Market Timing based upon Technical Indicators

In chapter 7, we examined a number of chart patterns and technical indicators used by analysts to differentiate between under and over valued stocks. Many of these indicators are also used by analysts to determine whether and by how much the entire market is under or over valued. In this section, we consider some of these indicators. In chapter 7, we looked at evidence of negative long term correlation in stock prices - stocks that have gone up the most in recent periods are more likely to go...

Technical Indicators and Charting Patterns

Over the years, technical analysts have developed hundreds of technical indicators and detected dozens of chart patterns that they contend help them forecast future price changes. While we cannot describe or even list all of them, we can categorize them based upon the nature of irrationality that we attribute to markets. Consolidating all of the irrationalities that have been attributed to financial markets, we have created five groupings Market participants over react to new information If...

Dividends and Equity Valuation

When valuing equity investments in publicly traded companies, we could argue that the only cash flows investors in these investments get from the firm are dividends. Therefore, the value of the equity in these investments can be computed as the present value of expected dividend payments on the equity. Value of Equity (Only Dividends) - The mechanics are similar to those involved in pricing a bond, with dividend payments replacing coupon payments, and the cost of equity replacing the interest...

Ben Graham The Father of Screening

Many value investors claim to trace their antecedents to Ben Graham and to use the book on Security Analysis that he co-authored with David Dodd, in 1934 as their investment bible. But who was Ben Graham and what were his views on investing Did he invent screening and do his screens still work Ben Graham started life as a financial analyst and later was part of an investment partnership on Wall Street. While he was successful on both counts, his reputation was made in the classroom. He taught...

Introducing Uncertainty into Valuation

We have to grapple with two different types of uncertainty in valuation. The first arises in the context of securities like bonds, where there is a promised cash flow to the holder of the bonds in future periods. The risk that these cash flows will not be delivered is called default risk the greater the default risk in a bond, given its cash flows, the less valuable the bond will become. The second type of risk is more complicated. When we make equity investments in assets, we are generally not...

Market Efficiency Definition and Implications

Market efficiency means different things to different people. To those who are true believers in efficient markets, it is an article of faith that defines how they look at or explain market phenomena. To critics, it indicates an academic notion of infallible and supremely rational investors who always know what the true value of an asset is. In this section, we would like to first define what we believe an efficient market is and then follow it up with implications for investment strategies. In...

Broader Measure of Cash Flows to Equity

There are two significant problems with the use of just dividends to value equity. The first is that it works only cash flows to the equity investors take the form of dividends. the spreadsheet that contains the valuation of Coca Cola. It will not work for valuing equity in private businesses, where the owners often withdraw cash from the business but may not call it dividends, and it may not even work for publicly traded companies if they return cash to the equity investors by buying back...

The Fundamentals Behind Multiples

One reason commonly given for relative valuation is that it requires far fewer assumptions than does discounted cash flow valuation. In my view, this is a misconception. The difference between discounted cash flow valuation and relative valuation is that the assumptions that an analyst makes have to be made explicit in the former and they can remain implicit in the latter. It is important that we know what the variables are that drive multiples, since these are the variables we have to control...