Page 253 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes by investor expectations about earnings, risks, and so on, as investors grapple with an uncertain
future. If the market price of a security does depart from its estimated economic value, investors
act to bring the two values together. Thus, as new information arrives in an efficient marketplace,
causing a revision in the estimated economic value of a security, its price adjusts to this
information quickly and, on balance, correctly. In other words, securities are efficiently priced
on a continuous basis.
Passive strategies do not seek to outperform the market but simply to do as well as the market.
The emphasis is on minimizing transaction costs and time spent in managing the portfolio
because any expected benefits from active trading or analysis are likely to be less than the costs.
Passive investors act as if the market is efficient and accept the consensus estimates of return and
risk, accepting current market price as the best estimate of a security's value.

Active

Investors who do not accept the effective market hypothesis (EMH), or have serious doubts,
pursue active investment strategies believing that they can identify undervalued securities and
that lags exist in the market's adjustment of these securities' prices to new (better) information.
These investors generate more search costs (both in time and money) and more transaction
costs, but they believe that the marginal benefit outweighs the marginal cost incurred.

Most investment techniques involve an active approach to investing. In the area of common
stocks, the use of valuation models to value and select stocks indicates that investors are analyzing
and valuing stocks in an attempt to improve their performance relative to some benchmark
such as a market index. They assume or expect the benefits to be greater than the costs.
Pursuit of an active strategy assumes that investors possess some advantage relative to other
market participants. Such advantages could include superior analytical or judgment skills, superior
information, or the ability or willingness to do what other investors, particularly institutions,
are unable to do. For example, many large institutional investors cannot take positions in very
small companies, leaving this field for individual investors. Furthermore, individuals are not
required to own diversified portfolios and are typically not prohibited from short sales or
margin trading as are some institutions.

Most investors still favour an active approach to common stock selection and management,
despite the accumulating evidence from efficient market studies and the published performance
results of institutional investors. The reason for this is obvious – the potential rewards are very
large, and many investors feel confident that they can achieve such awards even if other investors
cannot.
The most traditional and popular form of active stock strategies is the selection of individual
stocks identified as offering superior return-risk characteristics. Such stocks typically are selected
using fundamental security analysis, but technical analysis is also used, and sometimes a
combination of the two. Many investors have always believed, and continue to believe, despite
evidence to the contrary from the EMH, that they possess the requisite skill, patience, and ability
to identify undervalued stocks.

Task Discuss which Portfolio Strategy do you think to be better and why.

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