beating the market - not what it used to be

[rb]

Yea, I'd underwrite mortgages in Detroit. Probably not as many as I'd like but i would do it.

[Cigarbutt]

My biggest mistakes revolve around selling. The desire to follow the “hold forever” mantra has thrown me off. I now realize the hold forever idea is only good for a few companies.

 

I have instituted some definitive sell criteria for myself now, that I hope will allow me to be more disciplined than thinking hold forever/until something fundamental changes.

 

When I look at say, a cheaper company like GE and look at a more expensive one like FB, I understand how FB makes money better than I do GE. I also think FB has higher probability for price appreciation in the next 5 years, despite FB being a “tech” stock and not meeting classic value criteria per se. Same with AAPL.

 

I think that FB is way cheaper than GE. GE does have a very low cash flow yield that is almost entirely consumed by the dividend, high debt load, pensions issues and probably more accounting skeletons hiding some where in the financial arm.

 

None of the above applies to FB. I think FB FCF yield is equal or higher than GE’s, especially if you take the EV as a denominator rather than  market cap (a bit unfair because GE has a financial arm)

 

-The assumption here is that I'm wrong and the post is respectfully submitted because the thread has a historical connotation.

-The quote is from Mr. Benjamin Graham and I concede that it comes from a different era.

-Still, the message is that is still hard to know the future but easy to project it.

 

"I am reminded of an analysis that we used in this course in 1939, in their very first lecture, which I believe illustrates that pretty well. We put on the board three companies: A, B, and C. Two of them, which we did not name, showed earnings of practically identical amounts for the last five years -- $3.50 a share in each case. The earnings year by year were closely similar. The only difference was that one stock was selling at 14 and the other was selling at 140. The stock that was selling at 140 was Dow Chemical; the one that was selling at 14 was distillers Seagrams.

 

Obviously, the difference between 14 and 140 meant that the market believed that the prospects for Dow Chemical were very good and those for Distillers Seagrams were indifferent or worse than that. This judgment showed itself in the use of a multiplier of four in one case and a multiplier of 40 in the other.

 

I think that represents a very dangerous kind of thinking in Wall Street, and one which the security analyst should get as far away from as he can. For if you are going to project Dow's earnings practically to the year 2000 and determine values that way, then of course you can justify any price that you wish to. In fact, what actually happens is that you take the price first, which happens to be not only the present market but some higher price if you are bullish on the stock, and then you determine a multiplier which will justify that price. That procedure is the exact opposite of what a good security analyst should do.

 

I think if a person had tried to project the earnings of Dow Chemical for a five-year period and the earnings of Distillers Seagrams for a five-year period, and compared them, he could not have gotten values which would have justified the price differential as great as ten to one in the two companies. It is always an advantage to give examples of this sort that have such a brilliant sequel; because I notice that this year Distillers Seagrams sold as high as 150 as compared with its earlier price of 14, and Dow Chemical sold as high as about 190, against 140 -- which is quite a difference in relative behavior.

 

We have been trying to point out that this concept of an indefinitely favorable future is dangerous, even if it is true; because even if it is true you can easily overvalue the security, since you make it worth anything you want it to be worth. Beyond this, it is particularly dangerous too, because sometimes your ideas of the future turn out to be wrong. Then you have paid an awful lot for a future that isn't there. Your position then is pretty bad. There will be other examples of that sort which we may take up as we go along."

 

 

In 1939, Dow Chemical was one of the stocks to own.

 

In 1939, Seagram introduced Crown Royal in honour of George VI and Queen Elizabeth’s royal tour of Canada that year. The bottle was presented in a purple pouch with gold stitching — which became synonymous with the brand.

 

[SnarkyPuppy]

I also own 40-50 different stocks. Largest 5 positions make up ~25% of my portfolio, smallest 10/20 positions are a few tracker/starter positions or part of a basket. So in practical terms I have around ~30 positions. I'm usually around that number but I don't mind concentrating a bit more at opportune moments. I kind of agree with Nate: each to his own. A basket of net/nets can probably outperform but so does a concentrated portfolio. What is best for you probably depends on your character, age, net worth, confidence, lifestyle, job, etc.

 

FWIW I think 'outperforming the market' is a bit of an overrated concept - I prefer to think in terms of my own hurdle rate and stomach for volatility. Nevertheless I think it is a good idea to have a grasp of what would cause your portfolio to 'outperform'. I think that, especially as a small retail fish, you can have several good angles to try beating the market with:

 

- Time horizon arbitrage: something like BAC in 2012 was a nice example: the thesis basically being: buy it, forget it, don't watch NBC, the storm will blow over in five years.

- Tax arbitrage: PFIC's are a bitch for US investors, maybe you can reclaim dividend taxes in some situations, get tax credits, etc. Research your tax situation and make the best of it. For me personally, Sapec was a great example. KMG was a nice example this year.

- Boredom arbitrage: somewhat related: basically buying cheap stuff without a catalyst: PD-RX was a nice example.

- Liquidity arbitrage: as a small fish it's relatively easy to boost returns if you can do a few good trades, i.e. put some lowball bids in several cheap stocks or try buying a microcap merger on the bid for a 20% IRR. CKTM was a great example this year.

- Gross stuff arbitrage: buying stuff that's so disgusting that no fund manager wants to own it. Chinese companies going private, Halal real estate in Dubai listed on the AIM exchange, microcap Canadian mining mergers, etc.

- Work harder and be smarter arbitrage: my least favorite option. Work harder and be smarter than other market participants.

 

I'm probably forgetting some options. Most of my investments fall in one (or even better: more) of these categories. I'm always surprised how many people (also on this forum) prefer the last option. Like, if you are a part-time investors and you buy TSLA or VRX or whatever, take a step back and think: what is my edge here? I guess it's an ego thing?

 

+1

[Guest longinvestor]

My biggest mistakes revolve around selling. The desire to follow the “hold forever” mantra has thrown me off. I now realize the hold forever idea is only good for a few companies.

 

I have instituted some definitive sell criteria for myself now, that I hope will allow me to be more disciplined than thinking hold forever/until something fundamental changes.

 

When I look at say, a cheaper company like GE and look at a more expensive one like FB, I understand how FB makes money better than I do GE. I also think FB has higher probability for price appreciation in the next 5 years, despite FB being a “tech” stock and not meeting classic value criteria per se. Same with AAPL.

 

I think that FB is way cheaper than GE. GE does have a very low cash flow yield that is almost entirely consumed by the dividend, high debt load, pensions issues and probably more accounting skeletons hiding some where in the financial arm.

 

None of the above applies to FB. I think FB FCF yield is equal or higher than GE’s, especially if you take the EV as a denominator rather than  market cap (a bit unfair because GE has a financial arm)

 

-The assumption here is that I'm wrong and the post is respectfully submitted because the thread has a historical connotation.

-The quote is from Mr. Benjamin Graham and I concede that it comes from a different era.

-Still, the message is that is still hard to know the future but easy to project it.

 

"I am reminded of an analysis that we used in this course in

 

I think that represents a very dangerous kind of thinking in Wall Street, and one which the security analyst should get as far away from as he can. For if you are going to project Dow's earnings practically to the year 2000 and determine values that way, then of course you can justify any price that you wish to

 

I think if

 

We have been trying to point out that this concept of an indefinitely favorable future is dangerous, even if it is true; because even if it is true you can

 

 

In 1939, Dow Chemical was one of the stocks to own.

 

In 1939, Seagram introduced Crown Royal in honour of George VI and Queen Elizabeth’s royal tour of Canada that year. The bottle was presented in a purple pouch with gold stitching — which became synonymous with the brand.

 

+1

[rukawa]

- Time horizon arbitrage: something like BAC in 2012 was a nice example: the thesis basically being: buy it, forget it, don't watch NBC, the storm will blow over in five years.

- Tax arbitrage: PFIC's are a bitch for US investors, maybe you can reclaim dividend taxes in some situations, get tax credits, etc. Research your tax situation and make the best of it. For me personally, Sapec was a great example. KMG was a nice example this year.

- Boredom arbitrage: somewhat related: basically buying cheap stuff without a catalyst: PD-RX was a nice example.

- Liquidity arbitrage: as a small fish it's relatively easy to boost returns if you can do a few good trades, i.e. put some lowball bids in several cheap stocks or try buying a microcap merger on the bid for a 20% IRR. CKTM was a great example this year.

- Gross stuff arbitrage: buying stuff that's so disgusting that no fund manager wants to own it. Chinese companies going private, Halal real estate in Dubai listed on the AIM exchange, microcap Canadian mining mergers, etc.

- Work harder and be smarter arbitrage: my least favorite option. Work harder and be smarter than other market participants.

 

I like this list. The only way to beat the market is to do things that other market participants are not doing. And the question then is why is it that market participants are not doing it. The above list provides a bunch of reasons:

 

1) Its gross

2) its boring

3) it takes too long

4) its too small

 

This list of reasons also extends to other areas of life  ;D

[tombgrt]

- Time horizon arbitrage: something like BAC in 2012 was a nice example: the thesis basically being: buy it, forget it, don't watch NBC, the storm will blow over in five years.

- Tax arbitrage: PFIC's are a bitch for US investors, maybe you can reclaim dividend taxes in some situations, get tax credits, etc. Research your tax situation and make the best of it. For me personally, Sapec was a great example. KMG was a nice example this year.

- Boredom arbitrage: somewhat related: basically buying cheap stuff without a catalyst: PD-RX was a nice example.

- Liquidity arbitrage: as a small fish it's relatively easy to boost returns if you can do a few good trades, i.e. put some lowball bids in several cheap stocks or try buying a microcap merger on the bid for a 20% IRR. CKTM was a great example this year.

- Gross stuff arbitrage: buying stuff that's so disgusting that no fund manager wants to own it. Chinese companies going private, Halal real estate in Dubai listed on the AIM exchange, microcap Canadian mining mergers, etc.

- Work harder and be smarter arbitrage: my least favorite option. Work harder and be smarter than other market participants.

 

I like this list. The only way to beat the market is to do things that other market participants are not doing. And the question then is why is it that market participants are not doing it. The above list provides a bunch of reasons:

 

1) Its gross

2) its boring

3) it takes too long

4) its too small

 

This list of reasons also extends to other areas of life  ;D

 

Agreed. Too many so called value investors don't dare to step away from large caps and/or North American borders. They refuse to invest in the temporarily ugly and dismissed stocks/markets. There are sectors and markets currently offering attractive bargains. They might hold slightly more risks, but they are often also potential multibaggers because everyone acts as if those risks have already played out. Investing in good, large and known US/CAN stocks isn't always an option if you want to outperform. 

[rukawa]

- Time horizon arbitrage: something like BAC in 2012 was a nice example: the thesis basically being: buy it, forget it, don't watch NBC, the storm will blow over in five years.

- Tax arbitrage: PFIC's are a bitch for US investors, maybe you can reclaim dividend taxes in some situations, get tax credits, etc. Research your tax situation and make the best of it. For me personally, Sapec was a great example. KMG was a nice example this year.

- Boredom arbitrage: somewhat related: basically buying cheap stuff without a catalyst: PD-RX was a nice example.

- Liquidity arbitrage: as a small fish it's relatively easy to boost returns if you can do a few good trades, i.e. put some lowball bids in several cheap stocks or try buying a microcap merger on the bid for a 20% IRR. CKTM was a great example this year.

- Gross stuff arbitrage: buying stuff that's so disgusting that no fund manager wants to own it. Chinese companies going private, Halal real estate in Dubai listed on the AIM exchange, microcap Canadian mining mergers, etc.

- Work harder and be smarter arbitrage: my least favorite option. Work harder and be smarter than other market participants.

 

I like this list. The only way to beat the market is to do things that other market participants are not doing. And the question then is why is it that market participants are not doing it. The above list provides a bunch of reasons:

 

1) Its gross

2) its boring

3) it takes too long

4) its too small

 

This list of reasons also extends to other areas of life  ;D

 

BTW, writser, what broker do you use to buy stocks on AIM. IB, AFAIK doesn't have this capability

[CorpRaider]

Beating the Market -  Same as it Ever Was.

[Midas79]

I just can't resist, shameful as it may be.

 

1) Its gross

2) its boring

3) it takes too long

4) its too small

 

That's what she said!

[Grant]

It really is remarkable how difficult it is to out-perform especially when you consider the virtually unlimited resources that some of these firms employ.

 

Suppose you're a small fund generating a lot of alpha. What happens? You attract more investor money. Because you invested your original capital the best you could, this additional money must be invested in less promising ways - i.e. the law of diminishing returns. As long as you generate alpha, you continue to attract more money which lowers your alpha.

 

This is why big hedge funds with unlimited resources have trouble beating ETFs. Just because it's hard for them doesn't mean it should be hard for you.

 

This said, I usually advise people to stick to ETFs except where they have specialized knowledge the market is unlikely to price in.

 

That's kind of the big muscle movement of capitalism, isn't it?  Excess returns get pushed toward the average by the allocation of capital.  Should apply to industries, markets, and investment styles and/or funds.  I agree with OP that the average investment dollar must underperform the index materially after taxes and costs are included.

I see no reason it should apply to individual investors, because individual investors don't run funds and don't usually attract more capital when they generate alpha. Also, market knowledge isn't homogeneous, so there's no reason adding additional investors to the market must obey the law of diminishing returns.

[KJP]

Fidelity supports trading on AIM.

[alwaysdrawing]

Fidelity supports trading on AIM.

 

Fidelity is quietly just easier and nicer for most investors than Interactive Brokers.  International trading (including AIM) is just one plus.

 

I wouldn't say I have complete knowledge on outperformance, however I would focus on these things:

 

1. Concentration.  This is the easiest way to have out-performance or under-performance, simply because it reduces correlation with the index.  Also helps because it's very hard for most people to follow a dozen stocks with any type of thoroughness (to say nothing of people with 20+ positions, who basically tie an anchor to their performance.  If you have a 5% position double, it's still just a 5% portfolio gain.)  I'd shoot for the Buffett goal of 80% across 5 companies, with the remainder in more asymmetric type bets that can still meaningfully impact performance.

 

2. Focus on small stuff with less eyes on it.  Just less competition from serious, professional analysts on small caps and random stuff.  Spinoffs, SPAC warrants, IPOs, International, arbitrage of various forms, distressed debt, etc.

 

3. Forced sellers.  Anything where someone has to sell based on non-economic reasons creates opportunity.

 

I would guess most people here don't have the makeup to make high conviction concentrated bets, and thus they will never significantly outperform.  I'd bet it's 50/50 that a dart thrower could beat anyone who has max position sizes of 5%....I just don't think it's common for anyone to have 20 ideas that outperform.  The winners (of which there will be some) will be hurt by the losers (of which there will be some), and it will take forever to determine if the person has any skill, especially if he or she trims stakes down if they win.