Comments on: Risk, Cost of Capital, and Expected Return http://www.obliviousinvestor.com/risk-cost-of-capital-and-expected-return/ Index Investing: The Oblivious Investor Fri, 12 Mar 2010 19:19:14 -0600 http://wordpress.org/?v=2.9.2 hourly 1 By: lurker http://www.obliviousinvestor.com/risk-cost-of-capital-and-expected-return/comment-page-1/#comment-4016 lurker Wed, 11 Nov 2009 13:33:44 +0000 http://www.obliviousinvestor.com/?p=5297#comment-4016 Pretty theory, but here's mine. Many fewer analysts cover the small and value names for a variety of reasons. Less coverage leads to inefficient pricing of the shares (sorry Burton M.), which leads to greater opportunity for outperformance...who knows, maybe the CEOs of these companies can actually do their jobs better when they don't have to dance for Wall Street...cheers! Pretty theory, but here’s mine. Many fewer analysts cover the small and value names for a variety of reasons. Less coverage leads to inefficient pricing of the shares (sorry Burton M.), which leads to greater opportunity for outperformance…who knows, maybe the CEOs of these companies can actually do their jobs better when they don’t have to dance for Wall Street…cheers!

]]> By: Dylan http://www.obliviousinvestor.com/risk-cost-of-capital-and-expected-return/comment-page-1/#comment-4015 Dylan Wed, 11 Nov 2009 12:47:50 +0000 http://www.obliviousinvestor.com/?p=5297#comment-4015 Monevator, the market makes smaller cap and value companies cheaper <i>because</i> they are riskier (it's the lower price that keeps those shares competitive). Think of the risk like this. Investors buy stock in companies because they think that the stock will be worth more at future points in time. The chances that it won't be is the risk. If the company has less capital (small cap) or is distressed or seen as broken/damaged (value) there is greater chance it wont be worth more at times. So, sellers of small cap and value stocks accept a lower price so others will actually buy it and take that risk. If the risk pays off, their discounted purchase price leads to greater a gains potential (i.e. they get a risk premium). Does this smell any better? :) Monevator, the market makes smaller cap and value companies cheaper because they are riskier (it’s the lower price that keeps those shares competitive).

Think of the risk like this. Investors buy stock in companies because they think that the stock will be worth more at future points in time. The chances that it won’t be is the risk. If the company has less capital (small cap) or is distressed or seen as broken/damaged (value) there is greater chance it wont be worth more at times. So, sellers of small cap and value stocks accept a lower price so others will actually buy it and take that risk. If the risk pays off, their discounted purchase price leads to greater a gains potential (i.e. they get a risk premium).

Does this smell any better? :)

]]> By: Monevator http://www.obliviousinvestor.com/risk-cost-of-capital-and-expected-return/comment-page-1/#comment-4014 Monevator Wed, 11 Nov 2009 11:11:47 +0000 http://www.obliviousinvestor.com/?p=5297#comment-4014 Hmm, isn't there something circular about this definition of risk? e.g. Small cap value stocks are riskier. Why? Because they tell us they are by being cheaper, as defined by P/E or dividend ratio. Okay, how does that risk manifest itself? By blowing up or by volatility (either way), not by the sticker price alone. I don't think I'm being clear here, but something doesn't smell quite right. :) Hmm, isn’t there something circular about this definition of risk?

e.g. Small cap value stocks are riskier. Why? Because they tell us they are by being cheaper, as defined by P/E or dividend ratio.

Okay, how does that risk manifest itself? By blowing up or by volatility (either way), not by the sticker price alone.

I don’t think I’m being clear here, but something doesn’t smell quite right. :)

]]> By: Rick Francis http://www.obliviousinvestor.com/risk-cost-of-capital-and-expected-return/comment-page-1/#comment-4013 Rick Francis Tue, 10 Nov 2009 21:44:02 +0000 http://www.obliviousinvestor.com/?p=5297#comment-4013 @Dylan I love the analogy- but the jolly old man with high returns with low risks is a lot more likely to be Bernie Madoff than St Nick. -Rick @Dylan

I love the analogy- but the jolly old man with high returns with low risks is a lot more likely to be Bernie Madoff than St Nick.

-Rick

]]> By: Dylan http://www.obliviousinvestor.com/risk-cost-of-capital-and-expected-return/comment-page-1/#comment-4012 Dylan Tue, 10 Nov 2009 20:46:35 +0000 http://www.obliviousinvestor.com/?p=5297#comment-4012 Great explanation. I like to think of the notion of high return with low risk as the Santa Claus of investing. You want to believe because its such a nice story and feels good to believe, but it just isn't rational to believe. Great explanation. I like to think of the notion of high return with low risk as the Santa Claus of investing. You want to believe because its such a nice story and feels good to believe, but it just isn’t rational to believe.

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