I came across a behavioral finance paper Information Uncertainty and Expected Stock Returns, which (among other things) ranks stocks based on the level of their “ambiguity”. Ambiguity, or information uncertainty as they call in in the paper, measures how hard it is to value a stock.
The most difficult to value are services, such as business, health, etc.. The least difficult to value is for example railroad transportation. Why these two?
Valuing a railroad transportation company is relatively easy, there is nothing hard about valuing the assets, such as trains, wagons, few buildings. The business relations and so the revenue stream is likely to be very stable. Finally the costs won’t fluctuate very much either (unless the unions go nuts of course).
On the other hand valuing a consultancy company (business services) is much tougher. Their main asset are the employees, about which you as an investors have very limited knowledge (what if a key employee left last year? What if the newly promoted partner turns out to be incompetent? etc.). Their revenue stream will also be significantly more volatile than in the previous case. Coal has to be transported from a mine to a power plant every day, but consultancy jobs come and go.
I guess you got where I am going by now. The least ambiguous category of stocks is the “Tobacco products” category. The reason why should be relatively clear by now. Tobacco companies have an extremely stable flow of revenues, they can truly rely on their customers and their demand for tobacco products.
Thank you for smoking…