Sunday, February 27, 2011

You Can Be A Stock Market Genius: Chapter 2

Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities

Greenblatt discusses some requirements that investors must follow if they plan to outperform in the market. First, they need to do their own work. The opportunities offering the best rewards will not be covered by the media or Wall Street. Investors must also not take advice from others, including brokers and analysts. These advisers are paid based on how much they generate in business for their firms, and not by how well you do.

Greenblatt also argues against too much diversification. For one thing, he cites research suggesting that as the number of stocks in the portfolio increases, the benefits of diversification drop quickly. For example, he argues that the diversification benefit between owning eight stocks and owning five hundred stocks isn't that large; but the benefit of owning eight stocks is that you can really pick your spots in terms of choosing stocks with potential upside that is higher than the potential downside. A better method of diversifying, Greenblatt argues, involves keeping some money out of the stock market (e.g. in cash, bonds, home equity etc.).

Greenblatt also advises that investors avoid looking at an investment in terms of its upside potential. Instead, look at the downside, and employ a margin of safety with all purchases. If you look after the downside, the upside usually takes care of itself.

Finally, Greenblatt discusses the fact that there are many ways to make money in the stock market. Every investor cannot possibly participate in even a fraction of the opportunities that are out there. Furthermore, there are many different methods by which investors can be successful. For example, Ben Graham used a quantitative, statistical approach, whereas Warren Buffett identifies and exploits competitive advantages. Greenblatt goes through a number of situations in the following pages that demonstrate the ways in which enterprising investors can profit from the market.

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