We are living in unpreced e n t e d times. Most markets including stocks, commodities, real estate and art have seen an increase in asset prices that are unparalleled in history. Many of these markets are historically at their highest levels and investors are struggling to figure out strategies for the future. With media and technology support there is a lot of coverage on this subject.
In this context, I must acknowledge that this book unlike many others focuses not on investment strategies or on making easy money but on assessment of the strengths and weaknesses of investment strategies and how one can improve the effectiveness of using them. The thought process is best summed up by what the author has to say: “Every investment story has its strong points and its weak ones. While you can rest assured that you will be given a detailed analysis of the strengths, proponents of the strategy almost most never talk about its weaknesses. To use an investment strategy effectively, though, you need to be just as informed about its limitations as you are about its potential promise.”
I really liked the manner in which Aswath Damodaran has identified the so-called investment fables and then researched each one of them and provide insights on (a) what the idea is really all about, (b) how and when best they can be used and (c) the times to avoid using the strategy. This aspect is best illustrated in chapter 11 that looks at arbitrage opportunities in the market. The three categories of arbitrages are clearly outlined and enough evidence is provided of the real depth in those opportunities (if they really exist!).
The book is split into three parts—one for the conservative and cautious investor, one for the aggressive and growthoriented investor, and one for the covetous and greedy trader. Each chapter starts with a story, along with its academic or theoretical basis, followed by his analysis of when and why it works, and when it does not. He insists that the book is not meant to promote any of these fables or dismiss any of these stories—it is to inform the investor and leave the decision-making to him. Though his analysis is entirely done on the American markets, we get a fair idea of the principles and can run similar filters in the Indian scenario.
For the risk averse, the first fable is the most popular of them all — high-dividend stocks. Benjamin Graham and Warren Buffett belong to this school of investment thinking. Damodaran rightly questions whether high-dividend stocks are bonds with a price appreciation and offer the best of both worlds (steady income and capital gain) to the investor. In an ideal unreal world of Merton Miller and Franco Modigliani, the dividends do not really matter as the stock is priced rightly before and after them. But the surety of taxes calls for the other side of the case, when dividends have a positive effect on the stock.
The second story is another popular one— low P/E stocks—how they suit value investors and bond investors, and how the peer group comparison makes them good investments. The third fable in this part talks about the bargain of low price/book value stocks. The idea behind this is that accountants estimate price better than the market and that the liquidation value is essentially the book value.
For the growth stories, he starts with the basic argument that growth stocks are the best bets for high pay-offs and the trick is in selecting the right stocks. Of course, Peter Lynch is the hero of growth investing. The next fable is the contrarian story when the worst is behind the stock. This takes care of investor irrationality, when the crowd is not so wise, as is the case during market bubbles. This section also talks about the story of the next big thing. Though a large per cent of mergers have failed, the market values acquisitions mostly in a positive way and boosts these stocks. This is explained in the last fable of this section. The last section starts with the sure story of arbitrage and discusses the short life of such opportunities. This is the very reason good arbitrage opportunities are very tough to spot.
Damodaran describes the best fable of them all in his penultimate chapter. Stocks always win in the long run. As the famous British economist John Maynard Keynes said, “In the long run, we are all dead.” The long term is not defined clearly and there have been periods of 20 years and more when stocks have performed badly as compared to debt instruments.
The author has provided very interesting insights for even the lay investor by summarising key points at the end of the book into a neat chapter titled “Ten Lessons for Investors”.
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