Chapter 13: Achieve Stock Market Alpha
Book Serialization | Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises
Welcome to Chapter 13 of the serialization of my next book, Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises.
I am writing the book on Substack Finance as part of the QVI Newsletter and look forward to subscribers’ support and feedback as we produce the manuscript in real-time.
Chapter 13 explores how quality-driven value investors aim to outperform the market by embracing investment practices that create alpha over time.
Chapter 13
Achieve Stock Market Alpha
Investing is that rare practice where you can sit on your butt and still succeed.
Most investors, whether professional or retail, underperform the market. As a result, they are perpetually craving new but speculative investing methodologies and stock-picking ideas for a straightforward reason — their chosen approaches to portfolio management are not producing alpha.
So, how do we counter this trend?
Explore and embrace proven, albeit largely unpopular, investment practices that create alpha instead of challenging it. An applied discipline such as stock market investing can be impactful by embracing winning attributes while spurning unsuccessful methods and discovering how to pick the winning stocks of enduring enterprises.
The Objective is to Get Rich Slowly
Quality-driven investors don’t give up on the underperforming stocks of excellent companies held fewer than three or four years as they envision the potential for a sizable market outperformance after five or more years of compounding.
They never bet on investment tips or perceived opportunities for quick, wishful gains. Unlike stock market speculators, quality-driven investors aren’t attracted to know-it-all gurus and are never magnets for get-rich-quick trading schemes. All the while, they welcome the relevant counter-opinions of others.
In contrast to top-down growth or momentum investors, strict bottom-up, buy-and-hold value investors disfavor price targets, price alerts, technical charts, deep-dive analysis paralysis, macroeconomic influences, industry trends, market-timing, short-selling, options trading, forward high-yield dividends, and trade set-ups.
Profitable investors embrace relevant data, exercise self-control, and apply rational thought to portfolio construction and maintenance while ignoring complicated or expensive investment vehicles or trading schemes in the hopes of fast money. They leave those speculative ventures to professional traders and market gamblers.
Alpha-achieving investors take advantage of the recent trend toward commission-free online brokerages. They never trade on margin or too often, avoiding unnecessary debt, trading fees, and tax burdens by keeping personal investing a low-cost experience.
Between bubbles, irrational investor sentiment from the daily news cycle and quarterly earnings releases provoke gyrations within the US domestic stock market. The volatility keeps portfolio holdings on a roller coaster ride in the short term. However, as irrational speculators panic and sell, alpha-seeking investors scoop up the ensuing opportunities and wait for the compounding return of capital gains and dividend income in their portfolios over time.
There are investors, and there are speculators. Each seeks to profit, the former in the long term and the latter in the short term. Nearsighted predictions are more or less crapshoots — yet Wall Street makes a living off of them in a paradox of epic proportions.
On the contrary, quality-driven value investors remember that trading stocks is a short game while investing in companies is a long game.
Treat the Wall Street Consensus as Senseless
The primary strategy of quality-driven value investors is protecting invested capital from permanent loss.
Alpha-achievers invest with rational thought, discipline, and patience, often realizing that as much as two-thirds of their value stock picks of enterprises with high-quality business models will outperform the market over time.
They equal-weight their portfolio to eliminate bias and unreliable predictive analysis.
Informed investors skeptically interpret the Wall Street consensus of definitive buy or sell signals. During celebrated quarterly earnings seasons, after a company comes up short on analyst consensus estimates of revenue or earnings, they ask, “Who missed — the senior management of the enterprise or the Wall Street analysts?”
In contrast, countless investors sell at a loss based on a report or event by placing emotion before intellect.
Patient retail investors place less weight on the forward consensus. They treat the practice as speculative, akin to trying to see through a foggy windshield. Nevertheless, most professional and retail investors underperform the market over time. Each buys or sells based on presumptions of what will happen via price targets, earnings estimates, sales volume, potential mergers and acquisitions, or market corrections. Yet, despite conveying confidence, do forecasters honestly know what will happen to a market, company, or stock price at any specific future point?
Perhaps it’s human nature, but financial readers seek entertainment value as much as factual information. Yet the investment thesis is often before us, negating the need to take a risky trip down some murky road of seemingly well-crafted predictive analysis. That is why alpha-achievers invest based on objective facts instead of subjective forecasts.
Wall Street is notorious for demanding steady, quarter-to-quarter growth in sales and profits from covered companies, with the market pounding any stock that misses management guidance or analysts’ forecasts. Day traders and momentum investors who cast votes daily serve the market instead of allowing it to serve them. Yet another trivial way investors manage portfolios with impatience or ignorance.
By sidestepping the crowd, quality-driven value investors weigh stocks for the long term instead of voting for them in the short term and paying an unnecessary premium.
In any upmarket cycle, those who compromise and join the herd in scooping up overpriced growth stocks, poor-quality value traps, or tempting fads because of the fear of missing out—FOMO—regret their purchases when the market retreats.
That is why investing is more profitable when practiced based on the fear of losing money—FOLM—or avoiding the permanent loss of invested capital instead of missing out.
Resist the Financial Industry’s Fee Magnets
Be skeptical of deep-dive predictive analysis and business modeling overkill.
When using an investment advisor or subscribing to an investment service, quality-driven investors ask what is producing the better run rate for the portfolio manager or author: The advisory and subscription fees or the returns on the investment picks?
As reported widely in the financial media, a minority of Wall Street traders and money managers beat the market consistently, whether the S&P 500 Index or any asset class the particular investment product benchmarks.
Collecting fees and commissions and leveraging assets under management finance the annual profit and bonus windfalls on Wall Street more than its investment returns. Assuming that most professional portfolio managers underperform the market, why does the collective of individual and institutional investors continue to pour trillions of dollars into the advisory fee-sucking coffers?
Perhaps it is all they know. Unfortunately, the Wall Street way induces customers to adopt its mode of thinking via slick advertising campaigns, press release regurgitation from mainstream print and online media, and the proverbial talking heads on financial television shows.
The purveyors of the Wall Street fee machine need lucrative incentives to build beach houses or drive sports cars to supplement the minimal fees and commissions generated from the portfolios of clients who are long-tailed, quality-driven value investors.
So, the fee machine promotes and advocates bonus-generating advisory or subscription-based investment fee models. Thus, institutional investors engage in options, short-selling, arbitrage, technical analysis, momentum investing, trend following, forward high-yield dividends, and other speculative, rampant turnover-driven trading platforms designed to underwrite pleasure drives to weekend retreats. But who’s driving the Maserati to the Hamptons, the retail investor or the professional money manager?
There are no extra points for complex or deep-dive research other than bonus-generating fees produced by Wall Street professionals’ dutiful exercise in intellectual prowess. However, unknowing investors on Main Street rarely ask, “What about portfolio performance from the investment thesis?”
If the complicated sell-side and buy-side research produced consistent market-beating outcomes, wouldn’t we become wealthy by merely following the published investment calls?
Based on the historical results, the answer is more no than yes. The Wall Street machine has convinced the masses that sophisticated approaches to research are the best paths to making money from investing. As it turns out, the fees collected as a derivative of the analysis generate a significant share of the profits by portfolio advisors and content providers.
When listening to or reading quarterly earnings conference calls, fast-money-thirsty investors embrace the numbers-crunching and forecasts from the crystal ball-wielding prognosticators. In addition, they welcome bold pre- and post-call predictions in simultaneous releases, including what the management team guides in the customary act of gaming analysts’ estimates.
Unfortunately, being pulled by the financial services industry’s fee magnet often leads to retail investor underperformance.
Remember the adage that taking advice from even well-intentioned salespersons is as biased as it gets. And the financial services industry is predominated by professional salespeople. So alpha-seeking investors circumvent the bias and do their research and due diligence, or at least get a second opinion before diving into the abyss.
By researching a company’s current wealth and a stock price’s present value, quality-driven investors know that facts usually prevail, while predictions mostly fail.
Beware of Confirmation Bias
Investment forums often broach the subject of confirmation bias. For example, how many investors are satisfied, or worse, feel good because a book, article, or podcast confirms their thesis on a stock, industry, or market, regardless of the quality of the content?
The bias occurs more often than we want to believe or admit. For better or worse, we live in a quantity-driven, confirmation-biased society fed by political ideology, news commentary, entertainment, career success, and personal finance. As a result, the demand is for content that confirms our beliefs and values, or we turn our attention elsewhere.
In today’s media universe, whether video, audio, or written, the targeted eyes and ears dictate the quality, perhaps having more influence than the well-intentioned content producers.
Don’t Speculate in Microcaps and OTCs
Is the company profitable? If not, why own stock in it?
Alpha-achieving investors buy the mispriced liquid shares of publicly traded enterprises with profitable, high-quality business models from cognitive due diligence and then hold for long-term compounding of capital and income with disciplined patience.
Microcaps represent over 70 percent of publicly traded companies on US exchanges, including major and over-the-counter—OTC—issues. Illiquid microcaps tend to be lower than $1 billion in market capitalization.
OTC shares, by definition, are traded via broker/dealer networks instead of centralized exchanges. As a result, investing in OTC issues—predominated by foreign-based enterprises—is speculative. Passing on the unnecessary risk forces investors to miss an international staple. However, an OTC listing represents the underlying security more than the business operation.
Many unknowing investors lose principal when these speculative stocks, unsupported by sound fundamentals or attractive valuations, take steep price drops. In lock-step with the enthusiastic casino gambler, retail investors who chase fast money brag when winning.
Remember, for the best chance of achieving alpha from quality-driven value investing, stick with the liquid major-exchange traded large-, mid-, and small-cap stocks and ETFs.
Spurn Instant Gratification to Achieve Alpha
Filter the noise on Wall Street and the stock market newsreel and stick with the facts based on the company’s current wealth and the stock price’s present value.
Despite a market history of underachieving performance, most investors seek short-term bursts of growth-driven capital gains and forward high-yield dividend income.
They want instant gratification from the implied assurances of promoted trading platforms that, based on historical results, more often underperform the market. Such incongruity reminds us that on Wall Street—and Main Street—the crowd is almost always wrong, or average at best, across market cycles.
Powered by MBAs using sophisticated software, Wall Street disseminates complex, assumptive financial models of precision earnings estimates and price targets each market day. However, many of those projections are no more intuitive than a Magic 8-Ball, or else the financial services elite is accumulating wealth from portfolio performance as much as from fees and bonuses.
Like clockwork, the herd investor asks, “At what specific price will the stock be trading next week, next year, and in 2034?”
The truthful answer is, “I don’t know.” They should know that alpha-achieving stock market investing ultimately requires a lifetime, not a single bull market. Nonetheless, deep-dive research and predictive analysis are overrated. If superior at predicting future stock prices, why aren’t all investors wealthy from following the stock picks of buyside fund managers and the price targets of sellside analysts, a vast majority being purveyors of the deep-dive, predictive approach?
Forecasting market directions consistently or within specific dates and time frames is impossible. Just ask the short-sellers who left their shorts down for the bull market decade of 2010 to 2019. Successful forecasts of particular market downturns occur randomly from the pundits’ few lucky calls. Each forecaster is then placed on a pedestal by the Wall Street media and guru-of-the-month trading clubs. Nevertheless, corrections occur at unknown points in time, and thus, anyone who predicts a market drop or pop, in general, gets to be correct eventually.
Wall Street lives and dies by its quarterly earnings releases and the fanfare preceding and following each report. However, forecasting future stock prices, market movements, revenue growth, or earnings per share with consistent accuracy is arbitrary, even from senior company management.
Most investors attempt to predict in detail what will happen with the stock market or any particular publicly traded enterprise instead of screening, researching, and monitoring high-quality businesses for mispriced value. Sometimes, it seems that what the crowd seeks is what they should avoid. Nevertheless, the disproportionate influence of the Wall Street fee-generating propaganda machine is undeniable.
At their portfolio’s peril, investors underperform from the lack of courage and conviction to sift the noise of Wall Street.
Common sense dictates that a slew of short-term momentum trades are required to make the same potential profits from just a few long-term investments in the publicly traded shares of quality companies purchased at reasonable prices.
Savvy investors bought the winning holdings at value prices because the traders sold them off during a negative trend. So when you read, “XYZ is trading at a 42 percent discount to intrinsic value,” remember how Wall Street justifies enormous fees and bonuses with predictions unnecessary in the scheme of things. If these market pundits were more often right than wrong, we’d become wealthy by following them.
Become a reformed and informed investor from lessons learned. Slow and steady investors know that stable companies appreciate in the long run, as the active trader moving in and out of positions in reaction to good and bad news gets punished in the short run. So, we can follow populist stock trends to our portfolio’s potential peril or invest in great companies over a long-term horizon and benefit from total return compounding with wide safety margins.
Rational, disciplined, and patient investors chase the enduring market truth of achieving a lifetime of alpha by accumulating the common shares of high-quality companies when trading at reasonable prices.
Copyright 2024 by David J. Waldron. All rights reserved worldwide.
About the Writer
David J. Waldron is the contributing editor of Quality Value Investing, and author of the international-selling book Build Wealth with Common Stocks: Market-Beating Strategies for the Individual Investor. David’s mission is to inspire the achievement of his readers’ financial goals and dreams. His work has been featured on Seeking Alpha, MSN Money, TalkMarkets, ValueWalk, Yahoo Finance, QAV—Australia’s #1 Value Investing Podcast, Money Life with Chuck Jaffe, LifeBlood with George Grombacher, The Acquirer’s Multiple, Capital Employed, Amazon, Barnes & Noble, Apple Books, the BookLife Prize, and Publisher’s Weekly. David previously enjoyed a 25-year career as a postsecondary education executive. He received a Bachelor of Science in business studies as a Garden State Scholar at Stockton University and completed The Practice of Management Program at Brown University.
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