Investment Philosophies: Successful Strategies and the Investors Who Made Them Work

Praise from the first edition of Investment Philosophies

"Damodaran is a well–informed scholar with a gift for organized, clearly written syntheses of complex topics in modern finance. With Investment Philosophies he provides the uncensored facts about winning in the marketplace. If you are a fund manager, an investor, or simply a student of finance, you will want to read this book."
Tom Copeland, Managing Director of Corporate Finance, Monitor

"Professor Damodaran has zeroed in on the most important missing element of many investment management processes: a clearly defined investment philosophy which can serve as a beacon in difficult markets. He offers a cornucopia of philosophies and strategies that have worked for many of the most successful investors, and which have stood the test of time."
Rob Arnott, Chairman, First Quadrant, LP; Editor, Financial Analysts Journal

"As an investor, I always have to look back to my philosophy and strategy for taking risk and making money. This book is an invaluable aid for ′taking stock′ before buying stock. It lays out the concepts and tools for understanding the basics of risk and return in the stock market, and presents a framework for any investor to construct his or her own investment philosophy."
Mitch Julis, Managing Partner, Canyon Capital Advisors

CHAPTER 1 Introduction 1

What Is an Investment Philosophy? 2

Why Do You Need an Investment Philosophy? 3

The Big Picture of Investing 4

Categorizing Investment Philosophies 7

Developing an Investment Philosophy 10

Conclusion 12

Exercises 13

CHAPTER 2 Upside, Downside: Understanding Risk 15

What Is Risk? 16

Equity Risk: Theory–Based Models 16

Assessing Conventional Risk and Return Models 32

Equity Risk: Alternative Measures 34

Equity Risk: Assessing the Field 45

Default Risk 46

Conclusion 50

Exercises 51

CHAPTER 3 Numbers Don t Lie Or Do They? 53

The Basic Accounting Statements 53

Asset Measurement and Valuation 55

Measuring Financing Mix 62

Measuring Earnings and Profitability 69

Measuring Risk 75

Differences in Accounting Standards and Practices 82

Conclusion 82

Exercises 85

CHAPTER 4 Show Me the Money: The Basics of Valuation 87

Intrinsic Value 87

Relative Valuation 110

Valuing an Asset with Contingent Cash Flows (Options) 119

Conclusion 121

Exercises 122

CHAPTER 5 Many a Slip: Trading, Execution, and Taxes 125

The Trading Cost Drag 125

The Components of Trading Costs: Traded Financial Assets 127

Trading Costs with Nontraded Assets 146

Management of Trading Costs 148

Taxes 150

Conclusion 159

Exercises 160

CHAPTER 6 Too Good to Be True? Testing Investment Strategies 163

Why Does Market Efficiency Matter? 163

Efficient Markets: Definition and Implications 164

Behavioral Finance: The Challenge to Efficient Markets 170

A Skeptic s Guide to Investment Strategies 204

Conclusion 206

Exercises 207

CHAPTER 7 Smoke and Mirrors? Price Patterns, Volume Charts, and Technical Analysis 209

Random Walks and Price Patterns 209

Empirical Evidence 211

The Foundations of Technical Analysis 239

Technical Indicators and Charting Patterns 240

Conclusion 255

Exercises 256

CHAPTER 8 Graham s Disciples: Value Investing 259

Who Is a Value Investor? 259

The Passive Screener 260

The Contrarian Value Investor 284

Activist Value Investing 293

Conclusion 326

Exercises 326

CHAPTER 9 The Allure of Growth: Small Cap and Growth Investing 329

Who Is a Growth Investor? 329

Passive Growth Investing 330

Activist Growth Investing 365

Conclusion 372

Exercises 373

CHAPTER 10 Information Pays: Trading on News 375

Information and Prices 376

Trading on Private Information 378

Trading on Public Information 398

Implementing an Information–Based Investment Strategy 421

Conclusion 422

Exercises 423

CHAPTER 11 A Sure Profit: The Essence of Arbitrage 425

Pure Arbitrage 425

Near Arbitrage 450

Speculative Arbitrage 460

Long/Short Strategies Hedge Funds 465

Conclusion 469

Exercises 470

CHAPTER 12 The Impossible Dream? Timing the Market 473

Market Timing: Payoffs and Costs 473

Market Timing Approaches 477

The Evidence on Market Timing 506

Market Timing Strategies 514

Market Timing Instruments 518

Connecting Market Timing to Security Selection 521

Conclusion 521

Exercises 522

CHAPTER 13 Ready to Give Up? The Allure of Indexing 525

The Mechanics of Indexing 525

A History of Indexing 527

The Case for Indexing 530

Why Do Active Investors Not Perform Better? 554

Alternative Paths to Indexing 562

Conclusion 571

Exercises 572

CHAPTER 14 A Road Map to Choosing an Investment Philosophy 575

A Self–Assessment 575

Finding an Investment Philosophy 579

The Right Investment Philosophy 581

Conclusion 583

Exercises 584

Index 585

ASWATH DAMODARAN is Professor of Finance at New York University′s Leonard N. Stern School of Business. He has been the recipient of numerous awards for outstanding teaching, including the NYU university–wide Distinguished Teaching Award, and was named one of the nation′s top business school teachers by BusinessWeek in 1994. In addition, Damodaran teaches training courses in corporate finance and valuation at many leading investment banks. His publications include Investment Valuation (now in its third edition), Damodaran on Valuation: Security Analysis for Investment and Corporate Finance; Corporate Finance; Investment Management; and Applied Corporate Finance, all published by Wiley, and The Dark Side of Valuation.