Prelims
New Principles of Equity Investment
ISBN: 978-1-78973-064-7, eISBN: 978-1-78973-063-0
Publication date: 5 February 2019
Citation
Coleman, L. (2019), "Prelims", New Principles of Equity Investment, Emerald Publishing Limited, Leeds, pp. i-xvi. https://doi.org/10.1108/978-1-78973-063-020191001
Publisher
:Emerald Publishing Limited
Copyright © 2019 Emerald Publishing Limited
Half Title Page
New Principles of Equity Investment
Title Page
New Principles of Equity Investment
Les Coleman
The University of Melbourne, Australia
United Kingdom – North America – Japan India – Malaysia – China
Copyright Page
Emerald Publishing Limited
Howard House, Wagon Lane, Bingley BD16 1WA, UK
First edition 2019
Copyright © 2019 Emerald Publishing Limited
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British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
ISBN: 978-1-78973-064-7 (Print)
ISBN: 978-1-78973-063-0 (Online)
ISBN: 978-1-78973-065-4 (Epub)
Contents
About the Author | xiii |
1. What this Book is About | 1 |
2. Four-Component Model of Equity Pricing | 23 |
3. How Professionals Invest | 57 |
4. Risk in Equity Investment | 79 |
5. Fundamental Analysis of Equities | 95 |
6. Pricing Equities within the Four-Component Model | 123 |
7. Market Level Influences and Transaction Timing | 149 |
8. Portfolio Construction and Performance Evaluation | 179 |
9. Summary and Conclusions | 197 |
References | 225 |
Index | 245 |
List of Figures and Tables
Figures
Fig. 1.1. | Summary of New Principles of Equity Investment. | xv |
Fig. 1.2. | Fama/French SMB and HML Factors. | 11 |
Fig. 1.3. | Proportion of Firm NPV Accrued in the First Year. | 12 |
Fig. 1.4. | Schematic of New Principles of Equity Investment. | 16 |
Fig. 2.1. | Waterfall Diagram of the Intrinsic, Transactional, Optional and Extrinsic Components of a Share’s Price (Not to Scale). | 29 |
Fig. 2.2. | Loci of Equity Price Components. | 48 |
Fig. 2.3. | Equity Valuation Framework (Not to Scale). | 49 |
Fig. 2.4. | Model of Contributors to Equity Price. | 51 |
Fig. 3.1. | Berkshire Hathaway and Fidelity Magellan Performance Versus S&P 500. | 63 |
Fig. 3.2. | Eerily Close Alignment of Lead Ups to the 1929 and 1987 US Equity Market Crashes. | 68 |
Fig. 3.3. | Alignment of the US Market and Japanese Market 13 Years Earlier. | 71 |
Fig. 4.1. | Prospect Theory. | 81 |
Fig. 4.2. | Sources of Firm Risk. | 85 |
Fig. 5.1. | Performance of Fundamental Valuation Techniques. | 120 |
Fig. 6.1. | United Technologies Corporation 1985–2015 Return Prediction. | 145 |
Fig. 6.2. | Excess Return for Large Firms Sorted by Decile of Predicted Return. | 146 |
Fig. 7.1. | Links between the Macro-Economy and Financial Markets. | 151 |
Fig. 7.2. | Trends, Patterns and Cycles in the US Equity Prices. | 161 |
Fig. 7.3. | Institutions’ Influence on Skew in Equity Returns. | 168 |
Fig. 7.4. | Return from Market Timing. | 174 |
Fig. 7.5. | Decision Tree Framework for Equity Investment. | 177 |
Fig. 8.1. | Volatility of the S&P 500. | 183 |
Fig. 8.2. | Returns by Style. | 189 |
Tables
Table 2.1. | Nature and Drivers of Firms’ Real Options. | 34 |
Table 2.2. | Attributes within Equity Price Components that Explain Behavioural Biases. | 52 |
Table 5.1. | Classification of Fundamental Equity Valuation Techniques. | 100 |
Table 5.2. | Elements in Fundamental Valuation of a Company. | 103 |
Table 5.3. | Common Firm-specific Variables Whose Lagged Values Explain Returns. | 106 |
Table 5.4. | Pro Forma Statement of Cash Flows. | 108 |
Table 5.5. | Averages of Valuation Measures in Different Markets During 2006–2017. | 115 |
Table 6.1. | Results of OLS Regression of Following Year Excess Returns against Historical Semi-deviation and Skewness. | 127 |
Table 6.2. | Enron Financial Accounts. | 129 |
Table 6.3. | Risk-related Features of Bankrupt and Non-bankrupt Firms. | 135 |
Table 6.4. | Firm Variables that Predict Value. | 139 |
Table 8.1. | Components of Net Wealth in the United States. | 187 |
Table 8.2. | Mutual Fund Total Return (% PA) and Comparison of Performance. | 194 |
An abundance of widely accepted folklore is used in the investments industry.
Francis and Kim (2013) Modern Portfolio Theory
Most claimed research findings in financial economics are likely false.Harvey, Liu, and Zhu (2015)
The market is not well anchored by fundamentals. People do not even know to any degree of accuracy what the ‘right’ level of the market is.
Robert J. Shiller (2000, p. 147) Irrational Exuberance
We need empirically valid theories of how business organizations operate, of how investment decisions are actually made.
Herb Simon (1986, p. xv) Handbook of Behavioral Economics
The transition from a paradigm in crisis to a new one … is a reconstruction of the field from new fundamentals, a reconstruction that changes some of the field’s most elementary theoretical generalizations as well as many of its methods and applications.
Thomas S. Kuhn (1962, pp. 84–85) The Structure of Scientific Revolutions
How can the validity of axioms and their implications be tested without referring to observed facts?
Maurice Allais (1988, p. 274)
The difficulty lies not so much in developing new ideas as in escaping from old ones.
John Maynard Keynes (1936, p. vii) The General Theory of Employment, Interest and Money
About the Author
Les Coleman is a finance academic at the University of Melbourne. There he completed a bachelor’s degree in Mining Engineering (1974), and a PhD by thesis which was published as Why Managers and Companies Take Risks (Springer, 2006). Les also holds a Master of Economics from Sydney University and a BSc (Economics) from London University.
Prior to returning to study in 2002 and then moving into academia, Les worked for almost 30 years in senior management positions with resources, manufacturing and finance companies in Australia and overseas. He started as a mining engineer with Anglo American Corporation in Zambia, and then joined Mobil Oil in Melbourne, where highlights of his career include four years in Mobil Corporation’s international planning group at its global headquarters near Washington, DC, and six years as regional treasurer for ExxonMobil Australia. In the last 25 years, he has filled senior investment roles as a trustee of two employee superannuation funds and that of a public offer superannuation fund, a member of the Investment Management Committee of IOOF Holdings Limited and a director of 10 companies involved in finance, retail and distribution, including Australian Ethical Investment Limited and Strasburger Enterprises Pty Ltd. Les has written and spoken widely on finance and investment strategies, and for four years was a weekly columnist with The Australian newspaper.
Les has published six books, four book chapters and close to 30 journal articles. His main research interest is applied finance, especially financial decision making by investment funds and firms. This was informed by his diverse industry experience and involved extensive field research, including interviews with almost 60 finance executives in Istanbul, London, Melbourne and New York. These insights enabled him to apply the scientific method to investment: The Lunacy of Modern Finance Theory & Regulation (Routledge, 2014) analysed shortcomings in the finance discipline, and was followed by Applied Investment Theory (Palgrave Macmillan, 2016) which set out a descriptive model of the practices of professional investors. He also has an interest in sustainability and risk as decision stimuli, and his book entitled Risk Strategies: Dialling up Optimum Firm Risk (Gower, 2009) foreshadowed a body of theory to manage risk strategically (in much the same way as human physiology and physical sciences support modern medical and engineering techniques respectively). He delivers executive education programmes in Australia and overseas, and has received research and teaching awards. Les is a member of the editorial board of three academic journals, and is a joint recipient of an Australian Research Council linkage grant.
Les has three adult children and lives in the coastal hinterland near Melbourne.
Fig. 1.1
Summary of New Principles of Equity Investment.
- Prelims
- 1. What this Book is About
- 2. Four-Component Model of Equity Pricing
- 3. How Professionals Invest
- 4. Risk in Equity Investment
- 5. Fundamental Analysis of Equities
- 6. Pricing Equities within the Four-Component Model
- 7. Market Level Influences and Transaction Timing
- 8. Portfolio Construction and Performance Evaluation
- 9. Summary and Conclusions
- References
- Index