Although it can only provide a partial explanation for the movement of stock prices, this theory may still be very useful for investors as it elucidates a market relationship that other investors have not yet understood. Investors have limited funds to allocate and limited intelligence to operate. They don't need to be jack of all trades, as long as their intelligence is slightly better than others, they can have the upper hand. Although there are strengths in specialized knowledge related to securities analysis, none of them have been able to address the key issues that investors are concerned about. The reflexivity theory is good at understanding and identifying price changes of historical importance, and therefore can directly reach the core of the problem.
In my own investment career, the aforementioned model has proven to bring considerable investment returns. On the surface, this model appears to be so simple and in line with commonly used stock market models, making it unlikely for any investor to be unfamiliar with it. However, the actual situation is far from that. Why is this happening? I believe that this situation is largely due to misconceptions among the participants. This concept originates from classical economics and can be traced back to the theoretical structure of natural sciences. They stubbornly insist that stock prices are a passive reflection of some fundamental reality factor, rather than a positive component in the historical process. We have seen that this is absolutely wrong, and it is worth noting that people have not been fully aware of this. Of course, investors do understand the market processes I have pointed out and have indeed responded to them, the only difference being that their actions are one step slower. Choosing the appropriate model and paying attention to finding the key features that determine the shape of the price curve is my advantage.
The first time I systematically applied this model was in the late 1960s, during the period of group enterprise boom. It helped me make money in both boom and bust stages. The key cause of the popularity of group enterprises is various misunderstandings among investors. Investors only know that the evaluation of earnings per share has increased, but they have not seen through the way to achieve growth. Many companies have mastered the method of achieving revenue growth through acquisitions. Once the market starts to respond positively to their performance, things become much simpler because they can offer their overvalued stocks as a payment tool when acquiring other companies.
The principle of this trick is as follows: First, assuming that all companies achieve the same internal revenue growth, but the acquiring company's stock is sold at twice the price to earnings ratio of the acquired company, if the acquiring company can achieve a doubling in size, its earnings per share will jump by 50%, and the company's growth rate will also increase accordingly.
In practice, early group enterprises were those that achieved high internal growth rates and thus won high P/E ratios in the stock market. Several major pioneers are high-tech companies with strong defense backgrounds, and their managers realize that their historic growth rates cannot be sustained indefinitely. However, as earnings per share growth accelerates, their P/E ratios rise rather than fall.
The stock price begins to decline, and the downward trend enters a self reinforcing process. The beneficial impact of acquisitions on earnings per share has disappeared, and new acquisitions have become unwise actions, exposing internal problems that were swept under the carpet during the period of rapid external growth. The earnings report revealed unpleasant surprises, investors woke up from a dream, company managers were all in danger, and the exciting success had passed. No one was willing to take care of the trivial affairs of daily management. This dilemma was exacerbated by the economic recession, and many arrogant group enterprises fell into collapse. Investors made the worst plans, and several such cases did occur. For other companies, actual performance proved to be better than market expectations. Finally, the situation in the stock market gradually stabilized, and most surviving companies underwent a major management change before struggling to emerge from the ruins.
The most interesting negative bias may occur in the technology stock market. After the stock market crash in 1974, investors were wary of companies that needed to raise funds through external channels to increase their equity capital. Distributed data processing companies are still in the early stages of development, and the market is actually rapidly expanding, but these small companies are being held back by difficulties in fundraising. Their stock price to earnings ratio is very low, and the downside is that they cannot meet the demand for their products through rapid growth, while IBM will eventually enter the market. This view has been proven to be correct, but once these companies become large and prosperous, and investors become willing to pay high price to earnings ratios, those who are willing to go to war against negative bias will receive favorable returns.
We should know that all the details of the basic trends in technological development are not enough to fully explain the rise and fall of technology stocks. To understand the latter, one also needs to understand the reflexive interactions between basic trends, mainstream biases, and stock prices. It is extremely difficult to combine these two understandings. People who want to be familiar with technology must continuously pay attention to the development trends of the industry. Those who want to profit from the deviation between participants' cognition and reality must constantly shift from one industry group to another. Most technical experts have no understanding of reflexivity and blindly hope to maintain sufficient investment forever. Their reputation and influence alternate between growth and decline in a reflexive manner. After the recent decline in market prices of technology stocks, it seems that a new group of analysts who are overly sensitive to investors' psychology is emerging in the market. After an appropriate interval, they may deviate from the mainstream and invest in technology stocks based on basic trends, which may be profitable again.
