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For decades now, I’ve regularly detailed the historical evidence linking equity valuations to actual subsequent long-term returns in stocks. An important feature of historically reliable measures of valuation is that they mute the impact of cyclical fluctuations in profit margins. Current earnings – or analyst estimates of expected “forward” earnings – should not be taken at face value, because profit margins are not permanent. The most reliable measures of broad market valuation are actually driven by revenues, not earnings. For a review, including the arithmetic linking valuations to actual subsequent market returns, see Ockham’s Razor and the Market Cycle and Margins, Multiples, and The Iron Law of Valuation.
Some advice from Jeff Bezos [H/T @derekhernquist] (LINK)It’s sometimes argued that the long-term expected return on stocks is simply the expected long-term growth rate of earnings, dividends and the like, plus the prevailing dividend yield. While this would be true if valuations were held constant for all of eternity, the fact is that elevated and depressed valuations tend to normalize over time, which investors know as “mean reversion.” As a result, higher valuations are systematically related to lower subsequent long-term market returns, and lower valuations are systematically related to higher subsequent long-term market returns.
He said people who were right a lot of the time were people who often changed their minds. He doesn’t think consistency of thought is a particularly positive trait. It’s perfectly healthy — encouraged, even — to have an idea tomorrow that contradicted your idea today.
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What trait signified someone who was wrong a lot of the time? Someone obsessed with details that only support one point of view. If someone can’t climb out of the details, and see the bigger picture from multiple angles, they’re often wrong most of the time.Notes on the book Diaminds: Decoding the Mental Habits of Successful Thinkers (Part 1, Part 2, Part 3, Part 4, Part 5)
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