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It’s in the price

Investment

When we talk about our investment approach, you might hear us say we believe prices are fair, that we believe in the power of markets, or that we believe there is information in stock market prices. These are different ways of saying largely the same thing—that we believe the market does a good job of incorporating information into prices.

For example, when a company reports its quarterly results to the market, there is often a near-instantaneous change in price as the market reassesses how the new information changes the company’s future earning capability.

To understand more deeply what is going on in the stock market, we can consider how another market, the market for bets on the English Premier League, operated this season.

You will undoubtedly have heard Leicester City won the league, a remarkable feat considering they were close to relegation last season. They started this season with some bookmakers offering odds of 5000-1 on them becoming champions. Bookmakers considered the event as likely as finding Elvis alive, with an implied probability of 0.02% (zero). One cheeky bookmaker scrawled “pigs might fly” on an optimistic punter’s betting slip.

As the season progressed, however, bookmakers quickly revised their odds every time new price-sensitive information came to light. That new information reflected not only Leicester’s (sometimes unlikely) results but also the results of their title challengers, which, of course, significantly affected Leicester’s chances. By Christmas, the odds had fallen to 10-1, and by mid-March, they were 10/11 odds-on favourites.

Stock Market prices are forward-looking in the same way betting odds express the likelihood of a future event occurring. Throughout the season, bookmakers priced and repriced their expectation of Leicester lifting the trophy like a market does when it collectively arrives at a security’s price. Company results, competitor results, and seemingly infinite outside influences combine to set expectations of future security returns.

Our investment approach harnesses this collective knowledge and enables us to build investment portfolios that put the power of the market to work for you.

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