Stock Market Terms Flashcards
(192 cards)
1
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fungible–
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meaning that it can be purchased or traded.
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true margin of safety
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is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience.”
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To evaluate co. Graham looked at
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the value of existing assets, such as cash, inventory, and property, by examining a target company’s financial statements.
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Graham also looked at
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looked at current earnings.
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Lastly, and only in rare circumstances, Graham considered
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future profits, but only in the core competence area of a firm with a sustainable competitive advantage.
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The concept of mean reversion is a major underpinning of the value- investing philosophy. It means
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that past winners often become future losers, while past losers often become future winners.
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behavioral finance.
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the role of market psychology in investing.
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Graham’s deep value strategy Net–Net.
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pick investments was to find companies selling for less than their cash- liquidation value.
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Graham would consider it a bargain under his Net–Net deep-value approach if when
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compared this aggregate amount of cash and hard assets to the stock market value of the firm, the company was selling for less than market value
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Graham’s distinction between the enterprising investor and the defensive investor.
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The difference was based on the ability of the investor to put time and effort into the research process.
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For the defensive investor, Graham suggested
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7 factors in selecting a common stock.
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Adequate Size.
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Graham reasoned that larger firms are less likely to go out of business; that they probably have resources, scale, and experience to weather any storm.
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Sufficiently Strong Financial Condition.
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Graham defined this term as current assets at least twice the size of current liabilities. He also thought total liabilities should not be higher than working capital (that is, current assets minus current liabilities).
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Earnings Stability. Graham defined earnings stability as
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positive earnings for at least 10 consecutive years. This rule eliminates many cyclical firms and those younger than 10 years.
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A Strong Dividend Record. This criterion recommends
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20 years or more of uninterrupted dividends. This rule eliminates most growth stocks, since the vast majority don’t pay dividends.
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Organic Earnings Growth
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of at Least 33% over the Past 10 Years And eliminate businesses that are stagnant or shrinking, even if they pay dividends or generate a lot of cash.
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Moderate Price-to-Earnings Ratio.
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the current price of the stock as not more than 15 times its average earnings over the past 3 years. This number makes sense to many investors, since the long-term P/E ratio for U.S. stocks is about 15.
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A Moderate Ratio of Price to Assets.
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a moderate price-to-assets ratio as a firm trading for less than 1.5 times its book value.
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Book value
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is also known as accounting net worth. It’s equal to all of the firm’s assets minus all of its liabilities. This factor of less than 1.5 times book value also rules out most growth stocks since they often trade at a high multiple of Price to Book.
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another simple Graham
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Create a portfolio that consists of at least 30 stocks with P/E ratios less than 10 and debt-to-equity ratios less than 50%. Hold each stock until it returns 50%. If it doesn’t achieve a 50% return after 2 years, sell it no matter.
21
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Buffett’s contribution to the concept of value investing
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find high- quality companies selling at a discount and to let the moat around these companies protect his investment, enabling him to hold them for his favorite holding period—forever.
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This time-value of money, called the “float,” is a boon to an investor
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An insurer has the use of every insurance premium for a period of time—from a day to months to forever—before it has to pay a claim on someone’s behalf.
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Buffett’s moat—a
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a durable competitive advantage— a buffer around a company’s core business that makes attack difficult for the competition. Two popular approaches to analyzing a company’s moat are Porter’s 5 Forces and Morningstar’s Economic Moat Framework. bargaining power when dealing with jewelry merchants. Conversely, clothes can be manufactured fairly cheaply in many places around the world, so companies like Nike have a lot of power in their supplier relationships.
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Porter’s 5 Forces.
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a framework to help explain the impact of industry structure on performance, generally referred to as
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The threat of new entrants.
Certain businesses require massive capital to get started. The harder it is for a new firm to enter a market, the greater the competitive advantage of the firms already in that market.
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The threat of substitute products or services.
Although some products have no substitute, most industries offer a variety of substitutes. The fewer substitute products or services, the greater the competitive advantage.
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The bargaining power of customers.
The Internet has given customers great power. Best Buy went from being a dominant company to one struggling to survive because customers could search for better prices on Amazon.com and other websites.
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The bargaining power of suppliers.
The less a firm is impacted by its suppliers, the greater its competitive advantage. The De Beers cartel of South Africa controls about 35% of the diamonds produced in the world. De Beers has extraordinary bargaining power when dealing with jewelry merchants. Conversely, clothes can be manufactured fairly cheaply in many places around the world, so companies like Nike have a lot of power in their supplier relationships.
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The intensity of competitive rivalry.
Firms in the airline industry, such as U.S. Airways, went bankrupt because of intense competition. Conversely, the less intense the rivalry, the greater the competitive advantage.
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Morningstar identified
5 factors that are a framework for its research rating based to a large extent on a company’s moat.
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The first factor is the network effect.
Morningstar believes a network effect occurs when the value of a company’s service increases, as more people use the service.
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The second factor is intangible assets.
A patent is an intangible asset that provides legal protection lasting up to 20 years. A brand name is an invaluable asset that can be hard to quantify, but easy to see in action.
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The third factor is cost advantage.
The concept of a cost advantage can easily apply to many industries. For example, stories abound of Wal-Mart and Home Depot driving their smaller competitors out of business because they couldn’t match the larger firms’ low prices. Having a cost advantage also gives these companies the opportunity to raise prices without worrying about losing the bulk of their customers.
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The fourth factor is switching cost.
Imagine if you had a new alarm system installed in your house. It would be expensive to switch it for a new system, even if the new system had lower monthly fees. The same concept applies to other products.
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The fifth factor is efficient scale.
Efficient scale relates to a niche market served by a small number of companies—in some cases, only one. For example, building a hospital is a massive undertaking, so there is likely to be only one in each town or county.
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Buffett came to believe that a better approach to value investing
would be to buy high-quality companies with a moat around their businesses.
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Fisher-Price (FP) on growth stock
is like a first-round draft pick: A lot is expected and it is in great demand, so it usually sells at a high price. One reason is that a stock can split.
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The two most common tools to differentiate growth stocks from value stocks are
the price-to-earnings ratio (P/E) and the price-to-book ratio.
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P/E ratio is
the price of a share divided by its annual earnings per share. If the P/E of the market is at 15, any stock with a P/E of less than 15 would be considered a value stock, while a stock with a P/E higher than 15 would be considered a growth stock.
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price-to-book ratio
is the price per share of the stock divided by the book value—that is, the accounting value or net worth figure on the balance sheet—per share.
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high price-to-book ratio
suggests a growth stock: It’s valued in part on its future potential.
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Low price-to-book ratio indicates
a value stock: It might be undervalued relative to its intrinsic worth.
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Another way to differentiate growth from value stocks is
the average valuation level of the market. Anything above the current market average is considered to be a growth stock, while anything below average is considered a value stock.
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As a growth investor, Fisher looked for companies
with the potential to significantly grow sales for several years into the future. The quality of a firm’s sales force was one of the factors that Fisher assessed. A firm that grows sales at a faster rate than the industry is one sign of a good quality sales organization.
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Fisher also
the integrity of a target company’s management.
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Signs of quality management included the following factors:
Management talks freely to investors about its affairs when things are going well and when they’re not.
The firm is able to keep growing when a product has run its course.
The company’s research and development function, or R&D is robust
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Growth stocks typically have
above-average profit margins.
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Price is
best known for his life-cycle approach to investing. He felt that the risks of owning a stock increase when the industry it competes in matures. He wanted to buy stocks when earnings were increasing or accelerating.
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The industry life cycle typically has 4 stages
* A period of rapid and increasing sales growth.
* A period of stable growth. Consolidation tends to occur during this phase.
* Slowing growth or maturity.
* Minimal or negative growth. The industry revenues and earnings are in relative decline.
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Price’s preferred hunting ground
was the stable growth phase since
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Price differentiated between two types of growth.
The first is cyclical, where the magnitude of the industry’s growth is tied strongly to the economy. For example, during the 1950s auto sales grew sharply.
The other type is stable growth. In this case, sales are not highly dependent on the specific phase of the economic cycle. For example, health care stocks can grow strongly during a recession.
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When considering growth, Price also looked at a range of criteria:
* Superior research and development activities likely to spur future growth.
* Avoidance of cutthroat competition.
* Relative immunity from government regulation
* Low total labor costs but fair employee compensation.
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Besides high growth in sales and earnings per share, Price also wanted
stocks with at least a 10% return on invested capital
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Return on invested capital can be calculated a few ways, but one popular approach
divides net income by capital, basically the value on its balance sheet of its debt and equity.
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Return on invested capital can be calculated a few ways, but one popular approach divides net income by capital, basically the value on its balance sheet of its debt and equity.
Many industries are defined by a sort of Darwinian process of elimination for achieving high profits. Price recognized this dynamic and suggested finding the most promising company or companies in a growth industry. He also provided some insight on how to determine when a firm was losing its edge
* Companies lose patents and new inventions may make old
* The legislative or legal environment can get worse for a firm, affecting its ability to grow
* The costs of labor and raw materials also affect a firm’s profitability significantly.
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He fleshed out his ideas by carefully looking at
sales growth, earnings growth, profit margins, and return on invested capital.
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Modern portfolio theory has its roots
in Markowitz’s work in the early 1950s. It’s still called modern portfolio theory
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The Theory of Investment Value,
The price of a stock is equal to the value of its future dividends, adjusted for the time value of money. That is, a dividend of $1 today is worth more than a dividend of $1 in the future.
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formula for the variance of a weighted sum essentially
is used to calculate the variance of a portfolio—a popular measure of risk.
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Markowitz also learned about the production possibility frontier concept,
which posits that an economy makes tradeoffs in what it produces.
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The standard deviation—
the square root of variance—is one widely used measure of volatility.
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risk of a portfolio is primarily based
on the interaction of the portfolio’s holdings, not on the risk of the securities individually or in isolation.
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correlation
The mathematical term for the way two assets move with or against each other
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The art of picking a diversified portfolio
is to select securities that have low correlation and positive expected returns.
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Markowitz’s efficient frontier
| Markowitz called this curve the
the notion of the production possibility frontier and imagined a graphed curve that shows the range of portfolios that maximize return for a given level or tolerance of risk.
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The optimal portfolio
for you is the place where your indifference curve matches the efficient set of portfolios.
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Capital Asset Pricing Model or CAPM
model showing that the expected return on any risk asset is equal to the risk-free rate of interest plus the market risk of the asset (beta) times the market risk premium as a whole.
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risk-free rate,
fixed-income security issued by the government, is virtually free of default. say a fixed-income security issued by the government, is virtually free of default
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To this risk-free rate add
The beta
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The average beta of the market as a whole is
one . Therefore, stocks with a beta lower than one are less risky than the market. Stocks with a beta greater than one are riskier than the market.
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The market risk premium
the expected return on the market minus the risk-free rate. The market premium is tied to market psychology, so it can expand or contract. On average, it tends to be around 6% or 7%.
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According to the theory, a portfolio of high beta stocks yields
high return. When the market goes up, such portfolios tend to outperform the market and low beta portfolios tend to underperform the market. But when stocks go down, portfolios of low beta stocks tend to lose less than high beta portfolios.
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from 1966 to the present, the theory held up less well.
High beta stocks returned less than expected and low beta stocks returned more than expected. In some respects, the theory was turned upside-down: Many low-risk investments outperformed many high-risk investments.
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Fama and French set out to better explain the relationship between risk and return. They found two factors that mattered greatly:
size and style
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Size is the
market value or market capitalization of the firm. It equals the stock price times the number of shares outstanding. Over long periods, small cap stocks outperform large cap stocks. This finding makes intuitive sense, since small firms are nimbler and can grow quickly from a smaller.
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Style refers
to growth or value. Value stocks historically return more than growth stocks over long periods because growth stocks tend to be glamorous, and investors often bid them up. Eventually, some run into competition or have missteps and fall back down to earth. Since not much is expected of value stocks, they often fix their problems and show a surprise upside.
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Professors Fama and French
used the price-to-book variable to differentiate between growth and value.
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The price part of the ratio is
the market capitalization that measures size.
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Style refers to
Value stocks historically return more than growth stocks over long periods because growth stocks tend to be glamorous, and investors often bid them up. Eventually, some run into competition or have missteps and fall back down to earth. Since not much is expected of value stocks, they often fix their problems and show a surprise upside.
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Fama and French used
the price-to-book variable to differentiate between growth and value. The price part of the ratio is the market capitalization that measures size. The book part of the ratio in the denominator is the net worth item on the balance sheet.
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Book value equals
all the assets on a firm’s balance sheet minus all its liabilities. A firm with a lower than average price- to book-ratio is considered to be a value stock, while a firm with a higher than average price-to-book ratio is considered to be a growth stock.
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The historical average price-to-book ratio of the Standard and Poor 500 is.
about 2.5
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Combining the two factors results in the following historical results:
* Small cap value stocks usually have the best performance over long periods.
* Large cap growth stocks usually have the worst performance over long periods. In the short run, investors might gravitate toward the safety of large cap growth stocks, especially during times of market distress, but over the long term, fear usually fades, and these investments tend to provide lower returns.
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Momentum investors
buy stocks that have been rising and sell or sell short investments that have been falling. In the short run, say a year or less, researchers have found that momentum works. High flyers keep flying and losers keep falling.
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Liquidity refers
to the ability to sell an asset quickly and at fair market value: Your house is probably not liquid, but blue-chip stock, U.S. Treasury bonds, notes, and bills are liquid.
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Researchers have found
that over long periods, investors get paid to own illiquid assets. These assets are basically another type of risk.
○ During times of distress, the opposite usually holds. That is, people gravitate towards the safety of liquid investments.
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you want to make the most money,
buy illiquid, small cap, value stocks that have upward momentum.
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The stocks that tend to have the lowest return are the
most liquid, large cap growth names, with downward momentum.
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you follow this approach,
be prepared to hold onto your hat when the market is falling, because in the short run you will lose a lot of money
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Eugene Fama breaks the efficient market hypothesis into 3 forms, or information sets:
Weak-form efficiency,
Semi-strong form efficiency,
Strong-form efficiency,
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Weak-form efficiency
wherein investors can’t consistently beat the market using historical price and volume data.
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Semi-strong form efficiency,
wherein investors can’t consistently beat the market using any public information; not only the historical price and volume information, but also a company’s financial statements, and whatever other information is available.
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Strong-form efficiency,
wherein investors can’t consistently beat the market using any information, whether historical price and volume data; public information; or private, inside information.
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The bulk of the academic studies of the efficient-market hypothesis find
that the market is both weak form and semi-strong form efficient, but that the market is not strong-form efficient.
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An index fund helps answer at least two important questions.
The first is, “How did the market do today?” You need to measure market performance to answer that question.
The second is, “How is my portfolio doing?” To answer that question, you probably want to compare the performance of your portfolio to a benchmark like a market index such as the S&P.
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equal-weighted index fund means
the price changes in the smallest stock have the same impact on the index returns as the price changes in the largest stock.
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a fund that owns mostly utility and consumer staples stocks
is likely to have less risk than the market as a whole over long periods, assuming the fund doesn’t materially change its strategy or types of holdings.
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cautions awareness of the law of large numbers for actively managed funds.
That is, the bigger a fund gets, the harder is it to outperform. One reason is that large funds are generally tilted towards large stocks that are widely followed; the manager is unlikely to uncover something unknown by the market, generally a precondition for outperformance.
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Bogle suggests
a long-term buy and hold approach. He advises looking at your portfolio once a year so you can have the miracle of compound interest and returns work in your favor
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target (or horizon date) funds, and tax-advantaged funds.
As you gradually approach retirement age, the horizon As you gradually approach retirement age, the horizon fund will increase your allocation to fixed-income index funds, because they tend to be steadier, and decrease your exposure to more variable equity investments.
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Index funds are best suited for people
who don’t have a background in financial investments or who are too busy to devote time to picking individual securities or funds.
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academic studies have found that over long periods,
small-cap stocks tend to outperform large-cap stocks by wide margins. That said, small stocks sometimes
also experience huge volatility swings, especially in declining markets.
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first measure is market risk, known as beta,
which measures the risk of one investment against the market as a whole.
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small-cap stocks
tend to be more volatile and usually have a higher level of beta than large-cap stocks.
have higher liquidity risk.
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One way to determine if a stock has been “discovered,” so to speak,
is to look at the percentage of the stock owned by institutions. This statistic can easily be found at no cost on many financial websites.
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As a rule of thumb, if institutional ownership is less than 50%,
the stock is not widely followed by larger investors such as mutual funds, hedge funds, and pension funds.
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Lynch likes small companies that
have proved that their concept can be replicated. Starbucks
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ADRs are.
negotiable certificates that represent an interest in the shares of a non-U.S. company, are deposited with a U.S. bank, and trade on the major U.S. stock exchanges
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Selling short
involves the same transaction but in the reverse order: The stock is sold first and purchased later—hopefully at a lower price. If you sold the stock short for $50, and then bought it back later for $40, you made a gross profit of $10.
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Yale method of asset allocation, a
strategy of mean reversion or rebalancing by trimming winning asset classes and adding to underperforming asset classes. The Yale method that Templeton used is different from what is known today as the Yale Model employed by Yale University’s endowment.
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A good investment
goes up more than the market on a risk-adjusted basis.
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Dremen looks for in companies to invest in, he likes
to buy solid or quality companies with high dividends and low price-to-earnings ratios, price-to-cash flow, and/or price- to-book value—at least 30% less than the market as a whole.
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a quality company, but it usually has several characteristics:
It’s likely to have been in business for a while, to be profitable, to pay a dividend at least 0.5% higher than the average for the market as a whole and with a history of rising payouts, and to have strong management.
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Dreman prefers to hold
a more concentrated portfolio than the typical mutual fund or index fund. He advises investing equally in 20 to 30 stocks, diversified among 15 or more industries.
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Dremen
recommends selling a stock when its P/E ratio (or other contrarian indicator) approaches that of the overall market, regardless of how favorable its prospects may appear, replacing it with another contrarian stock. Dreman’s approach is always to be a disciplined value investor.
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mutual fund is
an investment managed for the mutual benefit of its shareholders.
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expense ratio is
the “all in” number that expresses the fees you pay as a percentage of your overall investment.
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Growth firms trade
at above-average valuations relative to the market as a whole. For example, their price to earnings or price to book ratios may be higher than the S&P 500’s. By comparison, value firms trade at below-average multiples.
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Growth investors are often trying to find
rapidly growing smaller firms that have the potential to become large firms like the next Amazon. In contrast, value investors search for stocks trading at a low price relative to the company’s earnings or cash flow or paying an above-average dividend.
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Value stocks are companies that typically
are growing sales and earnings more slowly than growth firms. They also might be going through some problems, explaining why they may be trading at below-average valuations.
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Small-cap companies are valued
at less than $1 billion.
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company’s credit rating.
Standard and Poor, Moody’s, Fitch, and other credit-rating services evaluate the debt of most public companies. A bond rated below BBB– is considered high-yield or junk. If you are a stock investor, you’ll want to have a high level of conviction before investing in a company with a junk credit rating.
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Lynch had a portfolio liked
to buy baskets of companies in an entire industry. His logic was that when you are looking at small firms or a new industry, you might not know which will emerge as winners. Therefore, if you are right on the industry at large—and buy a basket of its stocks—then the winners will go up in multiples; if you avoid borrowing, you won’t lose more than 100% of your
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He looked for companies that consistently
bought back their own shares. If a company buys back its own shares, it tells the market that it thinks its stock is undervalued.
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Lynch Looked for companies that started out with
little or no institutional ownership. If the amount of institutional ownership is less than 50% of the total number of shares outstanding, the institutions haven’t piled in yet. Once the institutions pile in, the stock price can take off.
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Lynch viewed insider buying by management
as a positive sign. Corporate insiders should know more about the firm than almost anyone else.
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Interest-rate risk.
When interest rates go up, traditional bonds fall in value because the bond is viewed as riskier and is valued less. When interest rates fall, traditional bonds usually rise in value because the risk is perceived to be lower.
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Reinvestment rate risk.
When rates rise, the coupons and maturing face value or bond principal can be reinvested at higher rates in newer securities, drawing investor interest away from the older instrument.
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Default risk.
If a bond defaults, it may be forced into bankruptcy, and the bondholders may seize the assets of the issuer—often after a long and protracted bankruptcy court battle.
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Liquidity risk. A liquid asset is one that can be sold quickly, and at fair market value.
During times of market distress, such as the Great Recession in 2008, illiquid assets often take a big hit. In the bond market, they tend to be bonds that have less trading volume; bonds with low credit ratings; emerging markets bonds; and bonds with wide bid-ask spreads—the difference in price between when you buy and when you sell.
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Gross believes that successful investment over the long run, whether in bonds or in equities,
depends on developing a long- term outlook and acquiring the right mix of securities within an asset class. he believes that 3- to 5-year forecast horizons force an investor to avoid the near-term fluctuations that lead to panic and bad investment decisions. This focus makes him a top-down investor.
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The expected return on a bond over its term should be
pretty close to its yield to maturity—that is, the return from the coupon payment and the capital gain or loss on the instrument, together known as the bond’s total return. Gross focuses on yield-to-call estimates, as opposed to yield-to-maturity calculations, when estimating the most probable total return on a bond held until maturity.
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Gundlach believes
that if you buy bonds during periods of illiquidity and drops in price, you are likely to profit after the fear subsides and normalized market-levels return.
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Fannie Mae and Freddie Mac are
government-sponsored entities backed by the credit rating of the U.S. government and designed to facilitate the functioning of the mortgage market. In 1981, Fannie Mae issued the first mortgage-backed security. Think of it as a bond in which the cash flows are a group of individual mortgage payments rolled into a single security.
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Gundlach specializes in buying
Gunlach likes securities that appear to give a higher return than their credit risk might indicate. Like Freddie and Fannie Usually they trade at close to AAA or AAA- ratings while providing a slightly higher yield than U.S. Treasury securities.
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Gundlach usually starts
with a top-down view and sets a macroeconomic horizon of about 3 years when he enters a position.
*
This top-down analysis—taking into account the general state of the
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When conducting his top-down analysis, Gundlach looks at a few variables.
* One is the yield curve
* Gundlach also looks at what is happening in the economy
* looks at the credit cycle, which refers to bank lending and customer-default rates. Historically, as the economy approaches recession, credit gets tight and defaults go up.
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the yield curve—
a graph of the relationship between time to maturity and yield to maturity. The yield curve typically slopes upward, with long-term interest rates higher than short-term rates.
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Gundlach also looks at what is happening in the economy.
Gross domestic product growth might be a useful measure of how the economy is doing as a whole.
he also looks at the credit cycle, which refers to bank lending and customer-default rates. Historically, as the economy approaches recession, credit gets tight and defaults go up.
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This top-down analysis—taking into account
the general state of the economy, liquidity in the debt market, and borrower health—gives Gundlach a sense of the credit and interest rate risk in his portfolio.
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This top-down analysis—
taking into account the general state of the economy, liquidity in the debt market, and borrower health—gives Gundlach a sense of the credit and interest rate risk in his portfolio.
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Then Gundlach and his team turn to
a bottom-up analysis for bonds
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a bottom-up analysis for bonds,
which might include looking at loan-level details and specific geographic areas. They check relative value among different credit sectors in fixed-income, at horizons of about 3 years and do a rich/cheap analysis on the various bond sectors, including emerging and foreign markets.
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Why should we care about sovereign wealth funds?
The answer is because they control more financial assets than hedge funds and private equity funds combined, amounting to more than $7 trillion. As sovereign wealth funds grow in size and importance, they have come to play larger roles both in their own countries’ affairs and in market battles between traditional, independent companies and state-owned and -controlled companies.
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The U.S. Treasury Department defines a sovereign wealth fund as “
A Government Investment Vehicle which is funded by foreign exchange assets and which manages those assets separately from the official reserves of the monetary authorities, (the Central Bank and reserve-related functions of the Finance Ministry).”
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The distinction is intended to clarify
the difference between official reserves managed by a country’s central bank, with short-term horizons, focused on liquidity and security, and the longer horizons associated with, for example, national pension systems.
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Three main drivers behind the creation and growth of sovereign wealth funds
are balance of trade, economic stability, and the desire of sovereign nations to diversify their assets.
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The International Monetary Fund further classifies sovereign wealth funds in 5 categories, according to their form and function:
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Stabilization funds
Savings funds
Development funds
Pension reserve funds
Reserve Investment Corporations
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Stabilization funds
are formed to insulate a state budget and economy from commodity price volatility and external shocks. These investments sometimes are designed to move in the direction opposite the commodity prices against which a government wishes to insulate its economy.
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Savings funds
are designed to transform nonrenewable assets into financial assets that can be shared across generations. These portfolios are invested primarily in equities and other
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Pension reserve funds, as in Australia, Ireland, and New Zealand,
invest in equities and other investments to offset rising retirement liabilities.
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Reserve Investment Corporations are more
complex funds designed to earn higher returns on foreign reserves or to reduce the negative carrying costs of holding them. They may invest in equities and alternative investments to achieve higher returns.
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Axiomatic in the United States and the United Kingdom is that the goal of an investment fund is
to appreciate in value and maximize shareholder wealth.
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In many countries, the goal of an investment fund is not only to appreciate in value and maximize shareholder but also
That other stakeholders receive important consideration, including customers, employees, the local community, and the government itself.
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The balance of payments includes
all payments and obligations to foreigners balanced against all payments and obligations received from foreigners. The balance of payments must balance.
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If one country runs a persistent trade deficit with another, something must happen on the other side of the international ledger to square it away.
The typical transaction of the country with the trade surplus is to invest trade proceeds in securities or some other asset. Thus a trade deficit is usually offset by a positive financial account—including holdings such as foreign investments in stocks, bonds, commodities and real estate— or capital account balance including holdings such as foreign direct investment, which can include physical investments in equipment, buildings, and factories.
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The term “hedge” in a financial context.
means to reduce risk
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Although no uniformly agreed definition of a hedge fund exists,
a good working definition is a private investment vehicle that charges two types of fees: an asset-based fee assessed as a percentage of assets under management and a profit-sharing or incentive fee taken from the fund’s earnings, if any.
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Hedge funds typically
charge 1% or 2% of assets, plus a percentage of the profits they earn on your investment. The standard profit sharing fee is 20%, but some funds take as much as 50%
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These 3 characteristics—
limiting regulation, taking 20% or more of the profits and dynamically adjusting the long to short ratio— describe the bulk of hedge funds today.
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Loeb says that most of his investments share the following characteristics:
They have talented management teams.
They are businesses with strong and growing free cash flows. Free cash flow is money remaining after reinvesting in the business.
They are firms with a proven track record of capital allocation; that is, the company has invested its money wisely over the long term, whether in new projects or in mergers or acquisitions. Capital allocation also includes returning capital to shareholders in the form of stock buybacks or dividends.
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Ackman prefers companies that generate a lot of free cash flow, an important and recurring concept.
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The cash-flow statement has 3 parts: cash flow from operations, generated by a company’s core business; cash flow from investing activities, which mainly refers to capital expenditures or long term investments; and cash flow from financing activities, relating to the issuance or repurchase of stock or debt. The net increase (or decrease) in cash is the sum of the 3 parts of the cash-flow statement.
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Value investing is the investment strategy
that selects stocks based on a belief that they trade for less than their intrinsic value. That is, value investors seek stocks they believe the market has undervalued.
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Selling short: is called
Selling a stock in which you have no current position selling selling borrowed shares and hoping to buy them back later at a lower price.
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hypothecation agreement,
which allows the firm to lend your shares to other investors, usually hedge funds. To help a client sell short, the firm investors, usually hedge funds. To help a client sell short, the firm borrows the shares from another client of the firm.
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To engage in this short trading means
establishing a margin account using borrowed funds. While you have the ability to buy and sell stocks on margin, custody remains with the brokerage firm until the transaction is complete and you’ve fulfilled your obligation.
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for short sales An example is a stock that is overvalued: Investors rightly
expect to profit by selling it short, pocketing today’s price on the expectation the price will fall and completing the purchase after the price has dropped.
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Soros posits
a feedback loop between prices and fundamentals—earnings, dividends, and interest rates— wherein the price itself impacts the fundamentals.
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Soros’s investment thoughts were influenced in part by Werner Heisenberg, one of the pioneers of quantum mechanics, best known for the Heisenberg Uncertainty Principle,
which says that that the act of measuring influences the measurement.
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Soros’s theory of reflexivity states that
the connection between participants’ thinking and the situation in which they participate reflects two functional relationships: cognitive and participating.
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The cognitive function is
the participants’ efforts to understand the situation.
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The participating function is the
impact of their thinking on the real world.
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Because these two functions interact with one another in a recursive process,
markets are rarely in equilibrium, or balance. And yet, equilibrium is one of the central concepts of economics. The market is prone to boom-and-bust cycles.
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Soros provides some guidance on how a boom-bust cycle usually plays out. He says it
consists of seven stages.
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Soros seven stage
1. trend that is not yet recognized by the public 2. other people act on news and make the same trades. Soros calls this the initial phase. 3. surge in prices peters out. if the stocks that attracted attention survive this initial phase, they emerge strengthened. Soros calls this a period of acceleration. 4. large gap emerges between public perceptions and a company’s fundamentals, and the market also recognizes this reality. Soros calls this the moment of truth. 5. Stocks can stay inflated for a long time; they are overvalued. Soros calls this the period of stagnation, or twilight period. 6. something causes a broad loss of belief in the stock. This widespread loss of belief causes a reversal in the popular buying trend. Soros calls this the crossover point. 7. Selling results in more selling. causing an accelerating downward trend. Soros calls this phase a crash.
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Soros came to believe that modern economic theory has a fundamental problem:
that it is based on the assumption of a market usually in equilibrium, where fundamentals almost always drive prices.
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Soros believed
the market is rarely in equilibrium, and he added an element of thinking previously all but unaccounted for in market dynamics. And that is that investors impact market fundamentals through the feedback loop of their own thinking and trading in the market.
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several lessons from Soros and his theories:
1. have a global outlook.
2. try to understand how our own investing decisions are based on market movements and the actions of others and not simply on the market fundamentals.
3. be cognizant of the market’s tendency to gravitate toward boom-and-bust-cycles and the opportunities that these movements might afford.
4. if you are a trader, as opposed to being a long-term investor, be as willing to go short as you are willing to go long.
5. for the more adventurous and less risk averse—if you have high conviction in an idea, be willing to bet big.
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Bridgewater’s focus is
global macro- and multi-strategy. That is, the firm searches the world for investment opportunities and uses a range of strategies, both long and short, with a variety of financial instruments.
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Dario All-Weather strategy is
divided into 4 quadrants, driven by growth and inflation. It is managed by using trading models that historically have worked in each of the 4 quadrants. Thus, regardless of the general state of the economy and financial markets, usually at least something is working well in this portfolio.
Another unique facto
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technical analysis, which
relies on historical patterns in price and volume data in the belief they have some predictive value.
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moving average,
averages a stock’s data over different time periods and has the benefit of smoothing out erratic data. A stock trading above its moving average is considered bullish, while a stock trading below its moving average is considered bearish.
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Jones uses the
200-day moving average of closing prices. By keeping an eye on the 200-day moving average, an investor can sell quickly if the trend is down. Jones advises never averaging losers. In other words, if a position starts losing money, either sell or wait for the trade to be profitable before adding more capital.
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fundamental analysis:
examining such factors as earnings, interest rates, and industry gossip.
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Quantitative analysts
build financial models to estimate the value of security prices.
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fundamental analysis,
which focuses on looking at a company’s financials, along with its management, and factors affecting the industry, and
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technical analysis which
focuses on changes in security prices and their corresponding trading volume.
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Quants might look
at price and volume data, but also at a host of other data—including interest rates, currency values, financial statement data, and much more—to create their own quantitative models.
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the term black swan
describe an unforeseen and perhaps unpredictable event.
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One widely used technique is called a factor model,
which estimates the relationship between two variables. Independent variables are used to help predict dependent variables, and it’s not uncommon for quant models to contain dozens of independent variables.
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The term risk off refers
to an environment in which fear pervades the market, and investors are selling assets that are traditionally risky: such as stocks, high yield bonds, and emerging market securities. In a risk off trade, safe haven assets like U.S. Treasury notes or gold often outperform.
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The term risk on indicates that
investors are willing to increase the risk of their portfolio by purchasing more volatile securities, which they deem to have significant upside. High yield bonds and the stocks of smaller or speculative firms may also do well in a risk on environment.
