Tuesday, December 14, 2010

Yes, You Can Time the Market ! - Ben Stein - Phil DeMuth

I have just completed reading the book Yes, You Can Time the Market !, by Mr. Ben Stein and Mr. Phil DeMuth. The book is a well-written, no nonsense book, which gives practical and easy advice to follow for those who have a long term investment horizon. The authors have done their homework and they also discuss other academic studies which support their ideas. The authors make no claim that market timing can be done in the short run. If, however, you have a long term investment horizon (15-20 years), then buying when the market is “low” will generate better returns over other investment strategies.

So, you may ask, what is low? The authors look at a variety of criteria, such as market price, PE ratios, dividend yield, price to book, Tobin’s Q, price to cash flow, etc. In general, they argue that returns for any 5, 10, 15, 20 year period were higher when investors entered the market when it was trading better than the respective long term average of 15 years. For example, buying the SP500 when it was trading below its 15 year moving average price, was generally a good time to enter the market.

The authors are not ignorant that many times you may be sitting on the sideline feeling foolish as markets head to the moon, but they believe you will be rewarded over time because:

“Unlike other stock market anomalies, which disappear the moment they are pointed out, buying low promises to endure. This is because the extra returns it delivers do not come free. Rather they are a payment for assuming the psychological burden of buying stocks when everyone says the sky is falling, and demurring when Wall Street is having a feeding frenzy.”

The authors also believe that markets regress to the mean. This is why groups of stocks with high PE’s tend to underperform in future years, compared to groups of stocks with low PE’s, which outperform going forward. Another example of regressing to the mean was discussed in the performance of stock prices. Stocks that have outperformed (underperformed) over the past few years tend to underperform (outperform) in the future.

This is a good book to read for those who believe in investing for the long run. I enjoyed it and would recommend it.

The authors summarize their work in the following paragraph:

“The point of this book-so simple that a child can grasp it, yet so elusive that your broker will never get it-is that you are better off buying cheap.”

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