I’ve read a lot of books on the markets. Most won’t teach you anything you don’t already know. A rare few hold insights you’ll never forget. And some books are so wrong, they unintentionally lead you to an opposite strategy that actually works well.
Among this last group is Burton Malkiel’s A Random Walk Down Wall Street. In it, the Princeton economist describes the stock market as a drunken sailor.
Malkiel asks the reader to picture a sailor on a corner. He wants to cross the street. But he’s drunk, so his steps are unfocused. He might take a step toward the goal. Or he might move backward or sideways. His next move is unpredictable.
In other words, Malkiel argues the stock market’s movements are random. Further, since you can’t forecast the next step, he says you should give up and be a passive investor.
I never bought that argument. Passive investors lose 50% of their money when the market falls 50%. That’s not good. Yet many economists conveniently ignore that reality.
Economists like Malkiel developed a theory to explain why you can’t beat the market. It’s the efficient market hypothesis.
Mike Carr has beaten up the efficient market hypothesis many times in these pages, and for good reason. It posits that nobody can beat the standard market averages and there’s no point trying.
Smart investors know EMH is BS. They understand that beating the market is more than possible. And, as you’ll see, so do the economists who put forward EMH in the first place.
Today, we’ll cover how we beat the market in True Options Masters. But I’ll also shed some light on another investor who’s made a name out of beating the market with his own methods…
This Makes Swiss Cheese Out of EMH
Ironically, Malkiel shared a few “anomalies” to the efficient market hypothesis. These anomalies are things the theory can’t explain. There are so many of them, they basically break the theory in half.
For example, Malkiel pointed out momentum stocks tend to beat the market. These are stocks that have outperformed the market for several months. As Malkiel says, “Stocks do sometimes get on one-way streets.” That’s one anomaly.
But wait, so do value stocks (any stock that’s valued more cheaply than the market averages and grants a high dividend)…
Oh, and so do seasonal strategies (which trade based on historical calendar patterns)… Malkiel rationalizes this one as “Stocks are subject to seasonal moodiness…”
There are plenty more anomalies just like these. So many that, after you cover them all, EMH looks like Swiss cheese.
That doesn’t mean we should throw out EMH entirely. Because those anomalies Malkiel points out are worth exploiting.
We covered two anomalies just this week.
On Monday and Tuesday, we focused on the momentum anomaly. This says stocks that went up in the last few months are likely to keep going up. We know that’s true. We see strong trends lasting months and even years on charts. So, following these stocks is one way to beat the market.
On Wednesday and Thursday, we turned to the value anomaly. This one confirms that a portfolio of undervalued stocks can beat the market. Just like with the momentum anomaly, there are some tricks to successfully exploiting value.
There are many ways to measure value. Let’s take a simple one, the price-to-earnings (P/E) ratio.
A low P/E ratio could indicate a stock is undervalued. But it could also indicate the stock is headed toward zero as the company races toward bankruptcy. Knowing the difference between the two is the trick to success.
One way to profit from value is to buy every undervalued stock in the market. Some will go to zero. But others will be big winners. If you have more wins above 100% than you do complete 100% losses, the winners should offset the losers.
This is how academics prove value beats the market. But it’s not practical. Individual investors can’t buy every one of the hundreds of stocks with a P/E ratio below the S&P 500’s. They don’t have enough money.
There’s another way to profit from value, that doesn’t require a huge amount of capital, but it’s much harder. That’s by analyzing the company. This means reviewing financial statements, the competition, and countless other metrics.
It’s a complex process. It’s difficult to do. The truth is few individuals have the skill or patience to do this.
But some live for this kind of stuff. And more than any other, these are the types of investors that don’t just beat the market, but crush it.
How Charles Mizrahi Crushes the Market
Our colleague Charles Mizrahi, one of the top value investors at Banyan Hill, has the skills to analyze companies.
It’s all he’s done for his three-plus decade career investing in markets.
Back in 2009, he released what he called an “Inevitable Portfolio” six weeks before the market bottomed.
If you’d bought every stock then, you would’ve 5X’d your money by today – beating the S&P 500 during the biggest bull market of all time.
On Wednesday, Charles released his next Inevitable Portfolio. It’s a handful of stocks that he believes will hand investors 1,000% returns over the long haul. And with stock prices down this year, there’s never been a better time to buy them.
Charles likes to talk his book. That’s why he’s putting $1 million to work right now with this approach… and he’s giving new investors a head start to invest before he does.
Get the details here before that happens.
Amber Hestla Senior Analyst, True Options Masters