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Value Investing: Tools and Techniques for Intelligent Investment

Book Description

As with his weekly column, James Montier's Value Investing is a must read for all students of the financial markets. In short order, Montier shreds the 'efficient market hypothesis', elucidates the pertinence of behavioral finance, and explains the crucial difference between investment process and investment outcomes. Montier makes his arguments with clear insight and spirited good humor, and then backs them up with cold hard facts. Buy this book for yourself, and for anyone you know who cares about their capital!

—Seth Klarman, President, The Baupost Group LLC

The seductive elegance of classical finance theory is powerful, yet value investing requires that we reject both the precepts of modern portfolio theory (MPT) and pretty much all of its tools and techniques.

In this important new book, the highly respected and controversial value investor and behavioural analyst, James Montier explains how value investing is the only tried and tested method of delivering sustainable long-term returns.

James shows you why everything you learnt at business school is wrong; how to think properly about valuation and risk; how to avoid the dangers of growth investing; how to be a contrarian; how to short stocks; how to avoid value traps; how to hedge ignorance using cheap insurance. Crucially he also gives real time examples of the principles outlined in the context of the 2008/09 financial crisis.

In this book James shares his tried and tested techniques and provides the latest and most cutting edge tools you will need to deploy the value approach successfully.

It provides you with the tools to start thinking in a different fashion about the way in which you invest, introducing the ways of over-riding the emotional distractions that will bedevil the pursuit of a value approach and ultimately think and act differently from the herd.

Table of Contents

  1. Copyright
  2. Preface
    1. Part I: Why everything you learned in business school is wrong
    2. Part II: The behavioural foundations of value investing
    3. Part III: The philosophy of value investing
    4. Part IV: The empirical evidence
    5. Part V: The 'Dark Side' of Value Investing: Short Selling
    6. Part VI: Real-time value investing
  3. Foreword
  4. I. Why Everything You Learned in Business School is Wrong
    1. 1. Six Impossible Things before Breakfast, or, How EMH has Damaged our Industry
      1. 1.1. THE DEAD PARROT OF FINANCE
      2. 1.2. THE QUEEN OF HEARTS AND IMPOSSIBLE BELIEFS
      3. 1.3. SLAVES OF SOME DEFUNCT ECONOMIST
      4. 1.4. PRIMA FACIE CASE AGAINST EMH: FOREVER BLOWING BUBBLES
      5. 1.5. THE EMH 'NUCLEAR BOMB'
    2. 2. CAPM is Crap
      1. 2.1. A BRIEF HISTORY OF TIME
      2. 2.2. CAPM IN PRACTICE
      3. 2.3. WHY DOES CAPM FAIL?
      4. 2.4. CAPM TODAY AND IMPLICATIONS
    3. 3. Pseudoscience and Finance: The Tyranny of Numbers and the Fallacy of Safety
      1. 3.1. BLINDED BY PSEUDOSCIENCE
      2. 3.2. WATCHING TV IMPROVES YOUR MATHS ABILITY
      3. 3.3. SEDUCTIVE DETAILS
      4. 3.4. APPLICATIONS TO FINANCE
        1. 3.4.1. Risk Management
        2. 3.4.2. Analysts and their Addiction to Numbers
        3. 3.4.3. Performance Measurement as Pseudoscience
      5. 3.5. CONCLUSIONS
    4. 4. The Dangers of Diversification and Evils of the Relative Performance Derby
      1. 4.1. ON THE DANGERS OF 'NARROW' DIVERSIFICATION
      2. 4.2. EQUITY PORTFOLIOS: THE OTHER EXTREME
      3. 4.3. RELATIVE PERFORMANCE DERBY AS A SOURCE OF POOR PERFORMANCE!
      4. 4.4. A (VERY SHORT) PRACTICAL GUIDE TO DIVERSIFICATION
    5. 5. The Dangers of DCF
      1. 5.1.
        1. 5.1.1. Problems with Estimating Cash Flows
        2. 5.1.2. Problems with the Discount Rate
      2. 5.2. INTERACTION PROBLEMS
      3. 5.3. ALTERNATIVES
        1. 5.3.1. Reverse-engineered DCF
        2. 5.3.2. Asset Value
        3. 5.3.3. Earnings Power
    6. 6. Is Value Really Riskier than Growth? Dream On
      1. 6.1. RISK I: STANDARD DEVIATION
      2. 6.2. RISK II: CAPM BETA AND CO.
      3. 6.3. RISK III: BUSINESS CYCLE RISK
    7. 7. Deflation, Depressions and Value
      1. 7.1. VALUE AND JAPAN
      2. 7.2. VALUE AND THE GREAT DEPRESSION
      3. 7.3. WHY THE DIFFERENCE BETWEEN THE GREAT DEPRESSION AND JAPAN?
  5. II. The Behavioural Foundations of Value Investing
    1. 8. Learn to Love Your Dogs, or, Overpaying for the Hope of Growth (Again!)
      1. 8.1. OF DOGS AND STARS
      2. 8.2. ANALYST EXPECTATIONS AND IMPLIED GROWTH
      3. 8.3. BRINGING IN VALUATION
      4. 8.4. A CASE IN POINT: MINING
    2. 9. Placebos, Booze and Glamour Stocks
      1. 9.1. PAINKILLERS, PLACEBOS AND PRICE
      2. 9.2. DOES EXPENSIVE WINE TASTE BETTER?
      3. 9.3. GLAMOUR STOCKS
      4. 9.4. BEATING THE BIAS
    3. 10. Tears before Bedtime
      1. 10.1. BUILT TO LAST
      2. 10.2. ADMIRED OR DESPISED?
      3. 10.3. DON'T BE AN UGLY DEFENDANT
      4. 10.4. ANALYSTS' VIEWS ON GROWTH
      5. 10.5. CONCLUSIONS
    4. 11. Clear and Present Danger: The Trinity of Risk
      1. 11.1. VALUATION RISK
      2. 11.2. BUSINESS/EARNINGS RISK
      3. 11.3. BALANCE SHEET/FINANCIAL RISK
      4. 11.4. PUTTING IT ALL TOGETHER
    5. 12. Maximum Pessimism, Profit Warnings and the Heat of the Moment
      1. 12.1. EMPATHY GAPS
      2. 12.2. PREVENTING EMPATHY GAPS AND THE PERILS OF PROCRASTINATION
      3. 12.3. MAXIMUM PESSIMISM TRADES
      4. 12.4. PROFIT WARNINGS
      5. 12.5. LOCK-INS
      6. 12.6. CONCLUSIONS
    6. 13. The Psychology of Bear Markets
      1. 13.1. FEAR AND BEAR MARKETS
      2. 13.2. AS TIME GOES PAST
      3. 13.3. THE IMPACT OF BRAIN DRAIN
      4. 13.4. THE BLANK SLATE
    7. 14. The Behavioural Stumbling Blocks to Value Investing
      1. 14.1. KNOWLEDGE ≠ BEHAVIOUR
      2. 14.2. LOSS AVERSION
      3. 14.3. DELAYED GRATIFICATION AND HARD-WIRING FOR THE SHORT TERM
      4. 14.4. SOCIAL PAIN AND THE HERDING HABIT
      5. 14.5. POOR STORIES
      6. 14.6. OVERCONFIDENCE
      7. 14.7. FUN
      8. 14.8. NO, HONESTLY I WILL BE GOOD
  6. III. The Philosophy of Value Investing
    1. 15. The Tao of Investing: The Ten Tenets of My Investment Creed
      1. 15.1. THE AIM OF INVESTING
      2. 15.2. TENET I: VALUE, VALUE, VALUE
      3. 15.3. TENET II: BE CONTRARIAN
      4. 15.4. TENET III: BE PATIENT
      5. 15.5. TENET IV: BE UNCONSTRAINED
      6. 15.6. TENET V: DON'T FORECAST
      7. 15.7. TENET VI: CYCLES MATTER
      8. 15.8. TENET VII: HISTORY MATTERS
      9. 15.9. TENET VIII: BE SCEPTICAL
      10. 15.10. TENET IX: BE TOP-DOWN AND BOTTOM-UP
      11. 15.11. TENET X: TREAT YOUR CLIENTS LIKE YOU WOULD YOURSELF
      12. 15.12. CONCLUSION
        1. 15.12.1. The Ten Tenets of Investing
    2. 16. Process not Outcomes: Gambling, Sport and Investment!
      1. 16.1. THE PSYCHOLOGY OF PROCESS
        1. 16.1.1. Outcome Bias
        2. 16.1.2. Outcome Accountability
        3. 16.1.3. Process Accountability
      2. 16.2. CONCLUSIONS
    3. 17. Beware of Action Man
      1. 17.1. GOALKEEPERS AS ACTION MEN
      2. 17.2. INVESTORS AND ACTION BIAS
      3. 17.3. BUFFETT ON THE FAT PITCH
      4. 17.4. BIAS TO ACTION PARTICULARLY PRONOUNCED AFTER POOR PERFORMANCE
      5. 17.5. CONCLUSIONS
    4. 18. The Bullish Bias and the Need for Scepticism. Or, Am I Clinically Depressed?
      1. 18.1. THE BULLISH BIAS IN FINANCE
      2. 18.2. THE SOURCES OF BULL
        1. 18.2.1. (I) Nature
        2. 18.2.2. (II) Nurture – Self-serving Bias and Motivated Reasoning
      3. 18.3. SCEPTICISM AS A DEFENCE
      4. 18.4. A RATIONALE FOR EVIDENCE-BASED INVESTING
      5. 18.5. DEPRESSIVE REALISM
    5. 19. Keep it Simple, Stupid
      1. 19.1. IS MORE BETTER?
      2. 19.2. KISS: KEEP IT SIMPLE, STUPID
      3. 19.3. LESSONS FROM HEART ATTACKS
      4. 19.4. WHY?
      5. 19.5. CAN ANYTHING BE DONE?
      6. 19.6. SIMPLICITY IS KEY
      7. 19.7. EXPERTS FOCUS ON THE KEY INFORMATION
      8. 19.8. FROM THE EMERGENCY ROOM TO THE MARKETS
    6. 20. Confused Contrarians and Dark Days for Deep Value
      1. 20.1. DARK DAYS FOR DEEP VALUE
      2. 20.2. DEEP VALUE WORKS OVER THE LONG TERM
      3. 20.3. VALUE OUT OF VOGUE
      4. 20.4. SHORT-TERM UNDERPERFORMANCE IS A BY-PRODUCT OF A SENSIBLE INVESTMENT PROCESS
      5. 20.5. IS THERE LIGHT AT THE END OF THE TUNNEL FOR VALUE?
  7. IV. The Empirical Evidence
    1. 21. Going Global: Value Investing without Boundaries
      1. 21.1. THE EUROPEAN EVIDENCE
      2. 21.2. DEVELOPED MARKETS EVIDENCE
      3. 21.3. BRINGING IN THE EMERGING MARKETS
      4. 21.4. PATIENCE IS STILL A VIRTUE
      5. 21.5. CONCENTRATED PORTFOLIO
      6. 21.6. CURRENT PORTFOLIO STANCES
      7. 21.7. CONCLUSIONS
    2. 22. Graham's Net-Nets: Outdated or Outstanding?
      1. 22.1. GOING GLOBAL
      2. 22.2. THE CURRENT NET-NETS
      3. 22.3. PERMANENT LOSS OF CAPITAL
      4. 22.4. CONCLUSION
  8. V. The 'Dark Side' of Value Investing: Short Selling
    1. 23. Grimm's Fairy Tales of Investing
    2. 24. Joining the Dark Side: Pirates, Spies and Short Sellers
      1. 24.1. VALUATION
      2. 24.2. FINANCIAL ANALYSIS
      3. 24.3. CAPITAL DISCIPLINE
      4. 24.4. PUTTING IT ALL TOGETHER
    3. 25. Cooking the Books, or, More Sailing Under the Black Flag
      1. 25.1. COMPANIES LIE, SHORT SELLERS POLICE: THE EVIDENCE
      2. 25.2. WHO IS COOKING THE BOOKS? THE C-SCORE
      3. 25.3. DOES THE C-SCORE WORK?
    4. 26. Bad Business: Thoughts on Fundamental Shorting and Value Traps
      1. 26.1. A TAXONOMY OF SHORTS
      2. 26.2. BAD MANAGERS
        1. 26.2.1. Seven Habits of Highly Defective Managers
      3. 26.3. BEHAVIOURAL FOUNDATIONS OF BAD MANAGEMENT
        1. 26.3.1. I. Overoptimism and Overconfidence
        2. 26.3.2. II. Confirmatory Bias and Biased Assimilation
        3. 26.3.3. III. Conservatism
        4. 26.3.4. IV. Representativeness
        5. 26.3.5. V. Conformity and Groupthink
        6. 26.3.6. VI. Self-serving bias
      4. 26.4. BAD COMPANIES
        1. 26.4.1. Unnecessary Complexity
        2. 26.4.2. Speeding Out of Control
        3. 26.4.3. The Distracted CEO
        4. 26.4.4. Excessive Hype
        5. 26.4.5. A Question of Character
      5. 26.5. BAD STRATEGIES
        1. 26.5.1. The Illusion of Synergy
        2. 26.5.2. Faulty Financial Engineering
        3. 26.5.3. Deflated Industry 'Roll-ups'
        4. 26.5.4. Staying the Misguided Course
        5. 26.5.5. Misjudged Adjacencies
        6. 26.5.6. Consolidation Blues
  9. VI. Real-Time Value Investing
    1. 27. Overpaying for the Hope of Growth: The Case Against Emerging Markets
      1. 27.1. THE SORRY TALE OF SIR ROGER
      2. 27.2. EMERGING MARKETS AS THE SIR ROGER OF INVESTMENT
        1. 27.2.1. Valuation
        2. 27.2.2. A Bubble is Born
        3. 27.2.3. Decoupling and Deteriorating Fundamentals
        4. 27.2.4. Overpaying for Growth
        5. 27.2.5. Beware Dilution
      3. 27.3. CONCLUSIONS
    2. 28. Financials: Opportunity or Value Trap?
    3. 29. Bonds: Speculation not Investment
      1. 29.1. A LONG-TERM VIEW OF BONDS
      2. 29.2. INTRINSIC VALUE FOR BONDS
      3. 29.3. PUTTING IT ALL TOGETHER
      4. 29.4. INFLATION OR DEFLATION
      5. 29.5. IS THE USA JAPAN?
      6. 29.6. CONCLUSIONS
    4. 30. Asset Fire Sales, Depression and Dividends
      1. 30.1. DIVIDEND SWAPS: PRICED FOR WORSE THAN DEPRESSION!
      2. 30.2. DIVIDENDS AS AN INFLATION HEDGE
      3. 30.3. FORCED SELLERS AND OVERSUPPLY
    5. 31. Cyclicals, Value Traps, Margins of Safety and Earnings Power
      1. 31.1. THE EMPIRICAL EVIDENCE ON THE EARNINGS POWER APPROACH
      2. 31.2. USING GRAHAM AND DODD PEs IN OUR SCREENING
    6. 32. The Road to Revulsion and the Creation of Value
      1. 32.1. VOLATILITY – NOT UNPRECEDENTED NOR UNPREDICTABLE
      2. 32.2. THE CREATION OF VALUE I: DEBT MARKETS
      3. 32.3. THE CREATION OF VALUE II: EQUITY MARKETS
        1. 32.3.1. The view from the bottom up
      4. 32.4. THE CREATION OF VALUE III: CHEAP INSURANCE
      5. 32.5. CONCLUSIONS: THE RETURN OF THE COFFEE CAN PORTFOLIO
    7. 33. Revulsion and Valuation
      1. 33.1. BOTTOM-UP PERSPECTIVE
        1. 33.1.1. The problem of the disappearing dividends
        2. 33.1.2. Quality and deep value
        3. 33.1.3. Small caps and net current assets
      2. 33.2. CONCLUSIONS
    8. 34. Buy When it's Cheap – If Not Then, When?
    9. 35. Roadmap to Inflation and Sources of Cheap Insurance
      1. 35.1. FISHER AND THE DEBT-DEFLATION THEORY OF DEPRESSIONS
      2. 35.2. ROMER'S LESSONS FROM THE GREAT DEPRESSION
        1. 35.2.1. Lesson 1: Small Fiscal Expansion has Only Small Effects
        2. 35.2.2. Lesson 2: Monetary Expansion can Help to Heal an Economy Even When Interest Rates are Near Zero
        3. 35.2.3. Lesson 3: Beware of Cutting Back on Stimulus too Soon
        4. 35.2.4. Lesson 4: Financial Recovery and Real Recovery Go Hand in Hand
        5. 35.2.5. Lesson 5: Worldwide Expansionary Policy Shares the Burdens
        6. 35.2.6. Lesson 6: The Great Depression did Eventually End
      3. 35.3. BERNANKE AND THE POLICY OPTIONS
      4. 35.4. INVESTMENT IMPLICATIONS: CHEAP INSURANCE
        1. 35.4.1. Inflation/deflation Insurance I: TIPS
        2. 35.4.2. Inflation/deflation Insurance II: Gold
        3. 35.4.3. Inflation Insurance I: Dividend Swaps
        4. 35.4.4. Inflation Insurance II: Inflation Swaps
        5. 35.4.5. Eurozone Break-up Insurance: Spanish and Portuguese CDS
    10. 36. Value Investors versus Hard-Core Bears: The Valuation Debate
      1. 36.1. A TOP-DOWN CHECK ON ROBUSTNESS
      2. 36.2. NORMALIZED EARNINGS: A BOTTOM-UP VIEW
      3. 36.3. CONCLUSIONS
    11. REFERENCES