"So is there a reasonable expectation that a reasonably intelligent consumer can pick stocks?" was the question put to me by a friend. "That would be a challenge to blog on without it sounding like a sales pitch," he went on to write.
Indeed it will be, but I LIKE a challenge! Before I answer the question however, I need to tell you a little bit about myself so that you will better understand my world view...
The CFA Institute awards the Chartered Financial Analyst (CFA) designation to individuals who complete a three-year post MBA graduate program in finance, economics, accounting, statistics, and investing, and who have worked in the industry for at least three years. CFAs are trained as institutional investors and are hired by mutual fund companies, banks, insurance companies, and pension plans, among others, to invest assets on their behalf. My own background includes a 12-year run as a hedge fund manager ($55 million in assets and a tout in 2001 by Barrons as a top fund manager). As well, I've spent over 15 years dealing with individual investors and have learned quite a bit that the CFA textbooks don't teach an aspiring candidate. With all of that out on the table... here's my answer to stock picking for the masses.
Absolutely it is reasonable to expect that a reasonably intelligent consumer can (successfully) pick stocks! In fact, I could teach a person with average intelligence how to outperform the stock market by a wide margin over multi-year periods of time in just a few hours of instruction. Intellectually it just isn't that hard! Wanna beat the U.S. stock market over five-year periods? Piece of cake! Simply focus on companies with solid balance sheets, free cash flow, and which are trading in the bottom quintile of all stocks based on price to sales and/or price to book. You will outperform magnificently over 5 and 10 year periods. Now you won't necessarily outperform over one or two year periods. And you might not outperform after adjusting for volatility. But you will outperform in the metric that counts most - total return!
Okay, if it is so easy then why doesn't everyone simply eschew mutual funds and build their own portfolio of stocks? Because it takes patience and discipline, and a willingness to go against the crowd. John Maynard Keynes' edict that, "it is better for reputation to fail conventionally, than to succeed unconventionally." is spot on. It is well known in professional money management circles that losing money with the crowd is not a career risk, while losing money alone most certainly is! Individual investors share the same behavioral traits as the professionals. They would rather be wrong together than risk being embarassed alone.
Buying beaten down, out-of-favor stocks takes a level of courage and contrarianism that is uncommon to say the least. I have always found it amazing that more people don't focus on buying cheap assets, which can lead to highly profitable outcomes. Instead they are filled with the gambling lust, determined to find that needle in a haystack that might become Microsoft, or Google, or Cisco. The pot of gold at the end of the rainbow leads them to speculate, for instance, in small biotech companies, instead of buying historically profitable companies when they are demonstrably cheap. And speculating is exactly what most investors are doing these days. The average holding period for a stock on the New York stock exchange has fallen to 6 months, down from 6 years 40 years ago. Now, for those of you who would like to actually invest in good companies at great prices, here's all you need to do...
Buy companies with little or no debt. The current ratio should be 1.5x or better and long term debt should not exceed equity. Buy companies with low fixed costs and profitable histories, and which throw off plenty of free cash (what's left over after all the bills are paid, including salaries). Buy companies trading close to book value with a return on equity close to 15%, and buy them when they are trading cheaply based on their own history and relative to the stock market. Read the last few annual reports and the most recent 10K and 10Q to make sure that no long term negative changes to fundamentals have occurred. Finally, don't expect to make money in these stocks over night; it might be a few years before they kick up their heels and take you to the promised land of outperformance. Do all of those things and the academic data overwhelmingly points toward a serious case of studly performance in your future. About the only thing that could ruin it for you is faint heartedness, since you will be going against the crowd, forced to justify your choices to your friends who will sneeringly tell you what a fool you are to bet on boring stuff while they are getting ready to strike it rich in Nanobiotechno Industries Incorporated! Ignore them for they are the fools chasing a pipe dream and you are the true investor buying companies on the cheap!
