Understanding Of Stock Market
The hedge fund master George Soros summed it up well by saying that "the prevailing wisdom is that markets are always right; I assume they are always wrong." The prevailing wisdom of market efficiency is one way to view markets. In this view, price changes are due almost exclusively to changes in fundamental values. Therefore, a diversified selection of stocks with different pricing behaviors compared to the overall market makes the most sense. The contrary view says that lots of price changes occur for nonfundamental reasons. The goal here is to identify those companies whose prices are below their business value. This perspective calls for thinking about individual businesses rather than the overall market.
The next two chapters offer the alternative foundations of these two competing ways to think about markets. Chapter 2 is a history of how the efficient market idea came into being. Chapter 3 is an account of evidence that contradicts EMT on its own terms. If you are already a skeptic of market efficiency, you can skip these two chapters as a practical matter (though they contain valuable insights on the merits of the competing views). If you are an efficiency devotee, you should read them and be prepared to change your mind.
Either way, Chapter 4 assesses the current environment for clues concerning whether the direction in which we are heading is better described by the efficient market idea or by what might be called the "chaotic" market idea. It finds that we are heading toward less rather than more efficient markets. The rest of the book adopts the view of the investment masters that stock markets are not perfectly efficient and provides the equipment you need to take advantage of the inefficiencies.
Buffett and other outstanding investors, including Peter Lynch, know that an intelligent appraisal depends on your ability to understand a business. This gives you a basis for gauging points all these top investors consider crucial, such as a company's competitive strength, brand power, and ability to develop new products profitably.
The investment giants (not monkeys) don't worry much about whether their investments end up concentrated in certain companies. For example John Neff, the portfolio manager of the Windsor Fund from 1964 through 1995, generated returns exceeding the average by a steady 3% annually and did so while sometimes allocating as much as 40% of the fund into a single business sector. Buffett's Berkshire Hathaway is a wonderfully diverse collection of outstanding businesses, but that diversity was an accidental by-product of the tremendous growth in the capital it deployed rather than a conscious effort to participate in lots of different businesses or sectors.
This cast of illustrious investors extends the commonsense understanding of markets and businesses to the analysis of business fundamentals. Chief among these factors are economic characteristics such as strong financial condition, earnings stability and growth, strong sales and profit margins, and large amounts of internally generated cash to fund growth as opposed to a continuing reliance on external financing sources. These investors also pay attention to the quality and integrity of management, looking for
companies which consistently maximize the full potential of a business, wisely allocate capital, and channel the rewards of this success to shareholders. They emphasize the importance of exceptionally competent managers who own substantial amounts of equity in their own companies and can rapidly adapt to dynamic business conditions. They also believe that managerial depth and integrity include assuring good relations with labor and promoting an entrepreneurial spirit.
