The Financially Distressed and Bankrupt Security Investing Process

Investors in financially distressed and bankrupt securities must concentrate on the corporate balance sheet. Like knowing the opposing lineups at a baseball game, understanding the amounts and priorities of a company's liabilities can tell investors a great deal not only about how the various security holders are likely to be treated but also how the financial distress is likely to be resolved. The first step is to value the assets of the debtor. Once the size of the pie is known, it is...

The Relaxation of Investment Standards

Junk-bond issuers, underwriters, and investors each abandoned established standards of value for new, less rigorous criteria. Excessive prices were paid for businesses by buyers able to issue risky paper to investors who in turn stretched their own customary analytical standards to justify the prices paid. New wrinkles, such as non-cash-pay bonds and interest rate reset features, camouflaged the relaxation of standards. The substitution of cash-flow analysis for other barometers of business...

Present Value Analysis and the Difficulty of Forecasting Future Cash Flow

When future cash flows2 are reasonably predictable and an appropriate discount rate can be chosen, NPV analysis is one of the most accurate and precise methods of valuation. Unfortunately future cash flows are usually uncertain, often highly so. Moreover, the choice of a discount rate can be somewhat arbitrary. These factors together typically make present-value analysis an imprecise and difficult task. A perfect business in terms of the simplicity of valuation would be an annuity an annuity...

The Nature of Wall Street Works Against Investors

Investors in marketable securities have little choice but to deal with Wall Street. The sad truth is, however, that many investors are not well served in their dealings with Wall Street they would benefit from developing a greater understanding of the way Wall Street works. The problem is that what is good for Wall Street is not necessarily good for investors, and vice versa. Wall Street has three principal activities trading, investment banking, and merchant banking. As traders Wall Street...

The Complexity and Variability of Business Valuation

It would be a serious mistake to think that all the facts that describe a particular investment are or could be known. Not only may questions remain unanswered all the right questions may not even have been asked. Even if the present could somehow be perfectly understood, most investments are dependent on outcomes that cannot be accurately foreseen. Even if everything could be known about an investment, the complicating reality is that business values are not carved in stone. Investing would be...

Index Funds The Trend Toward Mindless Investing

An important stock market development in the past several years has been the rush by institutional investors into indexing. Indeed this trend may be a major factor in the significant divergence between the performances of large-capitalization and small-capitalization stocks between 1983 and 1990. Indexing is the practice of buying all the components of a market index, such as the Standard & Poor's 500 Index, in proportion to the weightings of the index and then passively holding them. An...

The Institutional Performance Derby The Client Is the Loser

Growing pools of retirement and endowment funds seeking sound investment outlets led to the most important development in the investment world over the last three decades the ascendancy of the institutional investor. Unfortunately institutional investing has developed in ways that are detrimental to the returns generated on the money under management. The great majority of institutional investors are plagued with a short-term, relative-performance orientation and lack the long-term perspective...

Value Investing Is Predicated on the Efficient Market Hypothesis Being Wrong

Investors should understand not only what value investing is but also why it is a successful investment philosophy. At the very core of its success is the recurrent mispricing of securities in the marketplace. Value investing is, in effect, predicated on the proposition that the efficient-market hypothesis is frequently wrong. If, on the one hand, securities can become undervalued or overvalued, which I believe to be incontrovert-ibly true, value investors will thrive. If, on the other hand,...