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Take Valuations Seriously and You Will Discover Things that You Were Not Initially Even Seeking to Discover

Valuation-Informed Indexing #267

by Rob Bennett

I learned about Sabermetrics (the empirical analysis of baseball) by reading Bill James' Baseball Abstract many years ago. In those days, it was a curiosity. James would argue that a hitter who hits .260 and walks in 10 percent of his at-bats is better than one who hits .290 and walks in 2 percent of his at-bats and the "experts" would dismiss his work as so much foolishness. Today, of course, Sabermetrics has revolutionized the sport.

Valuation-Informed Indexing is the Sabermetrics of investing analysis. Once upon a time, we all knew that the stock market is efficient, that price changes are caused by economic developments, that investing risk is stable, the timing never works and that stock returns cannot be effectively predicted. Then this crazy Shiller fellow came along and stood everything we once thought we knew about stock investing on its head. Well, that's in fact not quite true as of today. But we are getting there, slowly but surely. We are in the early years of a "revolution" (Shiller's word) in our understanding of how stock investing works.

Valuation-Informed Indexing (the model for understanding how stock investing works rooted in Robert Shiller's "revolutionary" [Shiller's word] finding that valuations affect long-term returns and that stock investing risk is thus variable rather than constant) is the first true research-based investing strategy. Buy-and-Holders claim that Buy-and-Hold is a research-based investing strategy. But if the valuation level that applies when you make a stock purchase is 80 percent of the story, as the last 34 years of peer-reviewed research shows, it's not possible to develop effective strategies without taking valuations into account and it's the first rule of Buy-and-Hold that valuations may never be taken into account (timing doesn't work...