Active investing can be hard. While it’s difficult to beat the indexed averages over the long haul, it’s not impossible. I believe this is more true as an individual investor, than a professional. Let me explain in more detail. An individual investor doesn’t have to worry about annual performance results, if your job is on the line, or or if you are you beating your peers. In addition, actively managed funds have the issue of redemptions, taxes, expenses, shear size and size of companies they can legally invest in that all drag down their performance. In many aspects they simply mirror an index they are trying to beat. As an individual investor you are much smaller and nimble and can follow your own game plan. Picking individual stocks can be hard, but it’s not impossible if you are a great shopper.
Why Active Investing?
Let me first state our portfolio isn’t mostly active stock picking. It is actually quite the opposite. My family has most (over 80%) of our investments in passive indexed based funds. It’s actually quite boring. Our asset allocation will always remain that way. I’ll only adjust asset allocation percentages as we increase in age, or I feel a need to stabilize future returns based upon new research data I’ve read.
I’ve designed our asset allocation in case we cannot beat the averages. Our active investments will not dramatically hurt returns. Yet it is also possible to get some alpha by actively picking stocks. A completely passive portfolio does not have this option. Like what we saw for the past ten years where the S&P 500 was flat, so would your portfolio.
Another way to look at our investment strategy is I’m hedging my bets between passive investing and active investing – favoring the belief of passive investing works better.
Quite honestly, the other aspect of stock picking is it’s an active hobby for me, and one of the primary reasons I created this investing blog. It gives me something to do than with a completely passive stock portfolio. To me a passive portfolio is like watching the grass grow. My investment strategy does introduce some increased risk with our portfolio, but with the potential for a higher rate of return. As long as you know and understand this, you should be ok for some part of your portfolio for active investing. The only way to increase your wealth is by increasing risk, though not by betting the farm.
Learn to Become a Better Investor by Shopping
I say to become a better investor, you should first learn how to be a better shopper. I mean this quite literally. When shopping for consumer goods or at the supermarket, would you overpay for something knowing you could get it somewhere else cheaper? I actually find it pretty amazing that people will trample over each other to save a few dollars during Black Friday, yet run away in fear when stocks tank. Mark Cuban stated right now middle class individuals should focus on saving money when shopping rather than the low returns they are getting in the market. I somewhat agree with this statement, but I feel now’s the time to also become an expert shopper in the stock market.
Learn what’s a good price for the products you buy on a weekly basis. Learn when something is a good deal, or when it isn’t. If you believe in value investing, then you should understand when a stock is a great price, and when it’s expensive. Using Warren Buffett’s analogy to baseball, only take swings at stocks you like. For the individual investor, unlike the professional, there is no pressure to buy a stock.
As a kid I always loved watching the game show Price Is Right, especially the game Cliff Hangers. How many times have you watched the show, and a contestant doesn’t understand how to play the game? While this is happening you are yelling at the TV? I know I have on a number of occasions, be it in the game Beat the Clock, or when on contestants row not outbidding the others by a dollar? Many people don’t study how to be good shoppers of consumer goods, so it doesn’t surprise me that most aren’t good at investing.
What’s the Two Factors for Value Investing?
In my mind, value investing really comes down to understanding only two aspects. When investing in a stock I ask these two questions:
- Is the stock cheaply priced?
- What’s the prospect of future growth for the company in the next five to ten years?
Everything else is secondary. While there are many quantitative data to help determine the answers to these questions, it all boils down to these two questions. If you only have one of these factors when stock picking, you might do ok, but having both is critical for good long term investing success. Is the stock a good value?
The important aspect when buying a product is are you getting the best value for your money. Notice I didn’t say the cheapest price. This philosophy also applies to investing. Would you buy a stock that’s priced expensively because everyone else is rushing into that stock? Technical traders do, but I think it’s silly way to look at the stock market by a rearview mirror. Would you buy a stock that has no growth prospects yet is cheap? For me, the answer is a resounding no on both counts.
For example, Microsoft’s (MSFT) stock price (not including dividends) has basically gone nowhere in the past ten years. Some value investors say Microsoft is a great deal and should be picked up. I agree it’s priced cheaply. In my opinion the prospects for future growth are weak at best unless there is some massive leadership changes. I believe Microsoft has a leadership issue and has it’s hands in too many low/no profit buckets. Microsoft has lost its way, and has missed many technology paradigm changes. Unless those factors change, I will not invest in Microsoft.
On the other hand, Apple’s (AAPL) stock has recently been valued cheap. But its growth prospects are much greater than Microsoft. This is even including the many headwinds it will experience in the next five – ten years:
- The passing of Steve Jobs. Will the current CEO or future CEOs be as iconic and a strong leader to help push innovation?
- Will Google’s (GOOG) Android operating system become the Microsoft Windows of smart phones killing into Apple’s profit margin?
- Can Apple keep it’s large profit margins?
- Will Apple continue to grow (though definitely slower)?
- Has Apple tapped out it’s growth with existing products?
- Will Apple continue to innovate with new products and in new categories?
I believe all of these factors are still positive for the company. I’ll continue to keep my Apple shares. For me, I will only sell Apple when these factors become a major detriment for the company.
So when it comes to value investing, know when a stock is a good deal and its future prospects for growth.
Disclosure: I own shares of AAPL.