Friday, April 22, 2011

The Aggressive Conservative Investor: Chapter 4

Martin Whitman founded Third Avenue Value Fund some twenty years ago. Over that time period, the fund has beaten the returns of the S&P 500 by several points annually. In The Aggressive Conservative Investor, Whitman collaborates with Martin Shubik to discuss a concept that they call "safe and cheap" investing.

The authors now take up the topic of modern portfolio theory, where it is assumed that prices properly reflect information relevant to a stock. The following passage from a textbook is critiqued:

"There are thousands of professional fundamental security analysts at work in the United States . . . As a result of the efforts of this army of professional fundamental analysts, the price of any publicly listed and traded security represents the best estimate available at that moment of the intrinsic value of that security. In fact, the fundamental analysts do such a good job, there is no reason for anyone who is not a full time professional to bother with fundamental analysis."

The authors flatly disagree with the above statement. They even go so far as to say that there aren't many competent analysts out there, certainly not enough to be able to render every security to its proper price. This is particularly true because many of the analysts out there are looking to determine where the stock price will go, rather than focusing on the fundamental value of the business.

The authors do argue that the market is efficient in some sense. For those who attempt to generate short-term returns, for example, empirical data suggest a "random walk" to prices. Furthermore, certain markets, such as the high-grade (low yield) corporate bond market are pretty efficient in the authors' opinions. However, the authors argue that it has not been proven that all investors interpret the public evidence correctly such that long-term gains in equities and other instruments cannot be realized due to market mis-pricings.

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