From what I gather, the BMWMethod expects a stock to maintain its CAGR in the long term through out the various periods of its market life. There for, a stock will always come down from its highs and it will always bounce off its lows. Yes, this is know statistically as "regression toward the mean."http://en.wikipedia.org/wiki/Regression_toward_the_meanThe rational being that great companies will have the non-analytical tools/culture/know-how to comeback from those lows and maintain it's CAGR. Due diligence enters only has a way to confirm that nothing truly revolutionary happened in the business as to prevent that recuperation. Not quite, the rational is "regression toward the mean." There are two reasons for the due diligence:1.- to ascertain that we are still talking about the "same" company. For example, the current AT&T is not the same company that Judge Green broke up years ago. HP, with its divestitures (Agilent) and its mergers (Compaq) might not be the same company it was five years ago.2.- to ascertain that nothing is fundamentally wrong with the company that caused the decline in share price.However, when those stocks happened to go bellow or near their CAGR lows, it was due to market efficiency: a flopped product, a SEC investigation, a slowdown in sales ; something that, computed by the market meant that the company was worth less.The BMWMethod seems not to care about that. It only cares if something drastically has changes in the business has to prevent it from regaining it's historical CAGR.That's why I say that it takes advantage of the market efficiency, while keeping "faith" that the company will recover has to maintain its historical growth. What you attribute to "market efficiency" BuildMWell attributes to market irrationality, I quote:The market's irrationality may drive the stock price too high or too low at times, but we can see the overall trend on the charts. http://boards.fool.com/Message.asp?mid=21266758Where does the average CAGR come from? In the long term it has to come from the growing cash flow that the company throws off. If you remain fundamentally in the same business and you continue to manage it the same efficient way there is no reason for the CAGR to deviate from the norm, but it does and it will return.Why does it happen? There are many reasons, some company related some market related and some totally anomalous. For example, the price drop of October 1987 was caused by portfolio insurance, a market phenomenon.P.S. Obviously this becomes somewhat of a paradox. Since, if everybody were to use the BMWMethod with the stocks that fall into the usability requirements, a strange market efficiency would be created. One that would disregard short and medium term changes to the company and would basically expect it always to recover. But that efficiency might be considered by others as inefficiency since it was not computing short term changes to profitability. Therefore, the terms efficient and inefficient, when applied to the market, would be subjective. I think the problem lies in how you define market efficiency.Proponents of the efficient market theory believe that there is perfect information in the stock market. This means that whatever information is available about a stock to one investor is available to all investors (except, of course, insider information, but insider trading is illegal). Since everyone has the same information about a stock, the price of a stock should reflect the knowledge and expectations of all investors. The bottom line is that an investor should not be able to beat the market since there is no way for him/her to know something about a stock that isn't already reflected in the stock's price. http://www.investorwords.com/1672/Efficient_Market_Theory.htmlDenny SchlesingerCaracas - Venezueladenny@softwaretimes.com
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