Stock picking vs Market timing

Abraham George Musings

My writings normally alternate between global macro, individual stocks and emerging technologies.

Now, for a change, let’s take a look at how the best investors beat the market. Surely, the market-beating investors just don’t follow the index or stay more or less overweight/underweight the index to make outsized returns. They also don’t guess whether they ought to be in the market or not. The one thing they do with unabashed conviction - they own individual stocks that they believe will give higher returns than the broader market indices.

If you ask a group of people who they think are the biggest stock pickers of all time, many familiar names may pop up. And I am pretty sure Warren Buffet and Charlie Munger will definitely be among them.

If you ask the same group of people who they think is the best market timer of all time, you may hear some names but you may not be persuaded. There are many who will boldly claim that they caught the bottom and nailed the top. Most likely with little or scant evidence to back their outrageous claims. Many of those whose prognostications turned out to be right actually didn’t have any position in the markets (!) If there is anyone out there who has developed that skill, he or she deserves some serious credit - because they had skin in the market and were not psychologically biased.

Jack Bogle who lived up to 90 years created the first index fund. He worked until the last day of his death. This is what he said, “After nearly 50 years in this business, I don’t know anybody who has timed the market successfully and consistently. I don’t even know anybody who knows anybody who has.”

Jack Bogle has very good reasons to say that. He preached investment over speculation. He created the Vanguard Group which probably has the lowest fees in the world. His idea was that investors should continue to invest over their lifetime with dividends reinvested and purchased with dollar-cost averaging. So he preached for everyone to get invested and eschew timing the market.

I don’t totally agree with Bogle. Maybe not at all times, but with a bit of luck, one can time the markets. I will elaborate on that from my own personal experience. But let’s get back to the world‘s biggest investors.

When they have zeroed in on a scrip, they will sometimes take a long time to get their desired amount of the stock. During this time, they will look at many factors to get the best execution. First, they will do everything to remain anonymous (or pseudonymous). They will study the scrip’s liquidity patterns. They will be very observant of the long-term averages like the 200-day moving average. They would want to buy into a falling market as it is the best time to get their quantity. But all of this happens only after they are fully convinced about the company’s fundamentals and future prospects.

Investors want to be associated with companies that experience rising sales, increasing market share, double- or triple-digit earnings growth, and high returns on equity that will see their share prices rise. Those that don’t see the above just won’t make the cut.

As is the case in life where we may start badly (adolescence phase), enjoy a period of mastery and success (adulthood phase) and finally have a gradual decline (old age phase), companies also unsurprisingly follow a similar life cycle.

We can see what happens in the major indices. In 2018, after almost 100 years, General Electric was dropped from the index. What happened? The reasons could be many. The company never kept up with the changing times, their technology became obsolete, changing consumer tastes, their business model was being challenged by new entrants. Sometimes, we cannot pinpoint the exact cause as it could be a combination of myriad factors.

One will never know if or when the current crop of titans like Amazon, Apple and Alphabet (Google) will be outcompeted by new technologies and new entrants. Perhaps but surely not anytime soon.

Once a company starts losing market share for whatever reason, it is often difficult to get it back. The new entrant already has disruptive technology and the advantage of nimbleness. However, there are rare exceptions that I will discuss in my future writings.

What are the main factors one should look for in being invested? There are many but three factors stand out:

Firstly, momentum stocks are companies that lead the market in sales and earnings growth, product innovation, and price action. They normally rise faster in a bull market and fall harder in a bear market or even during a correction.

Secondly, value stocks are companies that are cheaper than most on the basis of price to sales, price to earnings, and price to book value. Mostly, they pay above-average dividends too.

Thirdly, insider stocks are ones where promoters, directors, and beneficial owners are accumulating substantial amounts of their own companies’ shares with their own money at current market prices. Given that these individuals have access to all sorts of material, non-public information about their companies, business prospects, it’s no surprise that these stocks tend to outperform in good times and bad times.

We will tie all the above three approaches to one stock (and you already probably have guessed the stock) in my next report.

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Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and multi-billion dollar portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund. Currently, he is setting up a hedge fund where foreign citizens can invest in Indian growth stocks like Tanla operating in hyper-growth markets like CPaaS.