This article on simple value strategies for big returns was written by Thomas Niel. Thomas is a private investor, a financial blogger and an accountant in Washington DC. Creative Commons photo by FelixMittermeier, edited by Broken Leg Investing.
As an investor, how would you describe the value strategies you use to generate big returns? Would you call them “simple” or “complicated”?
I bet you try too hard to beat the markets. And why not? Outperforming the markets is hard work. The best and brightest minds are competing to generate alpha. If money never sleeps, how else does the little guy stand a chance, right?
Wrong! Sometimes the biggest risk to your portfolio is not outside factors, but your own personal flaws. Conceding that you can’t use a mess of data to “predict the unpredictable” can free your mind, allowing you to use simple value strategies for big returns.
More Information Doesn’t Always Equal Better Returns
Information for your portfolio is a lot like vegetables in your diet: you need enough for good health, but going overboard doesn’t magically give you immortality.
Investors are guilty of overthinking their way to tepid returns. Take for example the scores of individual investors who attempt to do what Warren Buffett does — find great companies with wide moats at fair prices. Or, look at options traders who spend countless hours building a complex system to beat the quants that rule the street. There are many ways for investors to “play the markets” — and by playing, they usually lose.
They lose because they try to use stacks of data to quantify the unquantifiable, to predict the unpredictable. Instead of relying on a smaller number of cold hard facts (such as a company’s fundamentals) to find deep value, they attempt to predict the future using cloudy information.
Investors with little inside knowledge and experience attempt to predict quarterly earnings right before a company announces them. They try to predict the outcome of an FDA decision on a new pharmaceutical drug. They can’t tell West Texas Intermediate from Brent crude, but they think they can predict trends in the oil & gas industry.
Investors are even guilty of betting on future trends, no matter the price. From electronic cigarettes and blockchain, to drones and 3D printing, trying to hit the mark with bets on future technology is as tough as predicting who will win the World Cup in 2022.
What if I told you that by overthinking your value strategies, you are sabotaging your performance? That simple, well-defined mechanical value strategies were the key to long-term returns?
You may be skeptical. As I mentioned earlier, money never sleeps; the smartest guys in the room rule the markets...
Because most investors lack the pros’ network and infrastructure, they convince themselves they can outfox them by concocting a complex, but flawed, prediction strategy.
They lose because they try what is hard, and not what’s simple. If only they had chosen to stick to the time-tested fundamental analysis techniques spearheaded by Benjamin Graham and his disciples (early Buffett, Walter Schloss), they would understand what works and what underperforms.
Mechanical Value Strategies: Simple Path To Big Returns
As a deep value investor, mechanical value strategies should be the bedrock of your portfolio.
Don’t get me wrong — you shouldn’t buy the first 50 deep value stocks you come across and hope for the best. Human interaction and judgment play their part.
Using time-tested criteria (undervalued securities on a balance sheet/earnings basis), you can select high-quality net net and deep value stocks without the inconsistent “handicapping” of industry and macroeconomic trends, “scuttlebutt” from industry pros and suppliers, and other time-consuming activities that may not produce valuable information.
Having solid criteria should be the basis of your investment decisions, but the emotional control to stick with the strategy through volatility and uncertainty is an equally important piece of the puzzle.
Failing to stomach short-term variance can really pile up your memories of woe and regret. I recall early in my investment journey getting scared by short-term volatility and selling off my positions after 20-30% declines. Several of those securities not only erased their losses, but doubled or tripled in value within an 18-month period. Let’s just say the regret is real.
The future is yet to be written, so be careful not to write off an investment idea due to future risks that investors have already priced into a stock. If you focus on asymmetrical wagers (situations where the odds are in your favor) and diversify across a wide field of opportunities, over the long haul you will achieve big returns.
Changing approach midstream is another way investors self-sabotage. In a hot market, it can be easy for investors to dump fundamental analysis and go for a “trend is your friend” momentum strategy. This works out — until it doesn’t. You can’t predict what next month’s headlines are going to be, so how are you going to predict when a trend will continue, or when there’s going to be panic in the streets?
While it’s tough on your ego to admit you can’t outsmart the markets, it is liberating to know that conceding to the truth and applying mechanical deep value strategies can get you the results you seek.
The game of investing is a game of probabilities. You can’t be right 100% of the time, but if you select asymmetric wagers, over the long run you will come out ahead of the markets.
Value Strategies Make Investing Less Complicated
Focus on the best mechanical value strategies, then stick to them over the long run. Investing doesn't have to be complicated — but it does take evidence-based choices and long-term resolve.
The most practical strategy for deep value investors is the simple approach. Base your strategy on hard facts, not “soothsaying.” Take a look at a company’s financial situation — its valuation on a net-net or earnings multiple basis. This will allow you to weed out situations that look good on paper, but qualitative factors (such as poor management or material cash burn) swing the odds out of your favor.
Being strategy agnostic will result in a haphazard, poorly executed approach. Dogmatic Graham style net-net and deep value investing value strategies will allow you to tilt the odds in your favor, generating strong long-term returns.
Sticking to the strategy can be tough when it’s all a game of probabilities — you won’t be right 100% of the time, and in some yearthoughs you will underperform the market. Just remember that, over the long run, a strategy built on selecting a diversified basket of high-quality net-net and deep value stocks will produce the big returns you once racked your brain to figure out.
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