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 Art of Business Valuation

Many investors insist on affixing exact values to their investments, seeking precision in an imprecise world, but business value cannot be precisely determined. Reported book value, earnings, and cash flow are, after all, only the best guesses of accountants who follow a fairly strict set of standards and practices designed more to achieve conformity than to reflect economic value. Projected results are less precise still. You cannot appraise the value of your home to the nearest thousand...

The Major Buyers of Junk Bonds

Individual investors in the 1980s sought to preserve the high nominal returns to which they had recently become accustomed. These yield pigs were vulnerable to the hype that surrounded the junk-bond market, a vulnerability exacerbated by the favorable treatment given to high-yield bonds by the media. Many of these investors found their way into one of the many high-yield mutual funds that came into existence. These funds appeared to offer professional management, diversification, low...

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...