Behavioral Finance and Decision Theory in Investment by Arnold S. Wood, Amos Tversky, Werner F.M. De Bondt, Meir

By Arnold S. Wood, Amos Tversky, Werner F.M. De Bondt, Meir Stateman, Leslie Shaw, Visit Amazon's Russell J. Fuller Page, search results, Learn about Author Central, Russell J. Fuller, , Richard S. Pzena, Visit Amazon's David N. Dreman Page, search results,

Behavioral Finance and selection thought in funding administration [Paperback] [Dec 01, 1995] Arnold S. wooden; Amos Tversky; Werner F.M. De Bondt; Meir Stateman; Leslie Shaw; Russell J. Fuller; Richard S. Pzena; David N. Dreman and Horace Woody Brock ... 187908757X

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0a aEnd of third quarter. Source: Sanford C. Bernstein & Co. margins have collapsed; debt is rising. And what has been happening to Wall Street earnings estimates? Progressive deterioration, as shown in Figure 1. Deep down, the analyst knows that buying low-P/B stocks makes sense, but recommending Kmart requires courage. The high-P/B list is a much more pleasant world. 25fI 1 . 0 0 L - - I- - . L - - - L - - - -I L - - - - - l 3/94 6/94 9/94 12/94 3/95 Source: Sanford C. Bernstein & Co. So, people tend to buy Microsoft and avoid Kmart even though history shows that, in the absence of other information, Kmart is the better investment.

When companies become cheap, a lot of their industry peers usually become cheap at the same time because the problems are not always company specific. Kmart's situation may be company specific, but the problems of banks, for example, are not; they are all facing the same issues. Our solution is simple: If we have a big opportunity, we concentrate; if we have a modest opportunity, we diversify. If the low-P/B stocks in an industry are selling at 50 percent off fair value, you want to buy a lot of them.

If earnings follow a random walk but analysts tend to extrapolate past earnings, the result should be fairly large forecast errors, which is precisely what the studies show. Behavioral Influences Although earnings are almost impossible to finetune, most analysts and money managers place a great deal of emphasis on fine-tuned earnings estimates. In the first edition of Security Analysis, published in 1933, Graham and Dodd noted that the thorough analyst will go through hundreds and hundreds of factors-fundamental factors in a company and its industry, monetary conditions, and so forthbut in the end, the analyst will place the greatest emphasis on the short-term earnings forecast.

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