Value investing skills #1: Informational Edge


The moment you invest in the stockmarket, you sign up to participate in what is known as a ‘zero-sum game’ – in essence, for you to make a gain, somebody else has to suffer a loss.

That simple idea has some profound implications. It means, if you want to outperform the wider market, it is not enough simply to be a nice person or to try your hardest or even to be, as the leader of the Free World might put it, ‘like really smart’.

As all your gains are funded by somebody else’s losses, you are operating in an extraordinarily competitive marketplace and so, if you want to outperform over time, you need an advantage over your competition.

You need an edge.

An edge can come in many different forms or flavours but, at its heart, an edge boils down to the difference between skill and luck.

We would suggest there are four broad categories across which investors can enjoy an edge, if they are prepared to put in the work:

  • Informational
  • Analytical
  • Behavioural
  • Organisational.

The very best investment processes will have a number of each type embedded throughout the strategy.

#1 - Informational edge

Let’s start at the very beginning then – the sourcing of ideas – an area in which today’s investors suffer from an embarrassment of riches.

Thanks to the internet, all that separates you from the sum of all human knowledge is a few keystrokes into your search engine of choice. What that means, of course, is that any informational edge to be enjoyed nowadays relates not to the data you can find but how you use it.

If you were to ask most professional investors how they make use of all the information potentially at their fingertips, they will tell you they will scour The Economist or the Financial Times, say, or they will read the research reports produced by company analysts or they will go to meet the management teams that run the businesses they are thinking of buying into.

The trouble is, if that is what most people are doing, it cannot be an edge.

For any aspect of an investment process to count as an edge, it must have two distinct qualities

  • It should be different to what everyone else is doing and;
  • It needs to work.

Rather than taking the comparatively scattergun approach of seeking investment ideas in the media or in broker reports or wherever, we simply focus our attention on the cheapest stocks in the marketplace – whether that be the FTSE All-Share index in the UK or the appropriate European or global indices – and we believe you will gain a significant edge if you do too.

This is the starting point of a value investment strategy - the art of buying stocks which trade at a significant discount to their intrinsic value. 

And as we often point out, here on The Value Perspective, there is now more than a century of data showing that, if you buy into the cheapest companies in the market, you should outperform (although past performance is not a guide to future performance).

Focus on the cheap stocks

Of course, if it really were that simple, everybody would be doing it – but just look at the sorts of businesses a valuation filter currently identifies as the cheapest 20% of the market.

Banks, mining companies, retailers … yes, we can picture you recoiling from your screen as you read those words.

But that is the point – these are sectors very few are willing to look at these days – and that is why most people do not use a valuation filter.

The fact they do not, however – twinned with the fact a valuation filter works – means, for the few who do use one, it certainly constitutes an investment edge.

 

Next time we'll focus on investment edge #2 - Analytical

To find out more: Schroder Global Recovery Fund

Important Information:
This material has been issued by Schroder Investment Management Australia Limited (ABN 22 000 443 274, AFSL 226473) (Schroders) for information purposes only. It is intended solely for professional investors and financial advisers and is not suitable for distribution to retail clients. The views and opinions contained herein are those of the authors as at the date of publication and are subject to change due to market and other conditions. Such views and opinions may not necessarily represent those expressed or reflected in other Schroders communications, strategies or funds. The information contained is general information only and does not take into account your objectives, financial situation or needs. Schroders does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this material. Except insofar as liability under any statute cannot be excluded, Schroders and its directors, employees, consultants or any company in the Schroders Group do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this material or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this material or any other person. This material is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. You should note that past performance is not a reliable indicator of future performance. Schroders may record and monitor telephone calls for security, training and compliance purposes.