About a week ago, I read an interesting newspaper article that talked about index funds. It highlighted that investors are pouring their money to index funds. These investors were of the opinion that only a handful of money managers are able to beat index funds consistently, and with results that are possibly worse than what they can achieve on their own.
Efficient Market Theory
Furthermore, the idea of simply investing in an Index fund is well supported by the investment theory called the Efficient Market Hypothesis (EMH). This theory states that it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.
In other words, the theory states that, since stocks always trade at their fair value, one cannot consistently achieve returns in excess of average market returns through expert stock selection or market timing. Thus, the only way an investor can possibly obtain higher returns is by purchasing riskier investments.
Although academics have widely pointed to the support of EMH, it is highly controversial because there are times that the stock market is not efficient, and stocks can deviate significantly from their fair values during times of exuberance or despair. Ultimately, emotions are what lead to stock market booms and busts.
Beating the Market
A saying goes that you can “Cut your learning curve by learning from those who have been there, done that”. Thus, one way in which you can go about it through studying the success stories of the investment legends who have managed to consistently beaten the market over long periods of time, and one of which is Robert A Olstein.
Publicly denouncing that investing in an index fund is equivalent to accepting mediocrity, Olstein’s flagship fund, Olstein All Cap value fund saw a 10.7% annualized return since September 1995; beating the S&P 500 stock index by more than 2.4% over the same period.
Just like Warren Buffett and Peter Lynch, Mr. Olstein has his own process by which he filters for stocks which are deemed attractive. Here are some of the key elements that stand out to him while making an investment case:
- Bottom-up approach while being aware of the macro environment
- Unappreciated stocks with high free-cash-flow yield [>7% can be considered very good]*
- Holding for the long term
*Free cash flow yield is derived by cash, after subtracting capital expenditures and working capital, divided by market capitalisation.
You don’t have to include all the key elements above in your own investing. All the great masters have their own investing style and criteria. History has shown that while George Soros have a totally different approach to investing as compared to Warren Buffett, they have both managed to beat the market over their long investment careers. But a well-honed investing process can allow you to beat the market. The key is to find your own style that suits you best.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.
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