Investment Theory versus Investment Behaviour

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There are many ways to skin a cat. Investment styles and philosophies abound, but the last thing you want is to behave differently from the theory you adhere to. Here are some investment theories and their corresponding investment behaviour.

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Efficient Market

Theory: Stock prices are totally efficient and investors can only manage taxes and trading costs

Investment behaviour: Buy an index fund and avoid trading

Semi-strong Efficient Market

Theory: Stocks are fairly priced until news arrives

Investment behaviour: Trade on news flow

Weak Efficient Market

Theory: Less structured news is not properly reflected in prices

Investment behaviour: Read trade rags, do channel checks and gossip with competitors, customers and suppliers


Theory: For short periods, stocks will keep moving in one direction

Investment behaviour: Buy stocks whose prices have risen at the fastest rate

Valuation relative to history

Theory : Stocks prices move around fair value, which is a static function of EV/EBITDA

Investment behaviour: Buy stocks at the low end of their historic EV/EBITDA band.

Intrinsic value

Theory: Stock prices move irregularly around present value, which is the sum of shifting expectations about the future

Investment behaviour: Buy stocks that are priced far below their value using assumptions you believe

Final words

Besides making sure that your investment behaviour is consistent with your investment philosophy, it is also important to keep an open mind and consider the alternatives, why they may or may not work and why they may or may not be a better fit for you.

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