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December, 2009

Choose One

An explanation of why stock prices can be affected by the tendency of institutional investors to 'choose one'.
I read Too Big to Fail because of this Financial Times review that called it the best account of a "tumultuous financial collapse or scandal" since Barbarians at the Gate. Needless to say that's what I'm reading now and it's excellent. All of that is a long way of introducing an interesting quote I read in the book last night about why one stock can be overvalued and another undervalued:
Institutional investors--the big pension and mutual funds who could make or break stocks--typically chose just one tobacco stock for their portfolios, and more often than not it was Philip Morris. With their support, Philip Morris stock had risen 25 percent since the beginning of 1987, while RJR Nabisco's, after spiking up and down, was flat. Portfolio managers liked Philip Morris's predictability. They thought they knew where Maxwell was going. They never knew what Johnson was up to.
This seems like the sort of thing that folks who know about finance already know (so if there are any of you reading this I apologize), but for me it was eye opening. I mean it makes perfect sense that you would choose one, most everyone is aware of the theory of diversification after all. I guess I'm just surprised at how obvious it is that, in this case, a very specific peculiarity of the market, and the way we approach it, is affecting the price. Not sure if I'm really explaining myself properly here, but I'll just leave it at that for now until I can come up with something better to say.
December 18, 2009
Noah Brier | Thanks for reading. | Don't fake the funk on a nasty dunk.