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Alpha, Beta, Gamma... Ignore Them!
Mon, 20 Jun Pre-Open

"Investors should be sceptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas." - Warren Buffett, 2009 letter to Berkshire Hathaway shareholders.

Are you impressed when stock market 'experts' or the media use such terms? Don't be. Like Buffett said, these terms sound impressive... indeed they are.

But are they helpful? No.

Recently we came across an interesting article in the Economic Times. Apparently, 17 'high Beta' stocks have more than doubled over the last one year. The Sensex is down about 5% over the same period.

'Beta' is a measure of volatility. It measures the movement of a stock in comparison to the movement of the index which has a Beta of 1. For example, if a stock's Beta is 1.2, then it is 20% more volatile compared to the index.

The question you should be asking yourself is this: 'Should I be worried about the Beta of my stocks?' Our answer is simple and direct: No.

As long as you are an investor and not a trader, you would do well to ignore all this Greek terminology. These terms only serve the purpose of distracting long-term investors from their only real task; identifying strong businesses to invest their money. These terms may be useful to the fund management industry but they are practically useless to the aam investor. This is why Warren Buffett warned investors to be wary of them.

At Equitymaster, we do not use 'Greeks' as these terms are known. Following a value-investing based bottom-up approach, has served us well. In the long-term there are only two things that you need to understand to make money in the stock market.

  • How to value a business
  • How to think about stock prices

Forget everything else!

For information on how to pick stocks that have the potential to deliver big returns, download our special report now!

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Jul 21, 2017 03:37 PM

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