Aswath Damodaran – The Secret To Investment Success: Self Awareness?

Johnny HopkinsAswath DamodaranLeave a Comment

One thing we love here at The Acquirers Multiple are great teachers in the world of investing. None is better than one of my favorites, Aswath Damodaran.

Damodaran holds the Kerschner Family Chair in Finance Education and is Professor of Finance at New York University Stern School of Business. Before coming to Stern, he also lectured in Finance at the University of California, Berkeley.

Damodaran’s contributions to the field of Finance have been recognized many times over. He has been the recipient of Giblin, Glucksman, and Heyman Fellowships, a David Margolis Teaching Excellence Fellowship, and the Richard L. Rosenthal Award for Innovation in Investment Management and Corporate Finance.

His skill and enthusiasm in the classroom garnered him the Schools of Business Excellence in Teaching Award in 1988, and the Distinguished Teaching award from NYU in 1990. His student accolades are no less impressive: he has been voted “Professor of the Year” by the graduating M.B.A. class five times during his career at NYU.

One of my favorite articles by Damodaran comes from his blog, Musings on Markets called, The Secret To Investment Success: Self Awareness? It’s one of the most simplistic overviews of how to match your personality with an investing strategy.

Here’s the article first published on Musings on Markets, its a must read for all investors:

I know that there are many who claim to have found the secret ingredient to investment success, though few actually deliver. However, I want to present an unconventional ingredient that I think most academics and practitioners miss when they talk about investment strategies: your personal make-up as an individual.

In one of my books, Investment Philosophies, I start with a puzzle. There are many different investment philosophies out there and they range the spectrum both in the tools they use (charts for some, fundamental analysis for others..) and their views on markets (markets learn too slowly, markets over react). In fact, some of these philosophies directly contradict others. But there are two puzzles. The first is that there are a few investors within each philosophy who have succeeded in using that philosophy to great effect over their lifetimes: there have been successful technical analysis, value investors, growth investors and market timers over the last few decades. The second is that within each philosophy, success seems to be elusive for most of those who try to imitate the Warren Buffets and Peter Lynchs of the world.

My explanation for the puzzle. Every investment philosophy works but only for some investors and not all of the time, even for them. Each investment philosophy requires a perfect storm to succeed: not only do the times and circumstances have to be right for the philosophy but the investors using it have to be psychologically attuned to the philosophy.

Consider, for instance, the investment philosophy that many argue is the best (or at least the most virtuous) investment philosophy for all investors. Good investors, they claim, invest long term in companies that are fundamentally under valued, usually in the face of market selling. Here is the problem. The strategy sounds good and makes money on paper but requires three ingredients from investors for success: a long time horizon, a strong stomach and a willingness to go against the grain. If you are an impatient investor, who has a worry gene and care about peer pressure, adopting this strategy will be a recipe for disaster. Not only will you end up abandon your investments well before they pay off, you will make yourself miserable (and physically sick) in the meantime. For this investor, a short term momentum strategy makes a lot more sense.

As you think about what investment philosophy is right for you, here are some things about yourself that you may want to think about:
1. Are you a patient or impatient person?
2. How do you respond to peer pressure?
3. Are you a “worrier”?
4. Are you a details person or a big picture person?

A little self introspection will pay off much more than investing your money in another “get rich quickly” book or [investnebt  idek],

Ultimately, what I am arguing is that there is no one best investment philosophy that works for all investors. The right investment philosophy for you will depend upon your time horizon as an individual and what you believe about how markets make mistakes. In the table below, I list the investment philosophy that fits best given your time horizon and views on the market:

Momentum Contrarian Opportunisitic
Short term (days to a few weeks) ·      Technical momentum indicators – Buy stocks based upon trend lines and high trading volume.

·      Information trading: Buying after positive news (earnings and dividend announcements, acquisition announcements)

·      Technical contrarian indicators – mutual fund holdings, short interest. These can be for individual stocks or for overall market. ·      Pure arbitrage in derivatives and fixed income markets.

·      Tehnical demand indicators – Patterns in prices such as head and shoulders.

Medium term (few months to a couple of years) ·      Relative strength: Buy stocks that have gone up in the last few months.

·      Information trading: Buy small cap stocks with substantial insider buying.

·      Market timing, based upon normal PE or normal range of interest rates.

·      Information trading: Buying after bad news (buying a week after bad earnings reports and holding for a few months)

·      Near arbitrage opportunities: Buying discounted closed end funds

·      Speculative arbitrage opportunities: Buying paired stocks and merger arbitrage.

Long Term (several years) ·      Passive growth investing: Buying stocks where growth trades at a reasonable price (PEG ratios). ·      Passive value investing: Buy stocks with low PE, PBV or PS ratios.

·      Contrarian value investing: Buying losers or stocks with lots of bad news.

·      Active growth investing: Take stakes in small, growth companies (private equity and venture capital investing)

·      Activist value investing: Buy stocks in poorly managed companies and push for change.

You can read the article as it was first published on Musings on Markets, here.

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