Many individuals new to the stock market are lured by the infomercials and investing books that favor jumping in and out of the market. They believe that successful investors are constantly buying stocks just before they sky-rocket, and then jumping out just before they come crashing do to earth. Sadly for the adrenaline junkies out there. successful investing is a boring, slow process that involves a lot of buying and holding for long periods. To beat the market, you need to invest for the long-term, because as explained in past posts, all news is already priced into stocks in the short-term, so trying to time the market is just gambling. It is a coin toss where you need to pay a fee each time you toss the coin. Because of the risk premium, however, there are great returns to be had for those who are patient and pick the right kinds of stocks.
This post is a continuation of a thread on making market beating returns. The original post of this thread provides the theme for this series, A Strategy for Market Beating Returns, for any who missed it:
In that post a series of principles were proposed which form the basis for the strategy presented. These are:
1.Some companies will grow faster than the general market because of more rapid earnings growth.
2. Some of these companies have earnings growth that is reasonably predictable for the next several years.
3. The current pricing for these companies, while it will be higher than its peers, will still be low enough so as to provide a market-beating return should it meet or exceed earnings expectations (because of the risk premium).
4. The rate of return on stocks that do succeed will be great enough to offset those that do not perform.
5. Long-term investing will be possible, limiting taxes and brokerage commissions.
Principles 1-4 were covered in earlier posts in this series. The final principle is often ignored, but very important. The reason that most mutual fund managers do not beat the market is that they basically need to buy a portfolio that will track the market, and then various fees and expenses are charged on top of their returns. It is predicted that day traders would need to make returns greater than 70% to make up for the fees and taxes, even if they fees were only a few dollars a trade. Wealth grows at the most rapid pace if fees and taxes are minimized, because this leaves the most money for compounding.
Good investors therefore pick stocks that they expect to grow for several years. Good companies that have shown consistent growth and have good prospects for the future. A serious investor will not trade unless it is absolutely necessary. He or she would be happy holding the same stocks for thirty years or more if possible.
Interestingly enough, it is easier to spot stocks that are likely to grow over the long-term than those that will be up next week or next month. This is because the market price of a stock will eventually follow its intrinsic value, which is based on earnings. As long as earnings can be approximately predicted, at least enough to spot stocks that are likely to have continued earnings growth, stock that are likely to outperform the market can be found.
With the next post I’ll begin describing the investment strategy using an example, hypothetical investor.
See the whole series: https://smallivy.wordpress.com/category/making-market-beating-returns/
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.