100 million or more in equity assets under management 13F reports only require funds to report their long positions, in addition to their put and call options, American Depositary Receipts (ADRs), and convertible notes. mutual funds, hedge funds, pension funds, and insurance companies could provide insights into what the "smart money" is investing in
Emerging Alternative data
Satellite Imagery Geolocation Social Media Natural Language Generation POS & Credit Card Transactions Website Scraping
Growth Investor Variations
Small cap investors IPO investor Growth criteria focused equity screening activist growth investors
IPO Returns
The average initial return is 15.8% across a sample of 13,308 initial public offerings However, about 15% of all initial public offerings are over priced.
Downfalls of Market Timing
Being wrong Time out of the market increased transaction costs tax implications
Determinants of TA Success
1. Behavioral basis: You can modify or abandon the indicator if the underlying behavior changes. 2. Don't trust, verify 3. Timely trading 4. Goldilocks time horizons 5. Control trading costs
Contrarian Indicators: Shift in Supply & Demand
1. Breadth of the market: This is a measure of the number of stocks in the market which have advanced relative to those that have declined. A market advance with less breadth is an indication of a demand shift (down) 2. Support & Resistance Lines: If either is broken, the market is poised for a major move. 3. Moving averages: A moving average line smooths out fluctuations and enables the chartist to see trends in the stock price. How that trend is interpreted then depends upon the chartist. 4. Volume shifts: Some technical analysts believe that there is information about future price changes in trading volume shifts.
Earnings Announcements Strategies
1. Buy immediately on the announcement, attempting to profit from intraday slow price adjustment 2. Play the drift: buy stocks with large positive earnings surprises 3. Accuracy in forecasting
What can go wrong with P/E?
1. Companies with high-risk earnings 2. Tax costs 3. Low growth
Assumptions of Technical Analysis
1. Market Value or price is solely a function of supply of an investment, how many shares, bonds or units are available. 2. The supply demand relationship is governed by rational factors such as fundamentals and emotions 3. Disregarding minor fluctuations in the market, stock prices tend to move in trends which persist for an appreciable length of time. 4. Changes in trend are caused by shifts in demand and supply
Categories of Technical Analysis
1. Market participants overreact to new information 2. Market participants are slow learners 3. Shifts in Supply & Demand (Investors change their minds frequently and often irrationally) 4. Certain investors lead markets 5. There are external forces that govern up and down movements in markets that override fundamentals and investor preferences
Graham's value screen
1. PE of the stock has to be less than the inverse of the yield on AAA Corporate Bonds 2. PE of the stock has to be less than 40% of the average PE over the last 5 years. 3. Dividend Yield > Two-thirds of the AAA Corporate Bond Yield 4. Price < Two-thirds of Book Value 5. Price < Two-thirds of Net Current Assets 6. Debt-Equity Ratio (Book Value) has to be less than one. 7. Current Assets > Twice Current Liabilities 8. Debt < Twice Net Current Assets 9. Historical Growth in EPS (over last 10 years) > 7% 10. No more than two years of negative earnings over the previous ten years.
Value Investing: The Screeners
1. Price to Book ratios: Buy stocks where equity trades at less than book value or at least a low multiple of the book value of equity. 2. Price earnings ratios: Buy stocks where equity trades at a low multiple of equity earnings. 3. Revenue multiples: Buy stocks that trade at low multiples of revenues 4. Dividend Yields: Buy stocks with high dividend yields.
Tips for value screens
1. Screen for cheapness 2. screen for low risk 3. screen for high growth 4. screen for high quality growth
Financial bubbles
A bubble is a large and often long lasting upward deviation of an asset's price from its fundamental value Bubbles usually arise from either exaggeration or unwarranted extrapolation of genuinely promising trends
The Value Investors' Tools for Success
Accounting checks The Moat: The "moat" is a measure of a company's competitive advantages; the stronger and more sustainable a company's competitive advantages, the more difficult it becomes for others to breach the moat Margin of safety: MOS is the buffer that value investors build into their investment decision to protect themselves against risk
Activist Investing
Activist investors invest in companies with a value and/or pricing gap and provide the catalysts for closing the gaps
Who is a Growth Investor?
An investor who buys growth companies where the value of growth potential is being under estimated. A growth investor, believes that their competitive edge lies in estimating the value of growth assets, better than others in the market.
Sell Side Analysts
Analysts operate at the nexus of private and public information. To the extent that they know something about the company that the regular investor does not, their recommendations should convey information to the market Analysts are industry specialists who can use their knowledge to better assess value for individual companies Analysts make and consistently revise earnings forecast for firms They also make buy/hold/sell recommendations and price targets
Market Timing Strategies
Asset Allocation Rebalencing: Regularly adjust weights to reestablish optimal asset allocation Sector Rotation: Shift money within the equity market from sector to sector based on future expectations of economic and market growth. Switch Investment Styles: moving money based on expected market performance (i.e., value to growth) Market Speculation: Speculate on market direction, using either leverage or derivatives to magnify profits
Mean Reversion Measures
Based upon the assumption that assets have a normal range that they trade at and any deviation from the normal range is an indication that assets are mispriced. Stocks: the normal range is defined in terms of PE ratios Bonds: the normal range is defined in terms of interest rates
Market Slow Learners: Momentum Indicators
Basis: The argument here is that markets learn slowly. Thus, investors who are a little quicker than the market in assimilating and understanding information will earn excess returns
What can go wrong with Revenue Multiples?
High leverage Low margins
Acquisitions
Biggest price movement is on the acquisition announcement (not on the date completed) Significant excess returns can be made in the weeks leading up to the announcement (info leaked to some investors). About half the premium is already incorporated in the target's stock price by the announcement date Price drops for about half of all acquirers
Warren Buffett's Principles
Business Tenets: - business should be simple and understandable - firm should have consistent operating history, stable and predictable earnings - favorable long term prospects Management tenents: - managers of company should be candid - put a premium on managers he trusted - managers of the company should be leaders not followers
Pre-announcement Investing
Characteristics of typical target firm in a hostile takeover: 1. Underperformed compared to the industry and market 2. Less profitable than other firms in the industry in the years preceding the takeover 3. Low insider ownership
Lynch's Favorable Company Characteristics
Company name, product, or service is boring. The company does something disagreeable or depressing, or there are rumors of something bad about the company The company is a spin-off A fast growing company in a no-growth industry. The company is a niche firm controlling a market segment or that would be difficult for a competitor to enter. Companies that produce a product that is purchased regardless of the economic cycle. The company is a user of technology Low institutional holdings
Post-announcement investing
Focus on: - Acquisitions of a smaller firm (not equal sizes) - Cost-saving mergers (not growth synergies) - Small private companies for consolidation - Hostile acquisitions - Same industries (not conglomerates - CEO of target will be replaced in the first year.
Periods when Growth Outperforms Value
Growth historically has worked well when the yield curve is flat or downward sloping
Determinants of Success in Small-Cap Investing
Have a long time horizon. The small cap premium seems to hold over long time periods, but can disappear for many years at a time. The importance of discipline and diversification become even greater
Earnings Growth Screens
Historical growth: buyingstockswithhigh historical earnings growth show no evidence of generating excess returns because - earnings growth is volatile - substantial mean reversion in earnings growth rates - revenue growth is more predictable than earnings growth Expected earnings growth: Picking stocks that have high expected growth rates in earnings does not seem to yield much in terms of high returns, because the growth often is overpriced.
Lynch's Unfavorable Company Characteristics
Hot stocks in hot industries Companies with big plans that have not yet been proven Diworseification: Pursuing bad or diversifying acquisitions Companies in which one customer accounts for 25% to 50% of their sales.
2008 - Bursting of Two Bubbles
Housing Bubble - Movement to Zero Down - Adjustable rate mortgages - Sub-prime & Liar Loans - Transfer of risk - Home Equity Loans (second mtge) & HELOCs - Belief that home prices always rise
Can Bad Companies be Good Investments?
If the market is exaggerating the value of the firm, this strategy can lead to poor returns even if the firm delivers its expected growth. It is only when markets under estimate the value of firm quality that this strategy stands a chance of making excess returns. There is evidence that well managed companies do not always make great investments. For instance, excellent companies (using the Tom Peters standard) earn poorer returns than "unexcellent companies".
Earnings Announcements Strategies
In Efficient Markets, there should be instantaneous reaction to earnings reports. Wall Street focuses on short term quarterly earnings numbers (voting machine VS. fundamentals). Earnings announcements convey information to financial markets about their current and future prospects. The magnitude of the info, and the size of market reactions, should depend upon how much the earnings report exceeds or falls short of investor expectations.
Market Timing
In a 1992 study, Shilling studied returns if investors would have been able miss the 50 worst performing months from 1946-1991. Annual returns would have almost doubles from 11.2% to 19%
Value Investing: The Contrarians
In contrarian value investing, you begin with the proposition that markets over react to good and bad news. Consequently, stocks that have had bad news come out about them (earnings declines, deals that have gone bad) could be undervalued.
Financial Crisis of 2008
Inflated asset prices excessive leverage bad banking practices - Systematic risk - structured products - credit default swaps
Private Information
Insiders are managers, directors or major stockholders (5% or more) in firms. While they are constrained from trading ahead of information releases, they can still legally buy or sell stock in their companies.
Information
Investors attempt to assess the value of an asset based upon the information that they have about that asset at a point in time. Different investors will arrive at different assessments of value for the same asset Information affects stock prices
Stock Price Movement around Earnings Releases
Investors should expect stock prices to go up when earnings are better than expected and go down when they are worse than expected What is surprising is the drift in the days after the announcements, since it suggests that investors can trade after announcements and still generate profits.
Sell side analysts cover
Larger market cap companies Greater institutional holdings Liquid stocks
Who is a Value Investor?
Lazy definition: anyone who invests in low PE stocks is a value investor investors interested in buying stocks for less that what they are worth want to buy a business only if it trades at less than the value of the assets in place and view growth as an added benefit but not a requirement
Value Investing: Activist Investing Types
Lone Wolves: Individual investors with substantial resources and a willingness to challenge incumbent managers. Institutional Investors: While most institutional investors prefer to vote by selling stock in companies that are poorly managed, a few have been willing to challenge managers at these companies and push for change. Activist Hedge & PE Funds: Investing in (and sometimes buying outright) companies that they feel are managed less than optimally and changing the way they managed.
Information in Earnings Forecasts
New firm-specific info since last earnings report Macro Economic Information that could impact future growth Info revealed by competitors, customers, suppliers Private information Public info other than earnings (i.e., margins, asset turnover, earnings retention) that is useful in predicting future growth
Market Timing strategies
Non Financial Indicators Technical Indicators Mean Reversion Indicators Rebalancing Refusal to Timing - Dollar Cost Averaging
Small Caps
One of the most widely used passive growth strategies is the strategy of investing in small- cap companies. There is substantial empirical evidence backing this strategy, though it is debatable whether the additional returns earned by this strategy are really excess returns. small cap stocks have a return premium
Investors who Lead Markets
Specialist Short Sales: The assumption is that specialists have more information about future price movements than other investors. Investors who use this indicator will often sell stocks when specialists do, and buy when they do. Insider Buying & Selling: The ratio of insider buying to selling is often tracked for stocks with the idea that insiders who are buying must have positive information about a stock whereas insiders who are selling are likely to have negative information.
Non-Financial Indicators
Spurious Indicators: Remember correlation does not = causation Feel Good Indicators: Measure how happy investors are feeling Hype Indicators: Attempt to measure whether there is a stock bubble Super bowl: AFC win = market decline
Other corporate events
Stock split announcements and the signaling affect (negative on bid ask spread) Dividend Changes Share Buybacks Being added or removed from a major equity index (i.e., S&P 500)
Value Investing Conclusion
The common theme of value investing is that firms that are out of favor with the market, either because of their own performance or because the sector that they are in is in trouble, can be good investments.
Dangers in Growth Investing
The cost of growth: Growth, by itself, can be good, bad or neutral for value To generate growth, firms have to reinvest money The effect of growth then becomes a net effect, which weighs off the benefits of having higher earnings in the future (from the growth) against lower cash flows today.
PE Normal range?
The implicit belief here is that there is a normal range for PE ratios. If the PE rises above the top end of the range, stocks are likely overvalued. At the bottom of the range they are likely to be undervalued.
Dow Theory
The market is always considered as having three movements, all going at the same time 1) narrow movement (daily fluctuations) from day to day 2) short swing (secondary movements) running from two weeks to a month 3) main movement (primary trends) covering at least four years in its duration
Variant on Earnings Multiples: EV/EBITDA
The proponents of EV/EBITDA argue that it is better than PE, because it is less impacted by financial leverage and focused on a cash flow measure, rather than earnings.
Relative Strength:
The relative strength of a stock is the ratio of its current price to its average over a longer period (i.e., six months). The rule suggests buying stocks which have the highest relative strength (which will also be the stocks that have gone up the most in that period). RSI is used to recognize potential turning points to help make entry/exit decisions. RSI > 70 indicates an overbought condition, which suggests that the security has moved too high too quickly. Breaking back below 70 indicates a correction. RSI < 30 indicates an oversold condition suggests the security has moved too low too quickly. Breaking back above 30 indicates a correction.
Fibonacci Retracements
The theory of percentage retracements is based on the observation that after a period of market movement in one direction, prices tend to retrace a portion of the previous trend before resuming the move in the original direction.
IPO strategy
The under pricing of IPOs, on average, seems to offer an investment opportunity to investors. Why not try to invest in every IPO that comes along? 1. Selection bias 2. feast or famine 3. timing is everything
13F Filings Issues
They do not disclose short positions, foreign equities, or fixed income exposure. 13F filings are not necessarily reliable because no one at the SEC analyzes the content for accuracy and completeness (Bernard Madoff can testify to this). They are backward looking and can be filed up to 45 days after the end of a quarter. Most investors submit their 13Fs as late as possible. Therefore, a position in a new 13 filing could have been made more than four months prior to the release.
Technical Analysis of Stock Trends by Edwards & Magee
Three Principles 1)Stock prices tend to move in trends 2)Volume goes with the trends 3)A trend, once established, tends to continue in force
Strategies for Legal Information Trading
Trade ahead of the news (or on rumors) Trade on the news trade after the news
Possible Explanations for the Small-Cap Premium
Transactions costs of investing in small stocks is significantly higher than the transactions cots of investing in larger stocks, and the premiums are estimated prior to these costs. Additional risks: - estimation risk - less information - Illiquidity
Investment Bubbles
Tulips 1634-1637 Mississippi and South Sea Stocks (1720): Speculation and scandal in the shares of companies linked to growing global trade Rails: Financial Panics in the U.K. (1840s) and U.S. (1880s & 1890s): appear after booms in railroad stocks and bonds U.S. Stocks (1920s): Tech innovation of cars, planes, and electrical appliances. U.S. stock bubble culminates in Black Tuesday in October 1929, leading to the Great Depression Junk Bonds (1980s) Japanese Stocks and Real Estate (1980s and 1990s): Bubble lead to the "Lost Decade" Dotcom (1990s): A speculative mania in new internet stocks lead to a recession. U.S. Housing (2000s): Rapidly rising home prices and securitization, lead to a global financial meltdown and global recession.
Activist Growth Investing
Unlike activist value investing, which is usually directed at mature companies, late in the business life cycle, activist growth investing has to happen earlier in the cycle. Activist growth investing takes the form of Venture Capitalists providing capital to young, start up companies. Evolution of the Unicorns VC Batting Average
Active Growth beating Active Value
When measured against their respective indices, active growth investors seem to beat growth indices more often than active value investors beat value indices. - selection bias - valuation difficulty - sector/company specific knowledge
Timing & costs
With any information based trading strategy, you do have to make judgments about timing: - When you will trade - How quickly you execute - How long you will hold the investment
PE Ratios and Expected Growth Rates
Would a strategy to buy stocks that trade at a low ratio of PE to expected growth rate (PEG), relative to other stocks work? A Morgan Stanley study found that investing in stocks with low PEG ratios did earn higher returns than the S&P 500, before adjusting for risk. when rates are low, screen will uncover many risky stocks
Lynch's screening criteria
Year-by-year earnings: Look for stability and consistency, and an upward trend. P/E ratio should be in the lower range of its historical average. P/E should be below the industry average. P/E of half the level of historical earnings growth is attractive; twice the growth rate are unattractive.
Trend Lines
You look past the day-to-day movements in stock prices at the underlying long-term trends. The simplest measure of trend is a trend line.
MACD
a trend-following momentum indicator that combines a moving average crossovers with the elements of overbought/oversold metrics. based on the convergence and divergence of 2 exponential MAs. The FAST moving average is more sensitive to price changes, while the SLOW moving average has a smoothing effect as the calculation is based on longer term movement. The MACD then will look at whether the two moving averages are converging or diverging
Bollinger Bands
bands two standard deviations above and below a 20 day simple moving average. The interpretation is the price of an asset should remain within the bands about 95% of the time This study tries to identify periods of high and low volatility, as well as periods when prices are at extreme and possibly unstable levels. The width of the bands become narrower during less volatile periods and wider during more volatile periods.
Chart Formations
graphical representations of unchanging diverse human behavior by investors indicated by price change a visualization of the human mind and emotions as expressed in the financial markets.
Contrarian Investors
invest in companies that others have given up on, either because they have done badly in the past or because their future prospects look bleak. You are implicitly assuming that markets over react.
Activist value investors
invest in poorly managed and poorly run firms but then try to change the way the companies are run.
Markets Overreact: Contrarian Indicators
people tend to overreact to unexpected and dramatic news events 1. Odd-lot trading: The odd-lot rule gives us an indication of what the man on the street thinks about the stock (As he gets more enthusiastic about a stock this ratio will increase).Based on the assumption that the small individual investor is always wrong. Therefore, if odd lot sales are up - that is small investors are selling stock - it is probably a good time to buy. 2. Mutual Fund Cash positions: Historically, the argument goes, mutual fund cash positions have been greatest at the bottom of a bear market and lowest at the peak of a bull market. Hence investing against this statistic may be profitable. 3. Investment Advisory Opinion: This is the ratio of advisory services that are bearish. When this ratio reaches the threshold (i.e., 60%) the contrarian starts buying.
Passive Screeners
screen for stocks that have characteristics that you believe identify under valued stocks. You are hoping to find market mistakes through the screens.
Revenue Multiples Screens
some look at companies that trade at low multiples of revenues as cheap Studies seems to indicate that low revenue multiple portfolios outperform the market but do not outperform low PE or low PBV ratio portfolios.
Elliot Wave Theory
that the market moves in waves of various sizes, from those encompassing only individual trades to those lasting centuries, perhaps longer
The Fall out
•JP Morgan buys Bear Stearns •Fannie Mae and Freddie Mac put into conservatorship •Lehman Brothers allowed to FAIL •Merrill Lynch bought by BofA •Government lends $85 billion to AIG •Money market panic freezes short-term financing market
