beating the market

Is Beating the Market Possible?

 

The Efficient Market Theory was developed by Professor Eugene Fama who asserted that stocks always trade at their fair value, making it impossible for investors to buy stocks at a discount, or to sell them when overpriced. As such, it should be impossible to outperform the market through stock selection or market timing, and that the only way an investor could obtain higher returns was by chance or taking greater risk.

How to beat the market at its own game

However, Warren Buffet challenged this theory when giving a speech at the Columbia Business School, arguing that the super investors of Graham-and-Doddsville can beat the market by a huge margin. Their value-investing approach has been deemed out of date by college professors such as Eugene Fama. Yet Warren Buffett and several investors who took Ben Graham’s course managed to beat index funds by following the value approach.

“So these are nine records of “coin-flippers” from Graham-and-Doddsville. I haven’t selected them with hindsight from among thousands. It’s not like I am reciting to you the names of a bunch of lottery winners — people I had never heard of before they won the lottery. I selected these men years ago based upon their framework for investment decision-making. I knew what they had been taught and additionally I had some personal knowledge of their intellect, character, and temperament. It’s very important to understand that this group has assumed far less risk than average; note their record in years when the general market was weak. While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock. A few of them sometimes buy whole businesses. Far more often they simply buy small pieces of businesses. Their attitude, whether buying all or a tiny piece of a business, is the same. Some of them hold portfolios with dozens of stocks; others concentrate on a handful. But all exploit the difference between the market price of a business and its intrinsic value.” -Warren Buffet

Market increases explained

So there you have it. The efficient market theory recognized no distinction between price and value, while the master of investing, Warren Buffet, asserts there are in fact times when price can fall below its intrinsic value (a sale). That’s what has shaped our view of the market. Rather than assuming that the market is 50/50 regardless of where it has moved, we recognize that brick and mortar equity is in fact being traded. Eventually the market recognizes when a stock is overpriced, in which case it begins to sell back off. At other times, the market will recognize when the stock is selling at a real bargain, at which time the market will begin to buy it back up.

Investing in real estate and stocks

It makes sense doesn’t it? That’s how we invest in real estate too. We buy properties at what Warren Buffet’s teacher, Ben Graham, called a margin of safety. We target properties that are distressed, or where the owner is extremely motivated to sell. We make sure that the purchase price is low enough where we can still lock in a decent profit even after repair costs.

With the Stock Market, it’s the same thing. Deals pop up here and there. We teach our network that not only do individual stocks go on sale. But so does the market as a whole. It’s called a stock market crash, and our strategies rely on responding to the mood swings of the market. That’s why we have historically performed about double standard mutual funds.

Understanding the investment before buying is crucial

If you are a value investor like Warren Buffet, then it makes the most sense to thoroughly understand a prospective investment. That means knowing the industry, the competitive edge of the company, the financial trends, and the management involved. You have to factor this all in, and then have a method for figuring out a VALUE price for the stock. The VALUE price is different than the market price because the market isn’t always efficient. Fear and greed often warp the clarity of investors on a massive scale which causes irrational swings in the market from time to time. That’s what allows Warren Buffet to periodically capitalize on a discounted business.

Since not everyone wishes to go that route, and prefers to be a little more passive in the market while focusing on other ventures, we use tools that allow our colleagues to read the market as a whole. To recognize when the market is statistically overbought, oversold, and most importantly, when Wall Street catches on and starts to move the market.

We are responders, not soothsayers. We don’t need to read minds because we just watch what the big players in Wall Street are doing. It’s that simple.

Still not sure how to get started? We invite you to take a look at our free investment curriculum and tell us what you think.  We’re here to help you with your investment goals.

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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