Security Analysis and Business Valuation on Wall Street,: A ... - lib

Who’s Practicing <strong>Security</strong> <strong>Analysis</strong> <strong>and</strong> <strong>Business</strong> <strong>Valuation</strong>? 27selection by purchasing mutual funds or index funds. Others indulge in the occasionalequity speculation based on a broker’s suggestion, a friend’s advice, ora news item. A small minority apply the tools reviewed in this book to evaluateshare prices.As noted earlier, information is the lifeblood of the stock market. In this regardthe individual investor operates at a significant disadvantage relative to securitiesfirms <strong>and</strong> prominent institutions. The majority of new corporate information isdistributed in an even-h<strong>and</strong>ed fashion, but frequently word of a significant event leaksout to key market players, who are then in position for a short time to make a profit.Indeed, one study showed that 40 percent of takeover stocks rose significantly in pricebefore any public announcement of the deed. Besides access to leaks, institutions<strong>and</strong> securities firms have better access to corporate management in getting questionsanswered. On Wall Street, the individual hears information last. For example, anumber of sell-side analysts move stock prices when issuing recommendations tobuy or sell, as investors quickly follow their advice.Professional traders <strong>and</strong> computerized institutions have advantages over individualsin profiting on such new information. Few individuals spend their days trackingresearch reports, stock prices, <strong>and</strong> news items on a minute-to-minute basis, yet anydata coming over the Internet from the news services is read immediately by at least100,000 such professionals <strong>and</strong> instantaneously processed by institutional computers.Printed information in the Wall Street Journal <strong>and</strong> the New York Times, whileonly 12 to 24 hours old, is already discounted by practitioners. Thus, the individualplayer works off stale information that is days old. Only superior analytical effortovercomes this disadvantage.Despite these obstacles, some individuals apply security analysis techniques totheir equity investment activities <strong>and</strong> realize superior performance. In my experience,the most successful individual investors fall into two groups: (1) those with priorfinancial experience, which enables them to perform their own analysis; <strong>and</strong> (2)those with a strong industry expertise, which allows them to foresee developmentsimpacting stock prices in that one industry.Although the odds are stacked against individual investors, the situation is farfrom hopeless. There are thous<strong>and</strong>s of publicly traded stocks, <strong>and</strong> the vast institutional<strong>and</strong> brokerage communities can’t monitor every company on a continualbasis. <strong>Valuation</strong> anomalies occur on a regular basis because the thous<strong>and</strong>s of tapewatchers can’t maintain complete coverage <strong>and</strong> the computers are only as skillfulas their programmers. As individuals search for discrepancies, they can also practicecommon sense in the selection of widely followed stocks. Full-time players inevitablyget caught up in Wall Street’s herd mentality, which frequently produces outl<strong>and</strong>ishvaluations for the stock of the month. Inevitably, prices of these businesses return toearth after practitioners face their excesses, so an occasional short sale by a knowledgeableindividual is appropriate. Likewise, common sense sometimes triggers acontrarian approach on the buy side, as an individual purchases selected stocks thathave fallen from grace.The 2004 run-up in biotech stocks was a good example of institutional investorsgoing overboard in betting on the financial prospects of a specific industry. Over a12-month period, the NASDAQ Biotech index nearly doubled, only to fall 40 percentin three months.