Divergence trades represent a clear chart pattern of slowing price direction. At the same time they are countertrend trades and have a higher degree of risk. Before the October 1987 stock plunge, there were numerous divergence signals in the S&P, both long-term and short-term, and many traders posted losses trying to sell what might have been the top of the market. Most gave up before the decline. If, in fact, the greatest opportunities come when the divergence is strong, that is, the decline in the momentum peaks is large. then the best results will come from entering a short position, then holding that short when a long trend turns to a short one. By entering the trend trade early (and exiting the old long position), a divergence can become a large profit rather than a small one.
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Converting a Divergence into a Trend Trade
Sunday, December 6th, 2009Problems With P/E Ratios
Monday, November 16th, 2009So, what went wrong in the Cadbury Schweppes valuation? There are basically two possible explanations. The first explanation is that the stock market valuations—either of CSG or KO, or both—are just plain wrong. In this case, it makes little sense to use the methods of comparables. But this scenario is unlikely. If the market values were systematically wrong, you could presumably easily get rich if you purchased undervalued firms. If it is not obvious, the nest series of posts will explain why getting rich is not easy—and which is why only about half of all investors beat the market—so we will assume that misvaluation is not the principal reason. The second explanation is that your assumption that the two firms were basically alike is incorrect. This is the more likely cause. There is a long litany of reasons why comparables are not really comparable, and why the technique failed you in valuing Cadbury Schweppes. Here is an outline of possible problems, on which the remainder of this series of posts focuses:
Problems in Selecting Comparable Firms Comparing businesses is almost always problematic. Every firm is a unique combination of many different projects. Cadbury Schweppes owns Dr. Pepper, 7-Up, A&W Root Beer, Canada Dry, Hawaiian Punch, Snapple, Mott’s Apple products, Clamato juice, plus some confectionary brands. This may not be comparable to Coca Cola, which owns Coca Cola Bottling, Minute Maid, Odwalla, and some other drink companies. Each of these businesses has its own profitability and each may deserve its own P/E ratio.
Even for the main business, as any soda connoisseur knows, Pepsi Cola and Coca Cola are not perfect substitutes. Different consumer tastes may cause different growth rates, especially in different countries.
Maybe as a British firm, Cadbury Schweppes uses altogether different accounting methods.
Maybe Cadbury Schweppes has just had an unusual year, or a year in which it plowed most of its cash into advertising, thereby causing unusually lower earnings for now and much higher earnings in the future.
If you did not use earnings from the most recent four quarters, but instead forecast earnings over the next four quarters, maybe the numbers would then be more comparable.
Political decision making
Saturday, October 31st, 2009Public choice analysis is a branch of economics to the operation of the political process. Public-choice analysis links the theory of individual behavior to political action, analyzes the implications of the theory, and tests them against events in the real world. Over the past fifty years, research in this area has greatly enhanced our understanding of political decision-making.’ Just as economists have used the idea of self-interest to analyze markets, public-choice economists use it to analyze political choices and the operation of government. After all, the same people make decisions in both sectors. If self-interest and the structure of incentives influence market choices, there is good reason to expect that they will also influence choices in a political setting.
The collective decision-making process can be thought of as a complex interaction among voters, legislators, and bureaucrats. Voters elect a legislature, which levies taxes and allocates budgets to various government agencies and bureaus. The bureaucrats in charge of these agencies utilize the funds to supply government services and income transfers. In a representative democracy, voter support determines who is elected to the legislature. A majority vote of the legislature is generally required for the passage of taxes, budget allocations, and regulatory activities. Let’s take a closer look at the incentive structure confronting the three primary political players- voters,legislators, and bureaucrats- and consider how they affect the operation of the political process.