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Prelims

Les Coleman (The University of Melbourne, Australia)

New Principles of Equity Investment

ISBN: 978-1-78973-064-7, eISBN: 978-1-78973-063-0

Publication date: 5 February 2019

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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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No part of this book may be reproduced, stored in a retrieval system, transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the UK by The Copyright Licensing Agency and in the USA by The Copyright Clearance Center. Any opinions expressed in the chapters are those of the authors. Whilst Emerald makes every effort to ensure the quality and accuracy of its content, Emerald makes no representation implied or otherwise, as to the chapters’ suitability and application and disclaims any warranties, express or implied, to their use.

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.

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