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
In short, 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:
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 touble 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 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
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