I'd love to begin my first column for Globes by telling you that I'm a great natural investor, that I have an innate sense of how to pick stocks and how to get in and out of the market at precisely the right times. But the fact is that I don't have that kind of natural ability -- and neither do the vast majority of pundits you hear from on television or in newspapers and magazines.
I found this out the hard way. After spending nine years building up a successful computer networking firm, I sold my business to a much larger company in 1993, leaving me with a good deal of cash. I wanted to use the money to secure my family's financial future, so I tried my hand in the stock market. I was, after all, a successful businessman with degrees from MIT and Harvard Business School; surely I could find my way in the market.
Well, in short, I found that the way was littered with obstacles and disappointment. The experience was humbling, but I wasn't about to give up. What I needed to do, I decided, was find people who had been successful in the market, and try to learn how they had done it.
Revelation
As I began to investigate, I found a couple pretty amazing things. First, my research showed that I was far from alone in my lack of success. In fact, 90 percent of active money managers underperform the market in the long term. That's right -- nine out of ten professional investors would be better off putting their money in an index fund like the S&P 500 than trying to pick and choose winning stocks over the long haul.
But I also learned something else that was much more encouraging: Unbeknownst to me (and, I think, to many people), some of the greatest investors of all-time haven't just consistently beaten the market -- they've also publicly disclosed how they did it. And while their approaches may differ, they have one unwavering similarity: Each used his research and experience to develop a long-term strategy, and stuck with that strategy through good times and bad.
For me, this was a tremendous revelation. Some of the greatest financial minds of all-time had essentially left blueprints showing how they had made their fortunes. But because each guru looked at a different set of variables -- and often quite extensive sets of variables -- trying to apply these strategies when assessing a stock was quite time-consuming. To make things easier, I decided to use my computer expertise, and developed computerized models that mimicked the publicly disclosed approaches of eight gurus: Peter Lynch, Benjamin Graham, David Dreman, Martin Zweig, Kenneth Fisher, James O'Shaughnessy, William O'Neil, and the Motley Fool, a web site run by brothers Tom and David Gardner. Later, I added models based on the strategies of Warren Buffett, John Neff, and Joseph Piotroski. (I should note that my Buffett-based strategy is the lone model not based on writings or commentary that come directly from a guru; since Buffett has not publicly disclosed the details of his approach, I instead based the model on a book that his ex-daughter-in-law wrote about his philosophy.)
I had such success with these models that they didn't just form the basis for my personal investing approach; they became the basis for my new career. I created Validea.com, a web site that allows others take advantage of these models, and over the past couple years I have also opened both an investment management business and a hedge fund using these same methodologies.
Core beliefs
Guiding my investing approach today are a few core beliefs that grew from this long and winding road to investing success:
Don't try to reinvent the wheel: As I noted above, some of the greatest investors in history have been kind enough to lay out blueprints showing how they earned their fortunes. Imagine that you were a basketball player and Michael Jordan offered to give you a lesson on how to shoot a free throw, or that you were an aspiring children's author and J.K. Rowling wanted to give you advice on how to write a book. You'd be a fool not to listen to them. So why not take advantage of the guides these stock market gurus have left us?
Take emotion out of the investing process: Whether it's a neighbor or coworker urging you to invest in the next "sure thing", or a seemingly endless supply of television pundits constantly spouting tips on how to beat the market, investing advice is hitting us from all sides these days. It can be easy to get caught up in the hype instead of making decisions based on cold, hard, facts and figures. Over time, however, the most successful investors -- like the gurus on which my models are based -- have developed long-term, quantitative plans and stuck with them through good times and bad (even through times like last week's skid). No strategy is going to beat the market all the time, but if you stick to a proven strategy, you're likely to win more often than you lose.
You don't have to hold stocks for the long term to be a long-term investor: This is a critical distinction, one that many investors fail to make. Don't confuse the need to stick with a long-term strategy with the need to hold individual stocks for the long term. If you pick a strategy that focuses in part on companies with low debt, for example, and one of your holdings suddenly goes into billions of dollars of debt, you certainly shouldn't feel obliged to hold onto it. Turning philosophy into results
The main way I've put these core beliefs into action is through my model "Guru Portfolios". For each of my guru-based strategies, I monitor a portfolio of stocks that score highest using that strategy. There's no handpicking stocks based on hunches; the stock's fundamentals are the only things that matter.
I rebalance these portfolios every 28 days so that the stocks in each portfolio consistently meet the requirements of each portfolio's underlying strategy. The 28-day period was chosen after performing extensive research that found a 28-day model yielded the best results. I stick to this rebalancing plan no matter what.
Now, philosophy is great, but let's be honest: What investors worry about is the bottom line.
Well, Validea has a pretty good bottom line. I began tracking our eight original Guru-Based Portfolios more than four years ago. Since then, all eight have outperformed the S&P 500 index; in fact, five have more than tripled the S&P's growth, and two others have more than doubled it. The best performer as of the time of this writing was the "Contrarian Investor" portfolio that is based on the writings of David Dreman, which had returned 183.1 percent since July 15, 2003 (compared to 46.8 percent for the S&P 500). Not far behind is the "Value Investor" strategy I base on the writings of Benjamin Graham, which had gained 178 percent in its four-plus years.
In my future columns, I'll explain how these and the rest of my guru-based models work, examining the array of variables that each guru considers important (factors such as debt/equity ratios and price/earnings/growth ratios, for example). I'll look at how the different gurus' strategies are similar and how they differ, and why each uses his particular set of criteria. In addition, in each column I'll show you how I use my models to analyze stocks or industries of interest at the time.
In recent weeks, increased volatility in the market has worried some investors, and I think that makes the discussion of these guru-based models particularly relevant. By examining the strategies that some of Wall Street's greatest investors have used successfully through a variety of market conditions -- good and bad, calm and volatile -- we'll see what types of approaches really succeed in outpacing the market. During last week's volatility, for example, the S&P 500 dropped 1.5 percent, but my O'Neil-based strategy actually gained 0.3 percent. My Lynch-based strategy remained even, and a blended strategy that uses my top five models was also in the black.
By focusing on strategies with strong long-term track records through good times and bad, I'll give you the tools you'll need to sift through the vast amount of stock data and focus on the variables that are true keys to long-term success, I hope that you'll then be able to use these time-tested, proven techniques with the same kind of success I've enjoyed.
Published by Globes [online], Israel business news - www.globes.co.il - on August 9, 2007