Can Heuristic Valuation Improve Investment Performance Of Individual Investors?

The paper presents concept of simplified valuation models and tests their usefulness in application by individual investors at the Polish stock market over 2000-2013. It is discussed whether it would be rational to combine common fundamental valuation methods of multiples and DCF, preserving the relative simplicity of multiples as well as complexity and consistency of discounted cash flows to provide useful hybrid tool even when individual investors follow behavioral heuristics and simplifications while making investment decisions. Results of experiments indicate that use of proposed valuation methods wouldn’t have an unequivocal impact on investment strategy of irrational individual investors with quite a low average improvements of annual returns (from 5,2% to 10,5% extra return) only in about a half of all 415 analyzed stocks. Tests are preceded by results of the survey conducted on 66 experienced and 136 inexperienced individual investors to compare their investment techniques and attitudes. It is shown that rising experience in investment causes investors to follow intuition in risk assessment that may end in overconfidence. 74% of respondents without experience declared that they would measure investment risk in some way while practitioners usually don’t use measures but rather sense risk. Inexperienced respondents are more likely to use Fundamental Analysis tools than real investors in practice. Answers also suggest that the more investors are experienced the more often they declare using Technical Analysis tools.