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Chapter 5. Stable Earnings, Better Inves... > Theoretical Roots: Earnings Stabilit...

Theoretical Roots: Earnings Stability and Value

While it may seem intuitive that companies with more stable earnings should be worth more than otherwise similar companies with volatile earnings, the link between earnings stability and value is weak. In this section, you will begin by considering how having a diversified portfolio can color your views about risk and close by examining whether earnings stability can pay off as higher value for a firm.

Diversification and Risk

Investors have always been told that putting your eggs in one basket (or all your money in one stock) is a dangerous thing to do. In fact, the argument for diversification is at the core of modern portfolio theory. As Nobel prizewinner, Harry Markowitz, noted in his path-breaking paper on portfolio risk, if stocks do not move in tandem (and they do not), a portfolio's risk can be lower than the risk of the individual stocks that go into it.


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