If you're right that something is mispriced it will eventually take care of itself. We think it matters because you can conceivably avoid a lot of pain waiting for truth to prevail if you have a good read on why it currently doesn't." So again, just to reiterate a little bit, just because a company is a good company doesn't mean it's a good stock investment. There has to be something about your perception of how the assets they have or how the future's going to play out that differs from what everybody else thinks and what's built into the stock price. So a logical question following that would be, so why do stocks get mispriced?
It's efficient market. A lot of academics will tell you that it's an extremely efficient market and you should not even try to beat the market. So what a fundamental value investor who is an active manager is trying to do is identify what's going on that could make this the stock cheap. And I thought that was summed up pretty well in this quote from Steve Morrow of New South Capital. "We believe the market often misprices stocks due to neglect, emotion, misinterpretation, or myopia. So our value add comes from bottom-up stock selection. We're trying to buy at low prices relative to our current estimate of intrinsic value, and we want to believe that intrinsic value will grow." So neglect, emotion, misinterpretation, or myopia. Those are the types of things that can lead a stock not to reflect accurately what's going on in the future. Howard Marks of Oaktree Capital who is a longtime very articulate investor puts it this way in a more general way. "Investment markets follow a pendulum-like swing between euphoria and depression, between celebrating positive developments and obsessing over negatives, and thus, between overpriced and underpriced." "There are few things of which we can be sure and this is one. Extreme market behavior will reverse. Those who believe the pendulum will move in one direction forever or reside in an extreme forever eventually will lose huge sums. Those who understand the pendulum's behavior can benefit enormously." So what kind of situations can lead to neglect, emotion, misinterpretation, or myopia, and therefore, potentially inaccurate stock prices? A lot of things can make that happen, but there tends to be change. There tends to be uncertainty. And quite often there tends to be a problem or multiple problems. These are things that can throw off or cloud what the future may hold to a greater degree than if everything's kind of going OK. Again, I'm doing this because I think the people that we interviewed say it better than I would, so I'm going to quote John Jacobson from Highfields Capital where he talks about where he looks for opportunities. So what is the fertile ground for potential mispricing? "Two kinds of events create volatility, which creates opportunity. The first revolve around individual companies, such as earnings misses, unexpected news, M&A activity, restructurings, and legal issues-- things that can make prices and valuations change relatively quickly. We want to understand what made the price change and then figure out whether the facts have changed as much as the price. To the extent they haven't, that can be an opportunity." "The other major source of volatility is when a macro event or trend causes markets to move. The market reflects at any moment what investors think XYZ's business is worth. So if macroeconomic factors force people to buy and sell its securities, but we believe those factors have nothing to do with the underlying fundamentals of the company, or less to do with the fundamentals that is being reflected in the share price, that can also be an opportunity." You guys probably notice, even looking at Google stock, if you look at a Google stock chart over the last five years, you'll see it moves. It moves quite a bit. And it moves a lot more, one could argue, than the actual fundamental reality of what's going on at Google at any given time. And it's that if this is what's going on at Google at any time and this is the stock price, there can be opportunities to buy the stock when it's inefficiently priced. So while most discussions of stocks talk about what can go right about a stock-- everybody's talking about what's the upside, this is going to be great, it's going to double.
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