2008 November | WhereDoesAllMyMoneyGo.com

Determining Fair Value

Posted by Preet on Nov 30, 2008 | 0 comments

Where Were We?… Continuing on from the conversation about fair-value weighting versus market-capitalization weighting, we already know that we can never construct a fair-value weighted index or portfolio simply because no-one can know the true fair value of a company – ultimately, the best we can do is guess – which is basically the stock market’s function. It is a compilation of the current guesses as to the fair value. Sometimes it seems right, and sometimes it seems just plain loopy. We’re Just Guessing In The Short Run Based on financial theory, most guesses as to the price of a stock is based on another guess: a guess of the future...

Help Us Name A New Product

Posted by Preet on Nov 27, 2008 | 24 comments

The weekly Lap of The Blogs is postponed this week as I have a special request. We’ve been burning the candle at both ends as we have an insurance company who we’ve been meeting with in order to bring to market a competitor product to the “income for life products” like Manulife’s Income Plus and SunLife’s Sunwise Elite Plus. Essentially, I can’t go into the nitty gritty details as we have the actuaries working overtime trying to finalize the numbers right now, but suffice it to say that the product will be 99% the same with the only difference being we will be using low-cost index products to bring costs down (a lot). So now I...

Fair Value Weighting Part II

Posted by Preet on Nov 27, 2008 | 1 comment

Unfortunately, I don’t have much time to write in as much detail as I normally would, so let me basically use Harry Markowitz’s example of a fair-value weighting example: Let’s assume we have a new hypothetical index with only four companies in it. Each company has $1 of earnings, but two have growth prospects to justify a 20 times P/E (meaning the price should be $20) and the other two have growth prospects to justify a 10 times P/E (meaning their price should be $10). We know that the market will just guess at these values, but let’s assume these are the correct values (or the fair values). If the market does a “pretty good” job at...

Indexing Based on Fair Values Instead of Market Cap

Posted by Preet on Nov 25, 2008 | 0 comments

Fair-Value Weighting an Index First: This is impossible! No-one knows the true fair value of a company, so keep in mind the purpose of this demonstration is strictly academic, theoretic and shouldn’t create a pandemic. (Rhymes coutesy of Fiona…) In yesterday’s post, we looked at how our cap-weighted index overweighted the overvalued companies and underweighted the undervalued companies, thereby magnifying our pricing errors in the exact opposite way that one would desire. Today we are going to re-weight these same stocks based on their fair value. Take Two We will take the same values from yesterday: Stock A and B both have a fair value of $10, but...

Cap-Weighting Magnifies Your Exposure to Pricing Errors In The Wrong Ways

Posted by Preet on Nov 24, 2008 | 4 comments

Market Capitalization Weighted indices have a significant structural flaw. Namely, they overweight your pricing errors when they are unfavourably wrong and they underweight your pricing errors when you are favourably wrong. Allow me to demonstrate with a simplistic example. Example Let’s suppose we have 2 stocks in our stock market and that we magically know the true value (or fair value, or intrinsic value) of each. They each have a fair value of $10/share, but stock A has a stock market price of $20/share (market participants have bid the price up) and stock B has a stock market price of $5/share (market participants have bid the price down). If we assume that...

Contest Winners!

Posted by Preet on Nov 23, 2008 | 0 comments

Thanks to everyone who participated in the contest. There were over 115 entries composed of comments, gravatars and other bloggers promoting the contest. I’ll get right to it… The winner of the GPS System is: JME! The winner of the signed copy of ‘Findependence Day’ is: Tim from Canadian Dream: Free at 45! Congratulations! I’ll be contacting the winners by email to arrange delivery of their prizes.

Make Your Kids Fill Out A Paper Tax Return

Posted by Preet on Nov 20, 2008 | 4 comments

Don’t forget to enter the contest to win a FREE Magellan Maestro GPS system! It’s free to enter, and all you have to do is visit the contest page and leave a comment - say anthing you like, even “fuzzy wuzzy was a woman”. I had dinner with one of my best friends tonight and he mentioned that he reads the blog but understands very little of what I write. We had many neurosci classes together and if ever there was a smart guy, it would be him. I realize that many more people would read this blog if I wrote less technical articles, and when I’ve mentioned that before some readers have mentioned that the only reason they read this blog is because of the nitty...