Saturday, March 14, 2009

Even Buffett Isn't Perfect: Chapter 3

In this chapter, the author discusses some of the academic research devoted to studying the performance of value versus growth stocks. As defined earlier, value stocks are said to be those with the lowest P/E and P/B values, while growth stocks are those at the opposite end of the spectrum.

The author concludes that value stocks do outperform growth stocks over time, citing and discussing several studies. It is worth noting that value stocks do not outperform in all periods, however, the longer an investor sticks to value investing, the more likely he is to outperform the market.

Within the value stocks, the author determines that the small-cap subset outperforms the most. Buffett clearly agrees, as he has stated many times that as Berkshire gets larger, he cannot possibly match the returns he was able to achieve back when he was starting out.

Though Buffett and many value investors tend to buy and hold, the author does argue that traders do provide a valuable service. They offer liquidity to the market which would not otherwise be present, thus lowering trading costs (lower bid ask spreads, more scale for brokers etc) for all investors. It is also noted that traders prefer growth stocks since these are the stocks that perform well for momentum investing. Academic research is cites which demonstrates that momentum investing can be used successfully.

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