Meet the (Even More Successful) Cousin of Value Investing - Views on News from Equitymaster

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The Equitymaster Research Digest

Meet the (Even More Successful) Cousin of Value Investing
Jan 6, 2017

  • Define value investing in one sentence...
  • Another market anomaly to capitalise on...
  • What's your 2017 trading strategy?

It is hard to sum up value investing in one sentence. But if challenged, we can call it a technique that profits from overreaction to bad news.

Overreaction creates a big gap between price and true intrinsic value.

Take for example a temporary setback in a company's earnings. While the stock's long-term value may still be intact, it is not uncommon to see investors overreact to the bad news and cause the stock to correct by as much as 10%, 20%, or even 50%.

Smart value investors always keep an eye out for overreaction. And once they are convinced the long-term intrinsic value is intact, they swoop right in.

This anomaly shows up every now and then across different stocks and industries. An investor willing to work hard can end up with one hell of a long-term result.

Legends like Warren Buffett, Benjamin Graham, and Seth Klarman owe their stupendous track records to this anomaly.

Value Not the Only Anomaly

However, overreaction is not the only market anomaly we can capitalise on...

If people overreact to bad news, can they also do the opposite? Can they underreact to good news? They certainly can. And a smart investor who gets whiff of it can then ride the stock price movement till the underreaction ends in euphoria and herd instinct.

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