An Investing System To Beat The Market

Published in Investing on 13 July 2012

Finding a system to beat the market.

Do you have an investing system that consistently beats the FTSE's overall return?

If you do, please read no further. But if you don't, then I'd say you need one or you're probably wasting your time. As Albert Einstein once said: "The definition of insanity is doing the same thing over and over again and expecting different results."

It's important to bear in mind two fundamental points:

  • Most traders lose money.
  • Most shares are losers.

So it's not easy to beat the market. But many investors do so -- consistently. For example, Foolish writer Stephen Bland has his own excellent PYAD system, which seems to beat the market hands-down over time.

And for the uninitiated, PYAD stands for a low P/E ratio (a maximum of two-thirds' that of the market), with a healthy yield 50% above the market, a good asset base (with a price-to-book value, PTBV, under 1) and ideally no debt (and preferably with net cash).

This accords with some big market studies. For example, the data collected in 'What Has Worked in Investing' by Tweedy, Browne show companies exhibiting the following characteristics generally outperform the market:

  • Low price in relation to asset value.
  • Low price in relation to earnings.
  • A significant pattern of purchases by one or more insiders.
  • A significant decline in a stock's price.
  • Small market capitalisation.

Meanwhile, many other Foolish investors swear by Stephen Bland's recommended "hands-off" approach of concentrating on high yield investments.

No one size fits all

There's no "one size fits all" approach. Clearly, some traders make a handsome living, as do some investors concentrating on blue-sky hopefuls with nothing much in the way of assets or earnings. Others do endless research into small caps and invest heavily based on their superior knowledge.

The recent Foolish series profiling the current line-up of investments of various people who make their living from this game demonstrated various very different, but very successful approaches. But each has his/her own systematic approach. They know which investments they're holding and why, and their long track records give them reasons for confidence.

On this basis, therefore, the eight shares held by one of the most successful UK investors of all time have to be worthy of further research. There's nothing wrong with profiting from the superior analysis and insight of others -- as long as you agree with it.

And the best of them all, Warren Buffett's real investing edge is in being able to identify a company that may appear to be fairly valued, but which is very undervalued when you consider its potential to compound high rates of return into the future.

Personally, I try to map out my overall investing strategy with sufficient income from yields I think are sustainable to live on. I then add in a multitude of individual equities I think are undervalued across different sectors and wait patiently for what I perceive to be a fair value to come out (while watching any developments in the story along the way, of course). The sustainable yield is the bottom-line clincher for me, though, as I have dependents to support. Any capital rise is then a bonus. And on value credentials, net tangible asset value (and the nature of that asset value) is the single most important criterion.

So for example, among my largest holdings are RSA Insurance (LSE: RSA) where I believe the gravity-defying potential yield of almost 8.7% at 108.2p per share can be maintained. I also think defensive stock J Sainsbury (LSE: SBRY) has a little of everything given its PTBV of around 0.62 (when including the property valuation surplus over book value) and expected yield of over 5.5% at 306.5p. Its competitor Morrison (LSE: MRW) also looks good value to me at 266.5p, given its undemanding forward P/E of 8.8, gearing of 27% and a PTBV of 1.3.

And BP (LSE: BP) looks a long-term bargain at 435.1p given its forward P/E of just over 6 and potential yield of over 6.3%.

I'm not trying to recommend my own system of investing, nor anyone else's for that matter. But I am recommending that you find a system of some sort that -- demonstrably -- works for you.

Investing is by no means easy in today's uncertain economy. That's why we've published "Top Sectors Of 2012" -- our guide to three favourable industries. This free report will be dispatched immediately to your inbox.

Further Motley Fool investment opportunities:

> David owns shares in RSA Insurance,Sainsbury and BP.

Share & subscribe

Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

goodlifer 13 Jul 2012 , 11:36am

In my never very humble opinion,
http://www.rbcpa.com/Simple-and-Easy-Approach-Medical-Economics-Graham-1976.pdf
is worth a look if anybody's really interested

elephant888 13 Jul 2012 , 1:53pm

> I'd say you need one or you're probably wasting your time

What if I'm happy with equalling the FTSE's overall return?

F958B 13 Jul 2012 , 3:10pm

elephant

Your cunning strategy is likely to put you in the top half, maybe the top quarter of all performers.

Genius!

Surely to outperform so many people, you must feel tired at the end of a hard day's investing?

Can you run that strategy past me again - just so I can be sure to get it right?

Regards,
F

leftandright 13 Jul 2012 , 4:04pm

Aren't the Motley Fool writers getting a bit annoyed with having to 'subtly' incorporate the Neil Woodford and Warren Buffet reports into their copy?

Every article I read now I wonder where they will pop up. At the beginning? Near the end? Maybe in the middle!

moreuseless 13 Jul 2012 , 8:10pm

I would love to see an article that manages to squeeze in every other word a link to one or the other! Perhaps we can run a competition to find the most quotes in one article?

goodlifer 13 Jul 2012 , 8:25pm

"Most traders lose money."

I'm afraid this statistic is misleading and completely useless - except possibly to salesmen trying to flog index trackers.

For one thing, It makes no effort to disaggregate.

It just lumps together the young, the old, income investors, momentum investors, growth investors, value investors, riverboat gamblers, monkeys with pins, professionals, amateurs, chartists, day traders, astrologers, the cocky and the cowardly, together with common-or-garden thickos like you and me, as if there weren't important differences between us all.

Perhaps it's best to stick to lies and damned lies.

geddinquick 13 Jul 2012 , 8:50pm

goodlifer; "For one thing, It makes no effort to disaggregate"

Simply not true. The article says: "Clearly, some traders make a handsome living".

It could hardly be more clear on that point.

Yet it is statistically true:

http://www.fool.co.uk/news/investing/investing-strategy/2009/06/23/most-shares-are-losers.aspx

goodlifer 14 Jul 2012 , 9:55am

Thank you, geddinquick,

My criticism was aimed at the statistic I quoted, not the whole article.

goodlifer 15 Jul 2012 , 3:06pm

Since you ask, FWIW here's my "investing system."

What am I looking for?
A blue - or bluish - chip which pays a reasonable divdend while it appreciates 30% or more over the next few years.

Checklist

1) Would I be reasonably happy to work for this firm if need be, or for one of my family to do so?

2) Would this share fit into my existing portfolio?
For reasonable diversification I like to have at least 15 different holdings - in practice there seems to be no upper limit.
I don['t like any one holding to make up more than about 7% of my portfolio

3) PER?
Never - well, hardly ever - above 10, ideally 7 or less.
Check earnings history and forecast.

4) Yield?
Hardly ever below 5%.
Check cover, history and forecast.

5) Shareholders' equity?
Ideally 50% or more - almost certaioly have to settle for less.

Obviously no share's going to score full marks
Any that did would probably go down the plug'ole next week.
Which is why we diversify.

Any comments criticisms or suggested improvements?

Join the conversation

Please take note - some tags have changed.

Line breaks are converted automatically.

You may use the following tags in your post: [b]bolded text[/b], [i]italicised text[/i]. All other tags will be removed from your post.

If you want to add a link, please ensure you type it as http://www.fool.co.uk as opposed to www.fool.co.uk.

Hello stranger

To add your own comment, please login.

Not yet registered? Register now.