UnThreaded | Threaded | Whole Thread (6) | Ignore Thread Prev | Next
Author: yodaorange Big red star, 1000 posts Feste Award Nominee! Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 465046  
Subject: 36% chance of beating the market Date: 3/31/2013 8:10 PM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 30
There have been many studies that demonstrate how hard it is to outperform indexes like the S&P 500 over the long term. Burton Malkiel’s book A Random Walk Down Wall Street [1] was first published in 1973. Malkiel examines both fundamental analysis and technical analysis. His data indicates it is unlikely for individual investors to outperform.

Jack Bogle has spent his career advocating investors use index funds instead of actively managed mutual funds or individual stocks. His last book specifically on this topic is Common Sense on Mutual Funds. [2]

Longboard Asset Management recently published an outstanding update on this topic. [3] Their research stands out because it is based on total returns for each individual stock and it properly deals with “survivorship bias.” Survivorship bias is when you use today’s list of stocks and then do a backward looking analysis. What you miss is all of the stocks that have gone out of business, were bought out or otherwise stopped trading. Many of the simple backtesting strategies used by amateurs do not fully comprehend this. I am sure the folks over on the Mechanical Investing board understand this and include it in their testing.

Longboard focused on all stocks listed on the NYSE, AMEX and NASDAQ from 1983 through 2006. The only restriction was the stocks had to be eligible for inclusion in the Russell 3000 index. This index consists of the Russell 1000 large caps and Russell 2000 small caps. Longboard compared the individual stock returns to the Russell 3000. There were many significant results:

1. 39% of stocks LOST money on a total return basis. This is NOT “real returns” after inflation, but the nominal return. If you accounted for inflation, the results would be worse.

2. 18.5% of stocks lost at least 75% of their value.

3. 64% of stocks underperformed the Russell 3000. So the odds of you picking a stock that will beat the index are about 1 out of 3. NOT EXACTLY encouraging.

4. The distribution of stock returns minus the Russell 3000 is NOT Gaussian. It has significant “fat tails” both on the downside and the upside.

5. 3.9% of stocks underperformed the index by <-500%

6. 6.1% of stocks outperformed the index by >+500%

7. The average annualized return was -1.06% and the median return was +5.1%. You might ask how the Russell 3000 had a positive return if the average stock had a negative return. The reason is that the index is market cap weighted. If a stock kept falling in price, at some point it would be removed from the index. It might and likely did continue falling for the worst performing stocks.

At this point, you are probably not surprised by any of this data. But you ask: “What is actionable from the report?”

Glad you asked.

What is actionable is Longboard’s observation of the best performing stocks. Put simply, all of them kept making new all time highs. This is a tenet of Bill O’Neil’s CANSLIM method. [4] It has also been academically researched by Mark Carhart in 1997. [5] Mark came up with a new factor that was added to the Fama-French “3 factor model.” His new factor is essentially a new highs or momentum factor. This type of investing is broadly described as momentum investing.

This is exactly the opposite of the Catch a Falling Knife aka value investing approaches. The Longboard paper does NOT make any comment about value investing. Value investing certainly can outperform as many value investors have demonstrated.

BOTTOM LINE for the average investor is you should be looking at the “new highs” list instead of the “new lows” list if you are investing in individual stocks.

The paper is brief with a lot of graphs. Words, at least Yoda’s words, cannot adequately convey what the graphs show. Highly recommended if you are interested.

Thanks and happy Passover and Easter,

Yodaorange



[1] Random Walk Down Main Street by Burton Malkiel
http://www.amazon.com/Random-Walk-Down-Wall-Street/dp/039334...

[2] Common Sense on Mutual Funds by Jack Bogle
http://www.amazon.com/Common-Sense-Mutual-Funds-Anniversary/...

[3] Longboard Asset Management white paper
http://longboard-am.com/assets/The_Capitalism_Distribution-1...

[4] How to Make Money in Stocks
http://www.amazon.com/Money-Stocks-Complete-Investing-System...

[5] The Journal of Finance article “On Persistence in Mutual Fund Performance” by Mark Carhart
http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.1997....
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Print the post  
UnThreaded | Threaded | Whole Thread (6) | Ignore Thread Prev | Next

Announcements

Foolanthropy 2014!
By working with young, first-time moms, Nurse-Family Partnership is able to truly change lives – for generations to come.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Post of the Day:
Macro Economics

Economic Implications of Cuba
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and "#1 Media Company to Work For" (BusinessInsider 2011)! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.
Advertisement