There are numerous studies that have shown that most equity investment managers fail to outperform the stock index over the long term. What this suggests is that most investors are actually better off buying an Exchange Traded Fund (ETF) tracking the index and let the magic happen by itself.
Why bother picking stocks when there’s a better and stress-free alternative?
There is always an upward bias by glorifying the outperformers by Wall Street. If there isn’t any allure in making your own trades, there are no fees for the industry to be made. Having the full picture hidden from the public’s eyes, many simply jump into the stock market in search of the ticket to their dream house.
Amongst the sea of investment firms, there is only a handful who have done consistently a whole lot better than the average. In this article, we will share with you the tried and tested approach Tweedy, Browne Co LLC took and the reasons why it works.
What makes Tweedy, Browne so special?
Performance, of course! To have a peek at how well they have been doing, take a look at the following quote by the managing directors.
“…add extra return above the S&P 500 Index for its clients over the last 22 years, and with some consistency. Tweedy, Browne’s equity-only returns, after all advisory fees and transaction costs, have beaten the S&P 500 in 70% of the rolling 10-year periods, 67% of the rolling 5-year periods, 75% of the rolling 3-year periods and 73% of the 1-year periods…”
“Each $1 million invested in Tweedy, Browne’s stocks increased to $70.6 million over the 22-year period. By comparison, each $1 million invested in the S&P 500 increased to $25.9 million over the same period.”
Remarkable, isn’t it? Especially when most fail to even beat the index for the year, here is an outstanding company that has completely towered over the indices year after year.
You’d have guessed it! Tweedy, Browne religiously follows a deep value investing approach. Only through this way, can they readily pounce on any potential investment opportunities.
10 ways to beat an index (Part 1)
Invest in stocks with the kinds of extreme investment characteristics that have produced market-beating returns in the past
Stocks with price/earnings and price/book lower than 80-90% of all stocks have, on average, outperformed the indices for long periods of time. There are numerous studies by quantitative researchers. If you are interested in finding out more, you can refer to the finance journals that have produced such findings.
However, while picking stocks, it shouldn’t be a reflex action where you see low P/E and you invest. You need to consider whether the earnings and asset value reported are representative of the performance of the company.
The other characteristic would be that companies they invest in have high insider buying and company share repurchases activities. These are associated with above-market returns in the past.
What this suggests is that the management’s interests are aligned with the shareholders’ interest, suggesting that it is more likely that they are motivated to run the company.
Coverage of market capitalization including small-cap companies
Very often, I hear people who claim that they are being very safe and “risk-free” by investing in large-cap blue chips stocks. They are adamant about how indestructible these companies are and that if they ever run into trouble, the government will bail them out, unlike small-cap companies.
This is a very poor definition of risk that is solely based on impression and external influences.
Risk, as mentioned in this article, should be viewed as the risk of permanent loss of capital rather than anything else and by employing the value investing approach to look out for net net stocks, you are having a buffer for errors.
In no way does the above definition state that size and risk are related.
Out of 10,000 U.S. companies, 9,000 have market caps below $1 billion. By excluding small-cap stocks, you are ignoring plenty of opportunities from 90% of the companies.
Small investors have a huge advantage over large fund managers. By keeping a relatively small quantity of assets under management, you have an ability to invest a huge proportion of your assets into small-cap stocks. Returns are not limited by having too many assets to employ.
The following table by Tweedy, Browne illustrates this point clearly.
Statistics and specifics
By researching individual companies one at a time, Tweedy, Browne is able to understand more about the unique characteristics each company has. This special unique insight allows them to improve their expertise in the industry and increase the reliability and certainty of their valuation estimates.
No index mimicking
Are you out to “beat” the market or are you more interested in growing your capital over time?
If your concern is to be better than the rest by focusing on short-term metrics then value investing may not be suitable for you. Great value investors have to be accustomed to long periods of underperformance before their investments pay off.
Although Tweedy, Browne has outperformed the stock market by a huge margin since it was incepted, the benchmark has never been the market indices. They focus on selecting stocks that are likely to generate above-market returns, based on their philosophy and experience.
By having the right focus, you, too, will be able to grow your wealth exponentially.
Stay as fully invested as possible
“Empirical research has shown that 80%–90% of investment returns have occurred in spurts that amount to 2%–7% of the total length of time of the holding period. The rest of the time, stocks’ returns have been small.”
While investing in stocks, you have to be actively looking out for opportunities to reap the full reward.
Just remember, whenever you choose not to invest, you are choosing to invest in cash than in whatever opportunities there are in the financial market. By refusing to invest for whatever reason you may have (please don’t time the market!), you are accepting a close to 0% return on investment by sitting on cash.
Deep value investor
It is ironic that the secret to beat the index is actually not to compare your performance against the index.
Deep value investing is about looking at the places people do not usually bother about, investing when others don’t and taking a step back when others are greedy. Essentially, you are a contrarian investor seeking out intrinsic value.
If you have enjoyed the five points we have shared with you above, we encourage you to have a look at the other five points here(A13)!
To end off, here is another great advice by the managing directors to sum up what you should be expecting in your investing journey.
“You can think of investing as a long-term journey, with many starts, stops, changes of scenery, and occasional bumps. We believe that you are much more likely to enjoy the journey, or at least endure it, and reach your destination safely, if you know what to expect along the way. Your own psychology and ability to handle the emotional ups and downs of investing are likely to be important determinants of your long run investment success.”