The Large–Cap Portfolio: Value Investing and the Hidden Opportunity in Big Company Stocks + Web site

praise for The Large–Cap Portfolio

"Tom Villalta has crafted a thoughtful must–read for anyone who′s a stock picker, anyone looking to step up their game in investing returns, or even the casual reader interested in how markets work. The book not only offers insightful tips from a seasoned pro, but also a spirited defense of the passion for picking stocks in an age when many are content to let the machines take over investing." Tiernan Ray, Senior Editor, Barron′s magazine

"Most investors hold large–cap stocks in their portfolios but don′t really understand why. In The Large–Cap Portfolio, fund manager Thomas Villalta offers a clear explanation as to the importance of owning large–caps and why this asset class should not be taken for granted. He also offers a compelling case for actively managed strategies as opposed to indexes or ′closet–indexes.′ All in all, it′s an interesting, detailed look at an often overlooked sector of the market." Gregg Greenberg, Mutual Funds Reporter, TheStreet.com

Acknowledgments xi

Preface xiii

PART I: THE LARGE–CAP OPPORTUNITY AND CHALLENGE

CHAPTER 1 Trends in Large–Cap Investing and the Opportunities They Present 3

Defi ning a Large–Cap Stock 4

Understanding the S&P 500 Index 8

Examining the Growth of Indexed Equities 10

Defi ning Active Management 13

So What Does This Mean for Investors? 25

Two Additional Considerations 28

Finally, Something Timely 29

Conclusions 31

Notes 31

CHAPTER 2 Risk and Uncertainty 35

Financial Measures of Risk 37

Accounting Measures of Risk 41

Differentiating between Certain and Uncertain Cash Flows 43

Conclusions 48

Notes 49

PART II: MARKET INEFFICIENCY

CHAPTER 3 An Introduction to Market Efficiency 53

The Basis for Market Effi ciency 55

Effi cient Markets Hypothesis 58

Empirical Support for the Efficiency of Markets 59

Conclusions 60

Notes 61

CHAPTER 4 Evidence of Ineffi ciency in Investor Behavior and Market Behavior 63

Closed–End Fund Discounts and Premiums 64

Market Bubbles and Market Crashes 68

Investors vs. Their Investment . . . or Investors vs. Themselves 73

Book–to–Market Effects and Other Value Criteria 76

Conclusions 78

Notes 79

CHAPTER 5 Individual Decision Making 81

That Thing about Our Being Rational . . . 84

Bayesian, Non–Bayesian What Does This Mean? 87

Great Companies Always Make Great Stocks 90

Representative Sequences 93

Now That You Put It That Way . . . 96

Dropping an Anchor in a Sea of Information 105

Conclusions 110

Appendix: Utility Theory and Prospect Theory 112

Notes 116

CHAPTER 6 Correlated Mistakes and the Failure of Arbitrage 119

Herding and Why We re Predisposed to Correlated Mistakes 120

Evidence of Herding in Securities Markets and in the Analysis of Common Stocks 123

Feedback Mechanisms and Mood Contagions 126

Smart Arbitrageurs Will Save Us! Won t They? 129

Some Related Considerations in Approaching the Active Management of Investments 133

Conclusions 135

Notes 136

CHAPTER 7 Conventional Views on Sources of Market Inefficiencies 139

Structural Impediments to Market Effi ciency 143

Pertinence to Large–Cap Universe 150

Conclusions 154

Appendix: Underexplained Market Phenomena 155

Notes 158

PART III: RESEARCH AND PORTFOLIO MANAGEMENT

CHAPTER 8 Identifying Large–Cap Stock Opportunities and Optimizing Research Processes 163

Identifying Large–Cap Stock Opportunities 164

Filters and Relative Assessments of Value 165

Subjective Identifi cation of Overoptimism and Overpessimism 173

Overconfi dence, Information Overload, and the Structure of Investment Firms 177

Conclusions 180

Notes 181

CHAPTER 9 Approaching Growth in Large–Cap Stock Research 183

Are We Good at Predicting Growth? 185

Equity Valuation Basics 187

Limitations to Estimating Long–Term Growth Rates 190

Abnormal Growth Magnitude and Abnormal Growth Duration 190

Traditional Methods for Determining Growth 196

Perversions of Growth Estimates in Large–Cap Stocks 199

Recognizing that Markets Are Effi cient over the

Long Term: A Refresher on Microeconomic Theory 214

Some Further Considerations When Predicting Growth Rates 227

Solutions 228

Conclusions 231

Notes 233

CHAPTER 10 Hewlett–Packard Company Case Study 235

A Look at HPQ s Historical Performance and Operations 236

Behavioral Biases and Evidence of Analyst Overreaction 241

Evaluating the Market s Assessment of HPQ s Growth Prospects 243

Pulling It All Together 251

Appendix: Calculating Underlying Assumptions

Relevant to the Valuation of HPQ 253

Notes 258

CHAPTER 11 The Challenges of Managing Large–Cap Common Stock Portfolios 259

Understand Your Universe and Benchmark 260

Off–Benchmark Securities 264

Position Sizes 269

Turnover 271

Commodity–Oriented Holdings in the Large–Cap Portfolio 272

Macroeconomics and Portfolio Management 276

Conclusions 279

Notes 280

What s on the Companion Website 281

About the Author 282

Index 283

Thomas Villalta, CFA, is the lead portfolio manager for the Jones Villalta Opportunity Fund, and the Chief Investment Officer for Jones Villalta Asset Management. Having worked for twenty years in investment analysis and having taught university courses for seven years, Mr. Villalta brings a unique perspective that bridges theory with real–world application. In addition to having appeared numerous times on Fox Business, CNBC, AOL DailyFinance, and TheStreet.com, he has been frequently quoted in the Wall Street Journal, Barron′s, Bloomberg Businessweek, CNN, and many other media outlets.