"securities Analysis, Exam 3" Brett Olsen, Bus 408

Front 1

Market Efficiency, #1:
Why we care about market efficiency (from the perspective of determining firm value)

Back 1

If markets determine value, efficient market prices reflect the best estimate of fair value

Front 2

Market Efficiency, #2A:
The implications of market efficiency as related to security selection and investment strategies - efficient markets

Back 2

-Broad diversification (catch upward trend)
-Minimal trading (reduce costs)
-Randomness
-No arbitrage opportunities exist
-Cannot consistently outperform the market

Front 3

Market Efficiency, #2B:
The implications of market efficiency as related to security selection and investment strategies - inefficient markets

Back 3

-Arbitrage opportunities exist
-Investor attempts to find information regarding potential arbitrage profits
-Individual investors have differing models, assumptions, risk tolerance

Front 4

Market Efficiency, #3:
Challenges to the Efficient Markets Hypothesis

Back 4

Market anomalies
Behavior assumptions

Front 5

Market Efficiency, #3A:
Market anomalies

Back 5

According to the Efficient Markets Hypothesis...
-Trading volume should be low (is high)
-Whether or not returns are in the form of dividends shouldn't matter (some investors seek dividends)
-Market risk premium should be around 1% (is actually around 5%)
-Stock price should be random (shows patterns)
-Announcement effects should be instantaneous (show early movement, overreaction, drifting)
-Bubbles shouldn't exist

Front 6

Market Efficiency, #3B:
Behavior assumptions

Back 6

People make rational decisions
People make unbiased predictions

Front 7

Market Efficiency #4:
The implications of prospect theory for investors

Back 7

-Investors frame all choices in terms of potential gains and losses relative to a specific reference point
-Investors value gains and losses according to an s-shaped function (which is steeper for losses than for gains)
-Investors segregate each investment, tracking gains or losses, but should look at entire portfolio

Front 8

Investment Strategies:
Philosophy of value investing

Back 8

-Value of stock is related to value of business
-Find value of business, then determine if value > price
-Focus is on intrinsic value, which is "determined by facts"

Front 9

Buffett on risk and diversification

Back 9

Risk - The possibility of harm or injury (not volatility)
Diversification - "A remedy for ignorance;" reduces volatility, but also returns

Front 10

Value investing tenets

Back 10

Business
Management
Financial
Market

Front 11

Value investing: Business

Back 11

- Is it simple?
- Does the firm have a consistent operating history?
- Does the firm have favorable long-term prospects?

Front 12

Value investing: Management

Back 12

- Is management rational?
- Is management candid?
- Does management resist the "institutional imperative?"

Front 13

Value investing: Financial

Back 13

-Focus is on ROE, not EPS
-Like high profit margin
-"owner earnings" roughly equivalent to FCFE

Front 14

Value investing: Market

Back 14

-What is the value of the business?
-Can it be purchased at a significant discount?

Front 15

Summary of value investing

Back 15

-Circle of confidence
-Margin of safety
-Good outlook
-Good management
-Fiscally responsible
-Value vs. price