In markets, bigger is less riskier and gives better returns - fails CAPM - Capital Asset Pricing Model - How?

Capital Asset Pricing Model 

According to Investopedia - "The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks. CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and cost of capital."

Problems With the CAPM 

There are several assumptions behind the CAPM formula that have been shown not to hold in reality. Modern financial theory rests on two assumptions: 

(1) securities markets are very competitive and efficient (that is, relevant information about the companies is quickly and universally distributed and absorbed); 

(2) these markets are dominated by rational, risk-averse investors, who seek to maximize satisfaction from returns on their investments.

In real life....

In real market terms none of the these assumptions are 100% correct.  Even when the trading terminals have become electronic, financial results are announced over the internet and TV , there still are inefficiencies in the dissemination of information. 

Also all investors may not the equally inclined to collect the same type of information.

This creates bias.

Moreover what is the correctness in a management of a company providing for financial results and guidance of future performance.  

There is vast information available on irregularities of companies - having hidden sensitive information from investors.  

Flight to safety 

In uncertain times, the investor behaviour is to move capital towards safety - which in the equity market terms can also be interpreted as - surety of returns. 

Investors tend to believe that a company which has generated profits consistently, enjoys a market leaders position, has a superiors business model - will again provide for good numbers.  This means it will again generate profits and make its business even more stronger. 

And hence, even though these stocks are very expensive, money still moves to these stocks. 

Let's look at some examples. 

International Stocks 

Apple stock - last 5 years

Steve Jobs unfortunate demise - October 5, 2011.  Many critics of Apple had predicted the downfall of the company post Steve Jobs. 

Apple Stock over last 5 years is approx 5 times. 

Microsoft stock - last 5 years

Indian Stocks 

Reliance stock - last 5 years

TCS stock - last 5 years

Nestle India stock - last 5 years

Asian Paints stock - last 5 years

(Disclaimer : This blog is for information purposes and not to solicit any business or provide any kind of investment advise.)