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Often, the finance industry precedes finance academia in knowledge of finance facts and investment strategies. Finance practitioners have their own explanations and understanding as to why certain strategies work, largely from heuristic and intuitive arguments. Finance academics look for reliable statistical evidence and rigorous theoretical models, and tend to rely on large amounts of data for statistical analysis, along with the development of new theories. The reliance on data and rigorous theories means finance academics lag in learning and trusting the patterns practitioners have been implementing for years.
Value investing is one of the primary ways practitioners conduct investment research. Conceived through trial and error over centuries of business investments, the principles of value investing (applied to securities) were first codified by Benjamin Graham and David Dodd in their classic tome Security Analysis [1934]. Graham and Dodd's idea centered on identifying the securities of businesses trading significantly below liquidation value and realizing that value over time, as the spread between price and value closes. Over decades of application with hundreds ofbillions of dollars, their followers (including Warren Buffett, Glenn Greenberg, and Seth Klarman, et al.) have evolved the method to also incorporate the intrinsic value of a business's future earnings into the value investing we see today. Given the human nature of business valuation and projections, value investing represents an intuitive framework that incorporates many levels of subjective assumptions to interpret, understand, and then quantify the potential value of business investments. These analyses maintain a margin of safety, and investment risk is managed through discretionary sizing and an intimate understanding of each investment's business operations. The result is a range-based, quantifiable but subjective investment process.
Pioneered by John Campbell and Robert Shiller in the late 1980s, the Campbell-Shiller present-value identity is a celebrated academic formula that connects current dividend yield to future returns, future dividend growth, and future dividend yield. It derives a clean relationship among key security characteristics from the definition of returns. The beauty of the formula lies in its simplicity and the minimal assumptions required to derive a linear relationship between key variables used in the analysis of asset prices. Its linearity makes the expression especially easy to interpret, making it one of the most widely used...