I have news, unless you're a fly on the wall in a Board room, or snuck some inside information you have no edge. None, nada, zilch.
"But wait Nate.." you say. "What about patience?" or "What about my variant perception?" or "What about all of my in-depth research?" or "I have read their annual reports from 1675 to present and wall papered my room with Buffett's letters.." What about those things?
Consider the raw numbers. In the US alone there were 7,000,000 accredited investors in 2008, there were probably another 7,000,000 non-accredited investors. Maybe there are another 20-30m investors outside of the US plus a few million people in the investment industry. For argument's sake there are probably about 50m investors worldwide. And those 50m investors are looking at the same pool of 60,000 stocks. In the US there are 4,000 traded firms and 15,000 OTC firms, with another 39,000 firms worldwide.
If every company received equal coverage by investors there would be an average of about 1,000 people looking at each stock. For some large stocks it's even higher. Of the 4,000 US listed stocks I'd wager there are 50,000-100,000 people at a minimum combing over each company.
That means if you think you have an edge you're saying "I'm smarter than the other 1,000 people looking at this name." Are you? Do we all live at Lake Wobegon? A place where all of the women are strong, all of the men good looking and all of the children above average?
If you don't have an edge then what do you have? Simply put you have two options. When a stock is appreciating by investing you agree that the future is brighter than the present, and you agree with the crowd.
When a stock is flat or declining you disagree with the crowd about the future. That's it. You either agree with everyone, or disagree with everyone.
Buffett famously quipped that the market is a voting machine. It's the weight of the votes that determine a stock's direction. If you're agreeing with the crowd you hope no reasons for people to disagree occur. And if you're disagreeing with the crowd you're hoping news or opinion changes and people start to agree with you. When the weight of agreement crowds out disagreement the price appreciates.
But what about patience? The supposed edge that all value investors have? In theory professionals have to dump their stocks every few months because their clients aren't patient enough to wait for opinions to change. I think this theory is bunk. If an investment manager buys a position that they're convinced is going to go up they will move heaven and hell to stay in it.
Recognize that all investors are doing the same thing as you. They're reading, they're researching, they're talking to other investors, they're weighing the information. And they're all making the same decision, do they agree with everyone or disagree?
So how do you make money? You can make money two ways. The first is by being savvy and understanding how the crowd works. You buy into a stock when there is a small amount of excitement and hang on until the excitement has reached a critical mass. This is the growth or compounding approach. You are in names that everyone loves that are growing and getting bigger. To be a winner with this strategy you need to recognize when the psychology is about to change and get out before others.
The second approach is to disagree with the consensus and buy when others are selling, and sell when others are buying. With this method you're picking up the pink flamingo Hawaiian shirts on sale for $2.99 in the winter betting that they'll be a hit in the summer. In this market this second approach is stomach churning and leads to heart burn.
Right now if you want to make money you buy things, anything, and simply agree with everyone else. But at some point sentiment will change and everyone will be selling and you'll be forced to disagree and buy. Doing so doesn't mean you have an edge, it just means you can control your emotions. And if you're going to be a successful investor you need to be able to control emotions.
So being able to "control your emotions" is your edge! Didn't someone say: "It's not the IQ it's the temperament".
ReplyDeleteI haven't bought anything for 4 years till this week. I had 40% of my portfolio in cash. Found a good (if not great) business at a great (if not really not great price). Let see how I go with it over the next few years. 10% position allocated. I think the probability is very good that its a five year double. Never thought I'd say this, its a really expensive market, but there is still value in some shapes and forms. It wasn't hidden and its not a micro cap, but its a story thats has fallen well out of favour. It happens. Value is not not dead.
ReplyDeleteGreat post! However I believe that some parts of OTC space still does not fit your larger point. There still could be stocks that are forgotten and not many people know about them or not enough people follow them closely. The 'edge' there could be just one's perception of opportunity cost (i.e. people willing to hold without clear catalyst etc.).
ReplyDeleteThis is true for most of the stock market, but not all of it. Take the grey sheets, for example. The majority of investors don't even know that grey sheet stocks exist, so there aren't 1,000 people looking at each name. A lot of brokers won't let you buy grey sheet stocks - that reduces the number of investors too. You often have to call/email the company to get financial info - most investors won't do that. Etc.
ReplyDeleteI agree with this article to an extent. I think a lot of people could be wasting a lot of time (and money) thinking about what their edge is when they are staring straight at a $100 bill laying on the street in front of them. My edge, analogously, may be that when I see an empty parking spot close to the front of the grocery store, that I don't stop and think, "how can this spot be available with all the people trying to buy groceries at this time?" I instead pull straight in and continue on with my day.
ReplyDeleteI think of an "edge" as just something that gives me more than 50/50 chance. Don't have to be better than everyone else.
ReplyDeleteGive the ticket Anonymous, or just stfu.
ReplyDeleteBut wait, wait Nate. You're making a big mistake, I'm sure of, I do possess an edge, I mean come on, I'm reading ALL the footnotes... it should mean something, shouldn't it?
ReplyDelete:)
I think what you describe fits the megacaps but doesn't really apply to the no-names that don't trade every day. You're probably right that tons of research and credentials in finance won't significantly improve your odds when you decide to buy or short GE. But I think this knowledge is an advantage at the other end of the spectrum.
ReplyDeletePut another way I don't see much risk in blindly buying highly diversified ETFs, but to trade in the pink sheet penny stocks looking for your "second type" of vulture recovery play, you'll need to be able to parse financial statements because there's a lot more adverse selection at this end of the pool. The low market caps and thin floats make accumulating a large dollar position problematic, this keeps the big money uninterested and so creates an opportunity for the individual investor.
A good example is the topic you write about-- investing in small bank stocks. The years right after the 2008/2009 crash were a great time to be picking up these shares. The trick was separating the roadkill from those that at least had some chance to survive. The shortcut I found was through http://banktracker.investigativereportingworkshop.org/banks/
The low-hanging fruit has been picked clean several quarters ago, but I think there was a nice window of opportunity for those who were willing to dig.
Some stocks still have no following whatsoever and are incredibly undervalued. Take I.Gordon Corporation for example (GORL). Market cap about $6million. Owns and leases four apartment buildings in Rochester, NY. Value of buildings on tax rolls way in excess of historical cost on books. Negligible debt and lots of cash.
ReplyDeleteDo you have financials link or can post them to a dropbox? Thx
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