Wednesday, April 16, 1997
Las Vegas, Mr. Spock
and the Foolish Investor
by
[email protected]
We've all been there -- worrying about what will happen to the Beating the Dow approaches when word gets round about how well they perform. Terms like "Efficient Market Hypothesis" start to fly thick and fast and anxiety and doubt cautiously start to poke their heads above the parapet, growing ever bolder until there's nothing but a screaming: "Too late! I got in too late! Now, everybody knows about it, soon there'll be no slack left in the market and ten years down the line I'll be wiped out! Oy vey iz mir! What have I done?!"
But just hold on a second, take some deep breaths and remind yourself why the Beating the Dow approaches work. Reduced to their most basic level, these strategies involve buying relatively "out of favour" blue chip stocks, identified by a cheap share price in relation to dividend (a number which is relatively stable with time) and holding them for a year, followed by reallocation. The share price may well be low for reasons other than an ailing business; it may be low for reasons of market over-reaction to only moderately bad news.
The classic examples are Exxon after the Exxon Valdez disaster and Union Carbide after Bhopal. Leaving aside whether you can square investing in polluting multinationals with your green, 1990s conscience, neither of these disasters was likely to mean the end of the gigantic corporations involved, but the markets reacted as if they might. This emotional over-reaction hit the share prices for six, creating a tremendous buying opportunity for those who believed that one day the prices would return to fair value levels. Less dramatically, this kind of thing is happening to multi-billion dollar companies all the time and a high dividend in relation to share price is sufficiently predictive of an undervalued company to make Beating the Dow a market beater, if the strategy is followed consistently.
What is clear is that the strategy involves banking on the emotional over-reaction of a majority of investors. For the Efficient Markets Hypothesis to hold true, the majority of investors would have to discipline themselves to follow a Beating the Dow-type strategy, come what may, and not sell on the basis of fear or buy on the basis of greed. In short, to eliminate all pockets of market inefficiency, all investors would have to behave totally rationally. Likely? I don't think so.
Beating the Dow may be the most sensible, most rational, least hassle long-term investment approach on paper, but easy to follow it isn't! Let's face it, we're all fixers and tinkerers of one sort or another, or we wouldn't have stopped by the Fool. To sit and watch a single stock bring down the performance of a whole portfolio without pressing the "sell" button takes resolve, but who is to say that later in the year it won't be that stock which will provide the group's market-beating returns? Of course, by cherry-picking your portfolio you just might improve your performance, but you are bucking the strategy's entire foundation and converting an unemotional, rational, mechanical approach into an emotional, irrational, inconsistent one.
Good luck to you if you think you can beat the odds, but have you been to Las Vegas recently? If so, you'll have noticed two groups of investors - unemotional, rational ones basing their strategies on long-term odds subtly tipped in their favour and emotional, irrational ones desperately hoping against hope that they will be the ones to beat those odds. This second group generally walks away from the strip a whole lot poorer and not much wiser. Neither group of investors could exist without the other, but only one consistently wins.
When the Mob leaves Las Vegas for more profitable pastures, I shall rewrite this fribble. Meanwhile, the next time I receive unconsidered, frenzied, "sell" or "buy" advice, I shall raise a quizzical eyebrow and respond with a gentle: "Indeed?" Then, I shall turn away and reflect on how much more suited my cool, green, Vulcan blood is to the long-distance investment game than the hot, red blood of mere humans.
Beam me up, Scottie.
David Berger Devon, UK
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