This is a weak article. There are plenty of ways to beat the market averages while being just one individual with a small sum of capital.
A while back Buffett said that he thinks he could average 50% annually if he only had a small sum of capital. Here are some of the things he would likely be doing:
1. Go where the big investors can't
Many large institutional fund managers cannot go below certain market caps. Typically you can find a rich hunting ground of undervalued and ignored companies below $100M.
During the crisis I found it pretty useful to actually screen for negative enterprise value stocks. These were companies where they were trading BELOW the cash they had on their balance sheets. (EV = Market Cap + Debt - Cash). Some of these companies were pretty tiny, $10 to $50M mkt cap, but they worked out well. You have to be willing to deal with illiquidity though.
2. Odd lot tender offers
You can find situations where a company wants to go private and delist. To do that they need to buy out shareholders and get below 300 public shareholders. To do that sometimes they will pay a premium for you to tender shares if you have below 100 shares. Again, this is an area where a small investor can do well but where large institutions are precluded from being active.
3. Look for areas where institutions are forced to sell
Spinoffs are the classic example. Academic research has shown that spinoffs will in general outperform the greater market. Why?
Many index funds are mandated to only hold stocks that are a part of the index. Sometimes an index member will spinoff a smaller unit which cannot make it into the index. The index funds will be forced to sell that company and so its pricing may get below its actual value. That's why spinoffs tend to outperform the market in their 2nd and 3rd year of trading.
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There are plenty of other areas too. These are just a few but it is all pretty well publicized.
Fascinating. I imagine you are ludicrously rich via these obvious and well-publicized methods? How long did it take you to learn and implement these tactics? I would also love to see pictures of your yacht and/or Mansion.
you're still taking on the risk of waking up one morning to an accounting scandal rendering 5% of your portfolio worthless. unless you diversify so much that you're essentially an index investor anyway. the stock market isn't rigged against retail investors like many believe, but people are far too quick to assume a few years of good performance means they're "beating the market".
When it comes to picking out frauds, you can usually tell by looking at the accounting who is playing loose and who is not. That wont give you an indication of whether or not a company is necessarily a fraud, but it will give you the opportunity to know who is being aggressive with their accounting. And if they are being aggressive you should probably stay away.
There are a ton of books out there on forensic accounting (Financial Shenanigans, Creative Cash Flow Reporting, Quality of Earnings, Financial Fine Print -- Along with changes to GAAP and IFRS) where if you have read all of them you should be able to pick out weird issues with accounting.
The other benefit of investing in small companies is you can in general get better access to CEOs and managers. If you were to invest in JNJ, the chance of you getting to talk to the CEO is slim. But with a lot of nano-cap companies you can actually go visit with the CEO and start quizzing him to see if he is BSing you or if he is actually smart and competent. I like to ask the same questions to two competing CEOs and see how their answers differ. You can really go as deep as you want when investigating some CEOs. You can start visiting their community, talking to people who are active with them in organizations. Just a lot of work to really scrub their background and get at who they are. Plus, these businesses tend to have fewer moving parts too, so you can analyze them in greater detail.
If you actually want to trade, be sure to go for a broker that has a decent real-time simulator. optionsxpress does. Trade on that for a while, always comparing against an index, and see whether you can actually beat it over a signficant amount of time. You probably cannot.
Dividends don't make sense for growth companies because they can invest the money at a higher ROI than you can. AAPL is a good example of this. Companies with high profit and low growth (MSFT, and soon GOOG) have to.
When I was younger, I could never understand the purpose of stocks that don't give off dividends. I just could not wrap my head around the concept of buying something for the sole purpose of expecting it to increase in value. It still boggles my mind.
At least in economic theory, a company does not give out dividends if it believes that it can get a better return on its cash (in terms of profit) than the investor can in the overall market.
But, companies must eventually give out dividends. There's a certain point at which the company's cash hoard gets so large that investors become unhappy (see Microsoft).
Yes, theoretically. In practice, managements have a long history of buying stock back at inflated prices and buying back stock simply to hide the shareholder dilution that is occurring due to management equity compensation. I prefer dividends to buybacks.
Companies tend to announce buybacks when things are going well and their stock is fully priced. How many companies were announcing buybacks in December 2008 when it would have really made sense?
Buying a stock is, essentially, buying a piece of a company.
It's nice to own stock in a company that's currently profitable and get a share of its current profits; it also makes sense to own stock in a company you expect to become profitable in the future and get a share of its future profits. Stocks can be a good investment even if they don't presently give off dividends.
Stocks that will never give off dividends are a bit different. I suppose they give you "ownership" of some portion of the company's assets, so if the price is less than the value of the current or future assets represented by a stock, that can also be a good investment.
What doesn't make sense is buying stocks that don't pay dividends, won't pay dividends, and are priced high in comparison to the company's current and expected future assets. Buying stocks in that category is like buying a house as an "investment" in 2008.
Nassim Taleb comes to a similar conclusion, but with much better examples (one of the best Planet Money Podcasts ever IMO... just posted it here: http://news.ycombinator.com/item?id=1623713)
Taleb slams Obama & the media, prefers recession over high deficits, advocates clawbacks, slams forecasting models when high debt levels are present and predicts the broad failure of public companies due to fundamentally misaligned incentives.
That said, here are two (rather discomforting) counter arguments to both Cuban and Taleb:
1) A warning against credit derivatives
(or betting the market will go down):
"The market can stay irrational longer
than you can stay solvent." - Keynes
2) In an inflationary environment, high levels of
long-term debt can actually be a good thing for the
issuers. It's the short-term debt that must be rolled
over that creates most of the problems (e.g. ARM mortgages
and a majority of commercial loans).
You don't need to know more than the other market participants to do well in the stock market, you just need to know one thing that other people don't (assuming your investment is a tiny fraction of the money in the stocks you pick). You should always expect that all the information on a product that is accessible to Wallstreet traders is already factored into a stocks price, but there may be things (does this product really make sense for someone like me who lives in a small appartment, how will this inovation interact with the stuff I learned in all those technical courses I took in college) that you might better information about than the market makers.
Of course, it might just be that random chance has caused the author of the post to do badly in the market and me to do well - causing us both to be biased. You should always diversify your investing and its probably a good idea to put most of your stock money into index funds.
Bolshevism. An S&P 500 index will crush any bond, CD, whatever, over the next 20 years. When you are investing long term, the ups and downs and whatever volatility traders and hedge funds cause do not matter, you are still owning a piece of the company that on average will grow exponentially in value.
With inflation on the horizon, stocks are a way better hedge than cash or bonds.
And that said, if you go hunting for value and well priced stocks, you will be way better off.
Or, it might not. Stocks have been flat to negative over the last decade. Stocks are great when they are going up. You can make amazingly high returns, but the market has this bad habit of crashing every few years or so, and if you're relying on it for retirement money, you might be screwed. I truly hope you weren't heavily invested in stocks and needed to retire at the end of 2008, or in 2002.
I've found a much better portfolio allocation that gives similar long term returns to being invested in equities, but without the wild swings:
That's a huge presumption considering we've just done the same things that historically create deflation and resulting depressions.
Trillions in questionable debt is still outstanding, and the Fed and Govt's intervention is far from clearly solving that.
It's very possible we could end up like Japan in the 90s - deflating - or worse since they had household savings then and we don't.
It's also possible we could get some unholy combination of currency inflation and debt deflation, which I have no idea what that looks like, but I imagine it ain't pretty. Only thing I'm certain of is that stocks outperforming bonds and cash over the next 20 years is not a certainty. The past 50 years is not enough data to know that for sure.
Your using the word deflation wrong here. It trips many people up.
Inflation is when the money supply grows, deflation when it shrinks. The person your responding to is correct to point out out money supply is being inflated, and inflation has been increasing in rate.
This may well lead to economic troubles which will cause some businesses to lower prices out of desperation.
You can call that price deflation if you want.
But don't forget the qualifier and then claim the other guy is wrong when you equate one economic phenomena with another by misunderstanding the terms.
I know you probably haven't heard about this, most mainstream economics talk is acutallu political talk that tries to pretend inflation is measured in price (an effect of, not the cause of inflate.)
For instance it is correct to say inflation was one of the causes of the great depression which resulted in price deflation. Also a major effect there was the real deflation of the criminalization of gold that literally made the us currency illegal eliminating much if the money supply -- while inflating paper money.
That's not the commonly used definition. When the government puts out CPI, that's price inflation, not monetary inflation. Monetary inflation is only one component of price inflation. The other two are the velocity of money and change in productivity. There has been large monetary inflation in the past couple of years, but low price inflation because the velocity of money has gone down so much.
In a fiat, fractional reserve system, money = debt. When large amounts of debt are defaulted, the money that had been created by fractional lending gets destroyed too, hence a decrease in the supply and velocity of money, hence 'debt deflation'. I wasn't talking about 'price deflation', though I should have qualified that term both times I used it, not just the second time.
Price deflation is just a symptom of underlying problem/s, not the actual problems. It's the canary in the coal mine, not the gas leak that's about to blow it up. Prices can deflate or inflate for a number of reasons, from supply:demand imbalances (typical business cycle), change in money supply (which changes demand for goods and services relative to supply), or some other structural change in aggregate demand. Price inflation/deflation is only interesting to me in that regard as a vaguely-specified warning light urging further investigation/troubleshooting, but not as the underlying problem.
I agree with Steve Keen's hypothesis that jwhite linked here, Bernanke can print all he wants, and drop interest rates all he wants, but there's a realistic chance that it won't have the effect he intends. Banks won't start issuing new credit until they are confident the economy can support both the old credit (at an acceptable, pre-crisis default rate) and the new credit.
With the government and Fed propping up a significant percentage of our GDP right now, the odds of banks regaining that confidence aren't great.
Qualifiers are certainly important in this case, it frustrates me no end that mainstream media can't distinguish these. Thanks for your insightful comment.
Steve Keen has an interesting article on endogenous money at www.debtdeflation.com. Bernanke has increased M0 drastically in an effort to stave off deflation (I guess asset price deflation is the key in this case), but Keen believes it won't work because our system is not a true fiat money system but a credit money system with a fiat money subsystem tacked on, and in the current circumstances banks/companies are not going to expand credit no matter what happens to M0. That is, banks lend money first, then go hunting for reserve supply (M0) to back it up, opposite to the text book theory for how the money supply works.
Looking back to 1971, for any 20 year period the S&P 500 netted a gain. For the last 20 years, that gain was 6% per year. OK, but not what I would term "crushing" performance.
For the last 10 years, the S&P 500 is down 2.5% on an annual basis. You could have done better w/ govt bonds & CD ladders.
I think the 20 year plan assumes a greater will power than the greater investing community possesses.
Right, you can cherry pick 10 year periods of time when the S&P did good, but don't forget about all those times it crashed. The problem with following Wall Streets advice to put all your money in stocks is that they make too much money from trading commissions to trust them for impartial advice.
Typical investment advisors tell you to buy stocks and then point out that over the last century stocks have done very well. The problem is that none of us are investing on 100 year long timelines. We are usually investing on 30-40 year timelines and hoping to have a good amount saved when we retire. If you happen to need to retire and start pulling money out in a bad year like 2008, you're screwed.
S&P 500 today is not made up of the same companies as back in 1971. The 6% annual growth excludes any companies didn't do well and were delisted or got wiped out (100% loss of investment).
Aren't we already closer to "blood in the streets" than "cheery consensus"?
Financial people love to say that the stock market grows at roughly 9% historically, and that is money in the bank. But if you look at any historic chart these days, the massive amount of wealth and trading volume that has been generated over the past 10 years has made it obvious that we are in uncharted waters for future equities growth.
The Internet has been the game changer here. It has allowed access to equities to a class of investors that really never had access purchase these types of assets. This changed the game.
Cuban is probably right when he tells us to be weary of the market, but I think there are different reasons to be weary than those he states.
Equities have been growing just fine. It's just that their market prices haven't been. The 10-year average earnings of publicly traded stocks--a rough but decent indicator of value--are quite a bit higher (70%, IIRC) than they were 10 years ago.
The lesson is not to avoid the stock market, but to avoid overpriced stocks.
I think Cuban is comparing vs the March '09 low when the market was down 40% from now. He made several posts during that time about actual purchasing stocks.
Right, it was a great time to buy. I do tend to think that we will see DOW 14000 before DOW 7000, barring some unforeseen crisis. And I guess that's market confidence, right? What investors think the chances of something unforeseen popping up are.
Of course because the more the dollar is devalued via inflation, the hugger stock prices will go even though they aren't actually appreciating in value.
The truth is that most people sell when the market is getting killed and buy when the market is running up.
It is human nature to follow the crowd. Savvy investors can make several hundred % returns buying during crashes and bear markets.
The main keys to success: 1) Never use margin (market day-to-day is too unpredictable 2) Leverage with Options
3) Try to remove emotion from the investment
Good advice, and while I see people repeating common myths in this thread, I should just be happy that they are there to take the other side of my positions.
"It is pretty much impossible for some man or woman or child who devotes a couple of hours per week to the market to outperform the professionals who spend 24×7 doing this for a living and when they are asleep, they have a workforce full of people doing more of the same. In this day and age, none of us are smarter than the market."
I agree that individual investors can't continue to try and play in the big leagues. When you're competing with bankers, you're going to lose because they're doing it 24/7, like Mark said.
However, there is a significant amount of the market (30%? Tried to google the figure and couldn't find it) that Wall Street doesn't cover, analyze or do much of anything about. For the most part, this is the playing field for the individual investor.
My only other advice is buy at a profit. Use value investing tenets to buy stocks that are significantly discounted to their fair value. It's much easier to calculate the value of a company than most think.
However, there is a significant amount of the market (30%? Tried to google the figure and couldn't find it) that Wall Street doesn't cover, analyze or do much of anything about. For the most part, this is the playing field for the individual investor.
Is "a couple of hours per week" enough to do the research necessary to perform well in that area?
I stopped reading when the author said everyone wants stocks to go up. You can make money no matter what direction the market goes. A brief skim of the rest of the article finds similar errors. The OP doesn't seem to understand the basics of asset allocation and diversity.
technically he said people buy stocks because they think stocks will increase in value. it is an useless/obvious observation but different from what you stated.
like cuban i do wonder why individuals think they can beat the market. well connected and well capitalized groups have access to far more information than is publicly available. with the rise of hft and the like not only are you under attack by players who understand the fundamentals better but also by people who can game the exchange platforms themselves.
I agree the odds are stacked against the individual investor. However, I'm an individual investor who consistently beats the market. I don't do anything special. I just follow the tenets of value investing. IMHO, this is the only way to invest as an individual. Otherwise, stick your money in an index fund and hope for the best.
"Because people buy stocks for only one reason, they want them to go up in price."
Indicates the author knows little to nothing.
"It is pretty much impossible for some man or woman or child who devotes a couple of hours per week to the market to outperform the professionals who spend 24×7 doing this for a living and when they are asleep"
There are so many people performing so poorly - even professionals, that working 24x7 obviously doesn't buy you much "performance". While it's true you're competing against everyone else on the market, that doesn't mean there's a large group of professionals performing so well that you can't compete. In fact it's the opposite.
"So what does this mean for you ?
It means that I don’t know if the market will go up or down, or by how much."
I'm thanking God that what it all means to me is not dependant upon what this author knows.
As for the remaining "scarcity of capital" argument - it's like the author can only see one point in time, and not the big picture. There's a reason why all the capital being made available is not being borrowed. It's because smart companies know growing for the sake of growing, without demand is a bad reason to borrow, thus they don't. It's your job to determine who they are, and the fact you can't does not mean that it can't be done.
There's more to comment on, but overall - I couldn't find much I could agree with.
After selling his company to Yahoo for $5.9 billion in Yahoo stock, Mark Cuban personally architected a hedge of his enormous wealth with synthetic indexes, taking a $20 million cut for six months of protection before he could hedge the actual Yahoo shares.
Compare this to John Z. Rigos, who sold his dotcom for $42 million and walked away with $8 million of stock. Between the day of the sale until the day when he could legally sell his shares, the stock tanked, and Mr. Rigos was left with virtually nothing. Mr. Cuban came from a poor Jewish family; Mr. Rigos from a poor Greek family. Same story, two outcomes...
Today Mr. Cuban's net worth is more than $2 billion. I'd say he knows more than "little to nothing" about the market.
He also ran a successful hedge fund if memory serves me. From his writing you could easily get the idea that he is more opinionated than informed, especially since he seems to jump from talking about stocks to bonds and back again as if he didn't know the difference between them. I'm pretty sure it's just because he is such a poor writer though. While I don't ever agree with someone who thinks they can time the market, he certainly is knowledgable.
mark cuban is a smart guy & also a billionaire so i tend to listen to his advice.
the part i don't get is why we should be putting our money in the bank. our government is printing money at a record pace and our money is being devalued by the minute. as much as i hate having my money in the stock market, at least it has some protection against inflation.
Sort of. There's a real tendency to look at these CPI prints and say that inflation is low, but that is only one aspect of inflation.
Aggregate price inflation has been low over the past several years. A big part of that is that energy prices are much lower than they were three years ago (remember $4+ gas?). That is only a very temporary phenomenon (long term supply is constrained, demand is exploding as Asia develops), and in any case energy is only one part of the economy.
But asset inflation is a real problem. That is why the price of gold has tripled in the last half dozen years. If you put money into either stocks or cash 5, 10, 15 years ago, you're way behind where you would be having put the money into a store of wealth that is portable and not subject to inflation.
Gold doesn't do anything, except in some specialized applications.
Suppose you had some completely arbitrary asset. Kneezles. Over the last few years, the price of kneezles have tripled. The kneezle-bugs come out of the woodwork and say, "Look, if you had invested in a store of wealth that is not subject to inflation, you'd be doing better. Your kneezle-denominated wealth has fallen greatly."
Well, what are kneezles anyway? They're lumps of metal that don't do anything. Hey, sounds familiar...
Gold is a store of value. Stores of value provide a useful function in society. Very few things actually qualify as stores of value, and gold is the most known of them so I used that, but you could replace the string 'gold' with 'store of value' in my argument without changing the substance of my argument.
So are dollar bills. In some situations like prisons, so are cigarettes.
Something is a store of value because you expect that other people will value it as highly in the future as they do now. (Or at least some predictable fraction less, accounting for inflation.) Whether it's gold or dollars, it's still based on investor psychology, and is still just as subject to whims of herd behavior. Ask people who bought gold in 1979 how well it stored its value.
"Store of value" is the technically correct term, I suppose, but it's a misleading term because it doesn't actually store any value. The term "store of value" actually refers to currency, except civilization outgrew using cumbersome lumps of shiny metal to conduct its transactions.
> Gold doesn't do anything, except in some specialized applications.
Neither do paper dollars - it's an abstraction that has been historically coveted and accepted as money, and that's why it's valuable. I'd take gold alternative to paper money if someone wanted to pay me in it and had proof of its purity.
I know you're being sarcastic, but I actually saw this coming and invested a fair amount in kneezles. Now I wish I'd just bought kneezle options, since I could have gotten much better leverage.
What the hell do you mean gold doesn't do anything?
Gold is used by several industries. Gold is found in every cellular phone!
The reason gold is used as a metric against currencies is because its scarcity is NOT illusory. USD's scarcity is dictated by the FED. Gold's scarcity is dictated by the earth's limited supply of gold, and the socioeconomics of gold mining.
The inflation/deflation debate is fascinating to follow, and in my eyes currently the most important topic to make a correct call on financially. I'd recommend searching for "Mish" to learn more about the arguments on the deflation side, and "Marc Faber" on the inflation side. Both offer compelling arguments and both are entertaining to read.. My best guess is QE will eventually catch up with the US but it could be a while coming.
that's partly because the fed plays all sorts of tricks to hide the real amount of inflation they are causing. regardless of whether that inflation is visible now, it's inevitably coming. it's the only option we have to deal with that 13.3 trillion debt that we can't afford to pay.
I heard somewhere that Deflation right now is a fact, inflation a belief. One would've lost a lot of money being short long-dated treasuries this year with that belief. If inflation is the answer to this (most likely the case), would you say that it could be hyperinflation versus the milder demand-driven inflation that America is used to?- Specifically, if the Fed devalues the dollar.
* our government is printing money at a record pace and our money is being devalued by the minute. as much as i hate having my money in the stock market, at least it has some protection against inflation.*
Trust me, we're nowhere near inflation risk. The US is still in the middle of deleveraging $trillions in bad housing debt. The deflationary pressures will stick with us for years, if not decades, depending on how much money the government continues to waste trying to prop up a falling housing market.
While I think cash is definitely safer than stocks, you could make pretty good money investing in US treasury bonds or other "safe" investments, if you're worried about getting a better return than 1% or whatever the banks are paying for CDs right now.
if you were the innovator that was smarter and faster than the other guys, you could make money [on the long and / or short side of the market] before the imitators and then the idiots flooded the market. - That seems to be a market universal.
Same shit happens with Blogs, SEO and Internet in general.
It is easy to beat the market and invest well because most of thevworld is operating from a position of ignorance. You don't need secret or insider knowledge, you just need to know what you know, and know what you don't know. Buffett calls his a circle of competence. I studied investing, did ok, studied economics and then discovered that the world is full of ignorant or misinformed people who cling to their misinformation. Example- look at everyone bashing gold.
The conventional wisdom is you need someone to manage your money for you because you can't beat the market, and because that is such a common belief, I find it easy to beater the market.
Gold is a good hedge against financial crisis. Whenever the Dow has a day of selling, you'll usually see people buying lots of commodity ETFs like GLD or IAU.
The thing I like about gold is that it responds well to all types of financial crisis. Inflation risk? Gold goes up. Deflation/deleveraging risk? Gold goes up as well.
A while back Buffett said that he thinks he could average 50% annually if he only had a small sum of capital. Here are some of the things he would likely be doing:
1. Go where the big investors can't
Many large institutional fund managers cannot go below certain market caps. Typically you can find a rich hunting ground of undervalued and ignored companies below $100M.
During the crisis I found it pretty useful to actually screen for negative enterprise value stocks. These were companies where they were trading BELOW the cash they had on their balance sheets. (EV = Market Cap + Debt - Cash). Some of these companies were pretty tiny, $10 to $50M mkt cap, but they worked out well. You have to be willing to deal with illiquidity though.
2. Odd lot tender offers
You can find situations where a company wants to go private and delist. To do that they need to buy out shareholders and get below 300 public shareholders. To do that sometimes they will pay a premium for you to tender shares if you have below 100 shares. Again, this is an area where a small investor can do well but where large institutions are precluded from being active.
3. Look for areas where institutions are forced to sell
Spinoffs are the classic example. Academic research has shown that spinoffs will in general outperform the greater market. Why?
Many index funds are mandated to only hold stocks that are a part of the index. Sometimes an index member will spinoff a smaller unit which cannot make it into the index. The index funds will be forced to sell that company and so its pricing may get below its actual value. That's why spinoffs tend to outperform the market in their 2nd and 3rd year of trading.
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There are plenty of other areas too. These are just a few but it is all pretty well publicized.