3 Components Needed for Beating the Market

Time to look back

2004 is over, now we are in 2005. This is time to seriously

look at performance of your personal investment, such as

mutual fund, or individual stocks holdings, etc. Does your

fund beat index last year? Does it beat index over past many

years? How are you doing with your own stock investment

comparing to SP&500 index?

If the answer is “great”, well congratulations. You have

your own way of beating market and making big money already.

If the answer is “not so great”, or “failed to beat index”.

You have got a problem. You need to look deeper into the

investment strategy you used or your fund used. You can not

pretend that there is no problem when in fact there IS a

problem. I know there are just so many people out there that

can not face this. Let’s face it, Almost everyone, include

myself have ego that we JUST do not want to admit failure or

mistake or any hint of it. Here comes the 1st Component

below.

Component # 1 – ego, gut, perseverance

Value investing or investing in general is all about

psychology, ego, attitude, and gut.

Investing is serious business. It is our money, our life

savings at stake. Sometimes biting the bullet with pain to

trash the ego is worth the pain if that makes you more

money. Ego is one thing that we must avoid in stock market

investing business in order to make big money ahead. You can

not hide, you have to compare your own performance of past

many years to SP&500 index. Of course, I am not saying that

you should be comparing every month. It is OK to make some

mistakes, here and there for certain months. However, it is

NOT OK if the performance year over year has been bad. You

have got to change if that is the case.

Although ego is something you should all avoid, perseverance

is something you must treasure if you want to be that

marathon winner. When you finished your due diligence and

you have calculated your risk reward ratio and intrinsic

value, go for it and stick with it. Do not be scared of

negative comments or negative press, even if the source is

from a famous author or from your close family. Value

investing is lonely business. I know this for years. I have

been criticized over past many years for numerous reasons,

for not beeing able to sell at top, for not beeing able to

buy at bottom, for picking a risky bankruptcy related stock,

or for buying a low float small cap stock , blah blah. You

know what? in the end, my investment performance is better

than most of folks out there in the market, including those

“pro” mutual fund managers.

I have got comments like this before: “Blast, I like your

method, I know you are making big money. But, I can not do

as you are doing. I can not hold. Especially bad news hit, I

just have to sell, and my performance sucks”.

Well, if he/she do not have gut to hold like I hold during

bad time, she/he can not make big money with value

investing. One can be all right in paper, right with value

calculation, right with timing of purchase. However, if you

can not fight against panic during minor negative news, you

are out in the investing marathon.

Component # 2 – right method

Many investment methods are flawed, period. This is

especially true for many short term oriented trading

methods. Many mutual funds preach long term holding for

their fund investors, but the fund managers themself engage

in short-term trading like mad men. Performance of many

momentum based growth funds or tech funds looked horrible

for past 5 years. The reason for that is very simple: the

investing method itself. Growth investing or short term

trading sometimes can be very speculative and dangerous.

Wall street has famous theory that “the more risk, the more

reward”. Therefore, yeah, growth funds are risky, but if you

want to have more reward, you have to chase risky stuff.

Wrong. The truth actually is “the more risk, the less

reward”.

I know I am going to be hammered by saying above

non-conventional statement. I put out below example to back

up my point.

Las Vegas is world famous place for gambling. As an average

investor, you visit Las Vegas looking for opportunities to

make big money with $50,000 investing capital. Let’s assume

the theory “the more risk, the more reward” is correct.

Where are the riskiest opportunities out there in LV? Of

course, Gambling. The potential reward can be astonishingly

high. Black jacket, slot machine all have huge potential

with 1000% or even more within minutes. You can make

millions if you are lucky with your $50,000 principal at

slot machine. Actually, it is FACT there are small group of

gamblers who made millions in gambling in LV.

However, If you are sensible person, you know the answer. As

high as the potential reward can be, the most likely result

from gambling with $50,000 principal at LV is WIPEOUT. You

lose all your hard-earned money.

If you are a rich investor with multi-million dollar capital

looking for investment opportunities in Las Vegas. Certainly

casino company stocks and bonds or private offering might be

worth looking. However, the sad news is that no matter for

stocks or bonds or private offerings, the investment reward

is only around 10% to 20% yearly. Well, maybe it is not so

sad at all. 10% or 20% of return is certainly a lot safer

than gambling. Which reward is better, 10% – 20% return or

wipeout?

Well, I know you may want to protest against my above

example. Stock market can not be as bad as Casino, right?

It depends. Although casino gambling does not provide real

investment opportunities as stock market provides, sometimes

stock market can be even worse than casino due to insider

manipulation, cheating books, etc. Over the past couple of

years, I have heard so many negative news from stock market:

Enron, Worldcom, mutual fund scandals, market timing, etc.

But I have not heard of news of slot machine cheating by Las

Vegas Casino company. Casino does not need to cheat to make

money, the odds are against gamblers. Although stock market

does offer real investment opportunities for

businessman-like investors, stock market is also a place for

gamblers to place their bet just like a Casino.

In stock market, the odds are against speculators.

Well, I know you may have more questions. Why Casino bonds

or stock offerings or even private offering is only offering

10% to 20% returns?

Casino business is just another business. Numerous academic

study has shown that in US history of past many decades,

majority of companies can not maintain more than 20% of

return on equity over the long run. Many companies are

operating under loss, a negative return on equity. If you

read books on Warren Buffet method of Philip Fisher method,

you will know that they are experts in identifying those

small group of high return on equity stocks. But for most

companies, they are not as good as the stocks in which

Buffet or Fisher invested.

Competitive economics is also at play here. If a company can

make more than 20% of return consistently, the competition

will heat up and more smart businessmen will enter this

field to drive down the return.

If you think of value investing as special kind of business,

you will realize how hard it is to maintain 20% return for

the long run, as Warren Buffet achieved over past 50 years.

Very few investors can do that. Value investing business is

just as competitive as other business. Let’s face it, if

value investing is not competitive and easy to make big

money consistently, many smart business guys out there in US

will liquidate their own company and start their investment

firm instead.

Component # 3 – right tools – new way to find great picks

Peter Lynch mentioned many methods to get the stock leads

and identify the big winners in his book “One up in Wall

Street”. Tips from wife, tips from friends can land you the

great stock idea. Although his methods are very valid, there

are new ways to find that great pick in this internet stage:

Software Data Mining.

It is quite fortunate that I am a data mining expert myself.

If you are good at data mining, you can do yourself well

too. You can design and fine-tune your data mining tools to

get the leads you want and make big money by getting ahead

of crowds.

A successful value investor really has to find great pick

ahead of big guys and move fast in order to make big money.

In this internet stage, big guys such as mutual funds or

hedge funds really have no advantage over small guys or

small firms such as BlastInvest. At BlastInvest, we do stock

data mining with our in-house software just as good as those

big guys, if not better. Sarbane Oxley new law also helped

individual investors and small firms like BlastInvest a lot

because most of public companies now disclose information to

public and to big institutions simultaneously through

conference calls or press releases. Insiders now also have

to report insider buying and selling within couple of days

of transaction instead of several months before. Whenever

insiders buy or sell, You need to know that immediately

within a few days. You want to buy when insiders buy and you

may want to sell when insiders are selling too.

Don’t despair if you do not know how to program software

yourself. There are lots of tools and services out there to

help you out. Here I want to talk about the most useful

tools out there.

(1) Valuation screening tool. You need at least one tool for

screening against value metrics for you. Yahoo stock

screening is very useful tool and it is free.

(2) Insider buying tool. This is must-have tool to get you

the latest insider buying stocks. There are many offering

there, fee-based or free. We offer free insider-buying

weekly service as well at BlastInvest.

(3) Strategy screen. Validea.com offers an interesting stock

screening tool that can screen based on methods of Ben

Graham, Warren Buffet, or Peter Lynch. It has limitations

too. I have used it and found that its Warren Buffet tool is

not working well and its Ben Graham strategy screening is

only looking for “defensive” type of stocks, not the

“enterprising investor” type of stocks. My BIRTP newsletter

is really geared toward “enterprising investor” type of

stocks rather than “defensive investor” type of stocks.

Heck, still Validea is best kind of tool available at

affordable price in this category.

Final thought

If you follow up with my above 3 components

of value investing, you are on your path for financial

freedom.

However, if you can not do as I stated above, do not naively

believe that you can make big money alone in stock market

mainly by hunch. Buy the stock screening tools if necessary,

get the professional help from real experts and consider my

newsletter BIRTP as well.



Source by Henry Lu

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