comeinvest wrote: ↑
Sun Jun 30, 2019 4:03 am
Can you please explain how to interpret the numbers for value stocks in the graphs, and why an investor would avoid investing in stocks from an ensemble exhibiting those numbers? Maybe by means of an intuitive example? This is not a trick question, I'm genuinely interested.
Thanks for the response. I forgot to include a link to the original article:
https://www.factorresearch.com/research ... ion-models
The article found that value had a kurtosis greater than 3, with 3 being that of a normal distribution. The article also found that value has a positive skew. The argument was being made that one of the reasons that value outperforms is that value stocks are negatively skewed with more kurtosis, and investors don't like that, which contributes to a value premium.
In an earlier post on this thread, I wrote
"I've earlier raised the opinion that the market has more trouble with overpriced stocks than underpriced stocks, and speculated that may be due to the asymmetric difficulty associated with profiting from underpriced stocks (buying) versus overpriced stocks (shorting). It may also be due to simple arithmetic. The least a company can be worth is nothing, but there's no limit on how much a company can be worth. In other words, there's a lower bound on how how much a company is worth, but no upper bound. With a corporate structure in a company having excessive debt, the owners have no obligation to meet those debts. From an owner's point of view, their ownership share of the company cannot be worth less than zero."
The following is a possible argument for large and growth stocks having more trouble with overpricing than small and value stocks.
Stocks and bonds tend to be valued based on cash flows. But some assets don't have cash flows, such as commodities and currencies. They're valued based on supply and demand.
However, you can also value stocks and bonds based on supply and demand. Because of the fixed nature of income and return of principal, it doesn't work as well with bonds. Such constraints are less of an issue with stocks. Momentum and trend following are based on supply and demand, and can work well in the short term.
One could make the case that the internet bubble was an example where valuation, based on supply and demand, assumed greater importance relative to valuation based on cash flows. Supply and demand valuation depends on how strongly buyer and sellers feel about buying and selling respectively. If buyers feel more strongly about buying than sellers do about selling, the price rises. But sentiment doesn't last forever, and when sellers feel more strongly about selling than buyers do about buying, the price falls. Sentiment can be fickle, and profiting from it isn't straightforward.
Similar to bonds, small and value stocks are less susceptible to supply and demand valuation causing overpricing/underpricing relative to cash flows. If supply and demand valuation causes a small or value stock to become overpriced relative to cash flows, such a stock will tend to become a large or growth stock. But if such valuation becomes more important for a large or growth stock, it's still a large or growth stock. If supply and demand valuation causes a small or value stocks to become underpriced relative to cash flows, such stocks will tend to stay as small or value stocks. But in such a situation, a large or growth stock will tend to become a small or value stock. In the long term, valuation based on cash flows is what is important to stocks, and that can catch up to large and growth stocks that have been valued on supply and demand.