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Staying on the forefront of investing innovation is more important now than ever before. A fast-changing stock market is constantly evolving with technology, as well as with a shifting economy and shifting market conditions. I believe that as the markets change, investors’ approach to security selection should change as well.
This is why we have developed an approach to investing that looks at risk and security analysis very differently. Rather than relying only on the most easily digestible and quantifiable facts, we dig deeply to measure investment risk and select stocks in a unique way.
A Probability-Based Approach to Investment
New Age Alpha’s h-factor investment methodology asks a simple question of all stocks: What is the probability management can deliver the earnings to support the stock price? For instance, what is the probability Amazon’s management can deliver the very high growth expectations the market currently has for it? The answer to this question, though, reveals much. I believe that, when a stock price gets pushed beyond management’s ability to deliver, frequently human biases are at work. The stock pickers and fund managers that buy and sell stocks often give in to their optimism or wishful thinking. This results in a risk for which investors are not paid for taking: The h-factor.
Suppose the CEO of an under-performing company is suddenly and unexpectedly replaced by an all-star CEO. This is clearly good news for the company, but the extent to which this news should boost the stock price is unclear. Is the stock now worth 5% more? 10%? 50%? If investors as a group are overconfident or overly optimistic about the impact this news will have on the stock, the stock price will be bid up too high. This creates a new risk of investing in this stock. When such information is industry-wide this also creates a risk to asset allocation.
Sometimes, when new information is introduced to the stock market, it is quickly and appropriately incorporated into stock prices. This happens often for clear-cut information like an earnings release or an update on sales that has an obvious impact on the value of the company.
At other times, the information introduced is vague or ambiguous and investors have a difficult time determining how the information will affect the value of the company. I believe this is when The h-factor affects stock prices and when investors’ perceived risk level is inaccurate.
The Investment Risk Caused by Human Biases
By focusing on a type of risk in stock investing that the market is either unaware of or ignores, we can reshape the portfolio analysis and security selection process.
The market will continue to evolve, and this requires us to be particularly vigilant. At New Age Alpha, we are constantly researching how investors behave, what affects their risk tolerance and what new approaches to investing are necessary given these behaviors. We draw from our own internal research as well as that provided by researchers in academia.
I believe this gives us an advantage over investors who rely only on traditional measures of risk and valuation. More importantly, it allows us to stay abreast of all new innovations and trends in investing.
