Author: Richard Bernstein
- Market segments are groups of stocks with similar characteristics that tend to perform similarly. All market anomalies are segments.
- Macro economy and a firm's microeconomics are interrelated.
- The product bought and sold in within the equity market is nominal earnings growth.
- The macro economy will affect the supply of nominal earning growth, but so will accounting changes and one time change.
- The abundance and scarcity of nominal earning growth will affect how market segment and style will perform.
- A simple measure of supply of earnings growth is reported earning momentum for SP500
- Reported earnings are more important than the operating earnings (why ???)
- The abundance and scarcity of nominal earning growth alters investors' risk perception.
- Consensus expectations may be of little help. Insightful analysis is to predict earnings surprises and the direction of revision to consensus expectation.
- Earnings surprise are more like to happen when the consensus forms a uniform viewpoint.
- Earnings expectation life cycle
- Growth manager: high-expectation, undertake contrarian selling
- Value manager: low-expectation, undertake contrarian selling
- Contrarians tend to outperform not only because of "buy low / sell high", but also because they provide liquidity.
- Growth investing requires a rather pessimistic view of the world, while value investing requires a more optimistic view.
- Growth strategy historically tend to outperform when earnings momentum waned, interest rate fall, interest rate curve inverted, and payout ratio rose.
- Value strategy historically tend to outperform when earnings momentum improved, interest rate rose, interest rate curve steep, and payout ratio fell.
- "Good" companies do not necessarily make "good' stock.
- An available means for measuring quality is the S&P Common Stock Rating, which are based on the stability and growth in earning and dividends over a 10-year period.
- An index of C- and D- rated companies significantly outperformed A+ rated, even on risk-adjusted basis. (True? This is contradicting quality-minus-junk. Maybe because SP rating is lagged.)
- The profit cycle has a direct impact on whether "bad" companies make "good" stocks. Because US economy is growth-oriented, and spends more time in expansion than recession. "Bad" companies tend to make "good" stocks over time.
- Lower-quality companies tend to have higher fixed cost, such as debt. These costs lead to potential bankruptcy, and lead investors to invest in safe havens during times of poor profitability.
- Altman's Z-scores, a predictor of bankruptcy, is another measure of quality.
- Institutional investors tend to search for "good" companies due to factors such as a lack of available research, trading liquidity and psychological factors like regret-aversion.
- Beta is a measure of risk of a stock within the context of a well-diversified portfolio. Beta by industry: NYU Beta data. Low beta: Energy, Utility; High beta: Financial, Capital goods
- Higher yielding, larger, and more asset-stable companies tend to have lower betas.
- During 1980s, high beta stocks didn't have higher returns. The reason may be the low inflation and resulting declines in nominal earning growth.
- Betas are not stable and tend to gravitate toward 1.
- Investors should be aware of how performance, expectation, and overreaction can influence the calculation of a company's beta.
- (equity) Duration measures the change in return relative to change in interest rate (Page 131).
- To measure equity duration: 1) the inverse of the dividend yield: assume constant expectation; 2) DDM-based: based on a stream of expectation, generally in the range of 20 to 30 years although observed duration tend to be 5 to 10 years; 3) Leibowitz method: measure various sensitivity to nominal growth and to real interest rate (interaction). Companies that benefit from economic growth more than others tend to have their duration shorten.
- Higher yielding stocks are not necessarily more interest rate sensitive.
- Compared to value stocks, growth stocks have higher duration.
- During 1980s (low inflation), shorter duration stocks offered similar potential growth to that offered by longer duration stocks, which may help explain the under-performance of smaller capitalization stocks.
- Duration measures "certainty of returns". Given similar expected return, rational investors prefer shorter duration stocks.
- Equity yield curve relates duration to expected nominal growth (e.g. 5-yr exp. growth rate).
- Investors tend to define size according to market capitalization because it's an indicator of trading liquidity. Several other size variables, such as sale or number of employee, correlate well with market cap.
- Smaller cap stocks do tend to have higher transaction costs.
- Risk, as defined as volatility of return, tends to increase with decreasing market cap, but Mid cap have historically had higher return per unit of risk.
- Emerging growth stocks and small cap value stocks, although both small, perform quite differently. The small cap effect may actually be a small cap value effect, although it's often used "incorrectly" to support emerging growth investing.
- Capital gain tax rate tends to affect the after-tax expected returns of smaller cap stocks because smaller stocks do not tend to pay dividend.
- Small cap may be more influenced by the health of local economy rather than the health of the national / global economy.
- Small cap have lower analyst coverage.
- For plan sponsors, style tilting strategies may be preferable to firing/hiring process.
- Pension assets should be diversified relative to the overall corporate assets.
- P/E-to-growth is one traditional growth at reasonable price (GARP) type strategy.
- The percent of returns that fall below 0 or required benchmark is an insightful measure of risk.
- The need for hedging equity portfolio may increase as the consensus becomes more certain about the positive or negative outcome of a particular investment.
- The success of style investing may depend on a particular manager's willingness to be a contrarian.
- Derivatives allow the investors to be more of a contrarian because of the risk control they offer. Value managers should focus on derivative strategies to make the return distribution around buy points more certain. Growth managers: sell points.
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