The Large-Cap Portfolio: Value Investing and the Hidden Opportunity in Big Company Stocks

Large-Cap is an abbreviation of the term “large market capitalization” and refers to the stock of publicly traded companies with market capitalization values of roughly more than $10 billion, like Walmart, Microsoft, and Ford. Because of their size, the conventional view is that these companies do not present investors with an ability to be opportunistic. The Large-Cap Portfolio argues that, contrary to popular perceptions, significant opportunities exist in these stocks.

Author’s Note:

Broadly speaking this book is based on two important premises. The first is that markets for large-cap and mid- to large-cap stocks are inefficient. The wild swings we see in large-cap benchmarks such as the Standard & Poor’s (S&P) 500 Index are symptomatic of a market that fights to reconcile the passion that we as humans possess with an objective assessment of uncertain-ties. This is difficult in the best of circumstances but becomes most difficult in times of euphoria and times of despair.

The second premise that this book is largely concerned with is the source of opportunities. I propose that, unlike some types of markets (principally markets for micro-cap stocks, small-cap stocks, and emerging-market stocks), mid- to large-cap inefficiencies are driven by errors in investor behavior rather than what I term structural factors. This is a distinction that I can’t stress the importance of enough. One must be aware of what one is looking for, in order to determine if one has found it. Domestic mid- to large-cap stocks are not underresearched. Nor are they illiquid or subject to other structural factors. Domestic mid- to large-cap stocks become overvalued or undervalued due to errors in the assessment of uncertain assumptions that underlie their valuations. Identifying important assumptions that drive valuation and then determining the behavioral errors that investors make becomes the nexus for finding opportunities in the market.

To this end, understanding the heuristics—or shortcuts that we as humans make in our decision-making process—will allow us to better understand the errors we may be making in assessing important assumptions that underlie intrinsic value computations. In this regard, this book really straddles two very different realms of economic thought: behavioral versus classical assessments of market efficiency. This book acknowledges the importance of each of these characterizations of the market, and takes the view that they are not mutually exclusive. Rather, the investor should consider that markets ride a continuum of efficiency spanning egregious inefficiency to cold rationality. One should seek to invest in securities when their pricing is inefficient, but sell securities when their price converges on a more efficient assessment of a company’s merits.

The key element to this process is time. The time frame becomes the link between market efficiency and market inefficiency. Pricing in the market can be very inefficient at any given point in time, but pricing will gradually work toward, or converge on, objective, coldly rational efficient pricing. How long this takes is not known. Moreover, the time frame can become a manager’s undoing and an investor’s worst enemy.

This book is organized into three interrelated parts. Part I will discuss the state of the market for actively managed large-cap stocks. This will include an examination of the trends in passive investing and what such trends portend for the active manager over the long term. Part I will also include a chapter that discusses the difference between risk and uncertainty, an important distinction that will prove useful as we examine the errors humans make in approaching uncertainties.

Part II will start with an explanation of market efficiency and the theories that underpin this notion. With our understanding of how markets are understood to be efficient, we will next look at whether the market efficiently prices common stocks and empirical evidence of investor irrationality. We will then, over the course of two chapters, critique the three theories that support the broader notion of market efficiency, offering theoretical counterpoints to arguments that contend markets are efficient pricing mechanisms. Finally, I’ll end Part II by discussing the conventional view of market inefficiencies, and their relationship to both the efficient markets hypothesis and the three theories underpinning market efficiency. Importantly, much of Part II will focus on errors in judgment and the ways in which such errors pervert assessments of value.

Finally, Part III will discuss methods one can integrate into one’s investment process. These methods allow one to structure an investment process to conform with the opportunity set available to large-cap stock investors. Opportunities are available in the large-cap subset of the market, but one’s process must be attuned to take advantage of such opportunities. This will include some practical ideas for identifying large-cap stock opportunities as well as analyzing large-cap opportunities. Additionally, Chapter 10 provides a case study on a timely investing opportunity in the constructs of the ideas presented. Part III will end with some thoughts on managing large-cap portfolios and the challenge one faces in structuring portfolios to outperform broad market benchmarks.

Contents:

• Trends in Large-Cap Investing and the Opportunities They Present
• Risk and Uncertainty
• An Introduction to Market Efficiency
• Evidence of Inefficiency in Investor Behavior and Market Behavior
• Individual Decision Making
• Correlated Mistakes and the Failure of Arbitrage
• Conventional Views on Sources of Market Inefficiencies
• Identifying Large-Cap Stock Opportunities and Optimizing Research Processes
• Approaching Growth in Large-Cap Stock Research
• Hewlett-Packard Company Case Study
• The Challenges of Managing Large-Cap Common Stock Portfolios

The Large-Cap Portfolio: Value Investing and the Hidden Opportunity in Big Company Stocks By Thomas Villalta pdf