Until the banking crisis of 2008, investors had made a Faustian bargain, when it came to valuing and investing in banks. Banks were opaque in their public disclosures and investors often had little information on either the risk of the securities held or the default probabilities of loan portfolios. However, investors were willing to accept this opacity and view banks as "safe" investments for two reasons:Banks were regulated in their risk taking: In effect, we were assuming that bank regulators would bring enough scrutiny to the process to prevent banks from taking "rash" risks. (We also assumed...
Catastrophe and consequences for value
The airwaves have been inundated with news about natural disasters in Japan and their aftermath. Without minimizing the human impact - the thousands who have lost their lives and belongings - and the dangers of a nuclear meltdown, I want to focus on the impact of catastrophes, natural or man-made, on markets and asset values. While each disaster is different, here are some common themes that emerge after the disaster:a. Our definition of "long time periods" is woefully inadequate: After the quake, which measured 8.9 on the Richter scale and ranked as one of the five strongest in recorded history,...
A tide in the affairs of men...
In my last post, I noted how difficult it is to separate luck from skill in both investment and corporate finance. While I remain leery of stock picking success stories (and believe me when I say I hear dozens each week), I continue to admire successful businesses of all stripes, from the bagel shop in my town that manages to sell out every day to Facebook in the social media world.It is not that luck does not play a role in business success. In fact, most successful individuals and businesses can point to a stroke of good luck that got them started. Microsoft was lucky that...
Luck versus skill: How can you tell?
A hedge fund manager doubles her investors' money over the course of a year.. A company's stock increases four fold over the course of six months.... these are not unusual news stories but they give rise to one of those enduring questions in finance: Was it luck or skill? The answer of course is critical. If it was "luck", we should not be giving the hedge fund manager 2% of our wealth and 20% of the profits. If it was skill, the company's managers deserve not just a huge thank you but commensurate financial rewards.As always in finance, there are two extreme outlooks. At one end, there are those...
Behavioral Economics: Thoughts on Value and Price
I must confess that I was a skeptic on behavioral finance until a few years ago. At that point, the amount of information that had been accumulated on the "irrational" behavior of investors became so overwhelming that I faced one of two choices. I could ignore reality and live in the clean, rational world of classical economics or I could face up to facts and think about how investment and corporate finance decisions should be made in the messy world that we live in. After struggling with the conflict, I think I am making some progress. In an earlier post on the third edition of my corporate...
