aswath_damodaran-investment_philosophies_2012
.pdfINVESTMENT PHILOSOPHIES
S E C O N D E D I T I O N
Successful Strategies and the
Investors Who Made Them Work
Investment
Philosophies
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Investment
Philosophies
Successful Strategies and the
Investors Who Made Them Work
Second Edition
ASWATH DAMODARAN www.damodaran.com
John Wiley & Sons, Inc.
Copyright C 2012 by Aswath Damodaran. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
First Edition Copyright C 2003 by John Wiley & Sons, Inc. All rights reserved. Published simultaneously in Canada.
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Library of Congress Cataloging-in-Publication Data:
Damodaran, Aswath.
Investment philosophies : successful strategies and the investors who made them work / Aswath Damodaran.—2nd ed.
p. cm.—(Wiley finance series) Includes index.
ISBN 978-1-118-01151-5 (cloth); ISBN 978-1-118-22192-1 (ebk); ISBN 978-1-118-23561-4 (ebk); ISBN 978-1-118-26049-4 (ebk) 1. Investment analysis. I. Title.
HG4529.D36 2012 332.6—dc23
2012005823
Printed in the United States of America.
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Contents
CHAPTER 1 |
1 |
Introduction |
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What Is an Investment Philosophy? |
2 |
Why Do You Need an Investment Philosophy? |
3 |
The Big Picture of Investing |
4 |
Categorizing Investment Philosophies |
7 |
Developing an Investment Philosophy |
10 |
Conclusion |
12 |
Exercises |
13 |
CHAPTER 2 |
15 |
Upside, Downside: Understanding Risk |
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What Is Risk? |
16 |
Equity Risk: Theory-Based Models |
16 |
Assessing Conventional Risk and Return Models |
32 |
Equity Risk: Alternative Measures |
34 |
Equity Risk: Assessing the Field |
45 |
Default Risk |
46 |
Conclusion |
50 |
Exercises |
51 |
CHAPTER 3 |
53 |
Numbers Don’t Lie—Or Do They? |
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The Basic Accounting Statements |
53 |
Asset Measurement and Valuation |
55 |
Measuring Financing Mix |
62 |
Measuring Earnings and Profitability |
69 |
Measuring Risk |
75 |
Differences in Accounting Standards and Practices |
82 |
Conclusion |
82 |
Exercises |
85 |
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vi |
CONTENTS |
CHAPTER 4 |
87 |
Show Me the Money: The Basics of Valuation |
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Intrinsic Value |
87 |
Relative Valuation |
110 |
Valuing an Asset with Contingent Cash Flows (Options) |
119 |
Conclusion |
121 |
Exercises |
122 |
CHAPTER 5 |
125 |
Many a Slip: Trading, Execution, and Taxes |
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The Trading Cost Drag |
125 |
The Components of Trading Costs: Traded Financial Assets |
127 |
Trading Costs with Nontraded Assets |
146 |
Management of Trading Costs |
148 |
Taxes |
150 |
Conclusion |
159 |
Exercises |
160 |
CHAPTER 6 |
163 |
Too Good to Be True? Testing Investment Strategies |
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Why Does Market Efficiency Matter? |
163 |
Efficient Markets: Definition and Implications |
164 |
Behavioral Finance: The Challenge to Efficient Markets |
170 |
A Skeptic’s Guide to Investment Strategies |
204 |
Conclusion |
206 |
Exercises |
207 |
CHAPTER 7 |
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Smoke and Mirrors? Price Patterns, Volume Charts, and |
209 |
Technical Analysis |
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Random Walks and Price Patterns |
209 |
Empirical Evidence |
211 |
The Foundations of Technical Analysis |
239 |
Technical Indicators and Charting Patterns |
240 |
Conclusion |
255 |
Exercises |
256 |
CHAPTER 8 |
259 |
Graham’s Disciples: Value Investing |
Who Is a Value Investor? |
259 |
The Passive Screener |
260 |
Contents |
vii |
The Contrarian Value Investor |
284 |
Activist Value Investing |
293 |
Conclusion |
326 |
Exercises |
326 |
CHAPTER 9 |
329 |
The Allure of Growth: Small Cap and Growth Investing |
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Who Is a Growth Investor? |
329 |
Passive Growth Investing |
330 |
Activist Growth Investing |
365 |
Conclusion |
372 |
Exercises |
373 |
CHAPTER 10 |
375 |
Information Pays: Trading on News |
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Information and Prices |
376 |
Trading on Private Information |
378 |
Trading on Public Information |
398 |
Implementing an Information-Based Investment Strategy |
421 |
Conclusion |
422 |
Exercises |
423 |
CHAPTER 11 |
425 |
A Sure Profit: The Essence of Arbitrage |
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Pure Arbitrage |
425 |
Near Arbitrage |
450 |
Speculative Arbitrage |
460 |
Long/Short Strategies—Hedge Funds |
465 |
Conclusion |
469 |
Exercises |
470 |
CHAPTER 12 |
473 |
The Impossible Dream? Timing the Market |
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Market Timing: Payoffs and Costs |
473 |
Market Timing Approaches |
477 |
The Evidence on Market Timing |
506 |
Market Timing Strategies |
514 |
Market Timing Instruments |
518 |
Connecting Market Timing to Security Selection |
521 |
Conclusion |
521 |
Exercises |
522 |
viii |
CONTENTS |
CHAPTER 13 |
525 |
Ready to Give Up? The Allure of Indexing |
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The Mechanics of Indexing |
525 |
A History of Indexing |
527 |
The Case for Indexing |
530 |
Why Do Active Investors Not Perform Better? |
554 |
Alternative Paths to Indexing |
562 |
Conclusion |
571 |
Exercises |
572 |
CHAPTER 14 |
575 |
A Road Map to Choosing an Investment Philosophy |
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A Self-Assessment |
575 |
Finding an Investment Philosophy |
579 |
The Right Investment Philosophy |
581 |
Conclusion |
583 |
Exercises |
584 |
Index |
585 |
Investment
Philosophies