Saturday, May 5, 2007

Varian's Point Still Stands

So there has been a bit of a scuffle about what Ilia Dichev's paper really meant. Turns out I was wrong. The sole point is that the supply of stocks on the market changes as the market goes up and down.

Companies issue more stocks when the market is high, and they buyback more stock when the market is low.

So if you are buying into a rising market then you are buying into increasing supply. If you are selling in a falling market you are selling out of decreasing supply. That is, if you time the maket the way most people would try to then the basic forces of supply and demand are working against you.

Thus, you are better off buying and holding. Now that might also suggest that its better to take the Buffet strategy of buying against the market and then holding. But of course we know that seems to work. Its just that the opportunity cost is paid in stress.

9 comments:

John Thacker said...

Right, the point still stands. You pay a penalty for getting into the market, but the overall effect is that you still don't want to make too many transactions.

Another way of thinking about it that I find useful is that the company itself is the ultimate "insider." The company knows when to buy and sell its own stock better than the average investor, so in general the company's "investment" in its own stock does better than the stock price. Then, intuitively, the secondary market does worse than the stock price.

People who already own the company stock still approve, in general, because they'd rather the company get money than the new investors. :)

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