McGraw-Hill

20 selecting securities
returns on a consistent basis, over changing economic and market
environments. Successful investing isn't that easy.
The difficulty of the task stems from the nature of the market itself.
Random walk enthusiasts would have one believe that the
ket is a random system, that stock prices meander like a stumbling
drunkard. Trying to predict their path is a futile task..
Other investors-those who screen on fundamentals such as
low P/E, or technicals such.as moving averages-apparently believe
the market be to an ordered system. Ordered systems, such as
the structure of diamond crystals or the dynamics of pendulums,
are definable by a relatively small number of variables and predictable
by relatively simple rules. if But the stock market is predictable
on the basis of such simple laws, why isn't everyone profiting from
them?
We believe that the stock market is a complex system. Co
systems, such as the weather and the workings of DNA, can be
modeled and partly predicted, but only with great difficulty. The
number of variables that must be modeled, and their interactions,
are beyond the capacity of the human mind alone. Identifying these
variables, and detecting exploitable profit opportunities, requires
extensive computer-based statistical modeling across a broad range
of stocks. Robust insights into stock price behavior emerge only
from an analysis that carefully considers numerous factors simulta
neously.
In defining "value," say, a model that grapples with the market's
complexity does not confine itself to a dividend discount
model (DDM) measure of value, but also examines earnings, cashflow,
sales, and dividend yield value, among other attributes.
Growth measurements to be considered include historical, expected,
and sustainable earnings growth, as as well the momentum
and stability of that growth. Share price, volatility, and analyst coverage
are among the elements to be considered along with market
capitalization as measures of size.
These variables are often closely correlated with each other.
Small-cap stocks, for example, tend to have low P/Es; low P/E is
correlated with high yield; both low P/E and high yield are correlated
with DDM estimates of value. Furthermore, they may be correlated
with stock's a industry affiliation. A simple low-P/E screen,
for example, will tend to select a large number of bank and utility