A few months ago, around the time of the Facebook (FB) IPO, I tuned in to CNBC's Squawk Box, where Henry Blodget and Steve Rattner were guests. The segment truly disgusted me, for many reasons, but what really bothered me the most was to hear Rattner proclaim that individuals have no business picking stocks. Here is a clip if you want to hear for yourself, but he basically said that folks should just buy index funds rather than attempting something as difficult as performing surgery on oneself. He asks, "What does an individual investor know?" Blodgett said that "most individuals have no idea what a disadvantage they are at."
I was reminded of this arrogant and uninformed attitude conveyed by these two when I saw Roger Nusbaum's article "Should Stock Picking Be Mostly Left To Professionals?" His piece was inspired by a New York Magazine article that suggested so, but Roger points the argument away from should EVERYONE try to pick stocks to should ANYONE try to pick stocks. My favorite part of his article, by the way, was a comment from "Richjoy403", who shares his perspective. Anyone who wants to know what it takes to be a successful long-term investor will benefit from just reading this commenter's bio.
I believe that with a lot of time and effort, an individual can indeed beat the market. Unfortunately, it's not a "get rich quickly" endeavor. To succeed, one must know one's limitations as well as one's advantages. Lower commission costs, more information that is disseminated more broadly and more rapidly, and the democratization of analytical tools have made it easier for investors to have a shot at winning (delivering alpha), but these same tools have also made it easier for individuals to overtrade and to succumb to their own cognitive errors. Here, I mean professionals too.
I don't have the secret for how everybody can beat the market, because that, by definition, is impossible. I do have several suggestions for those who are willing to invest the significant time that I think it takes to excel at stock-picking. While larger institutions may have some advantages over plain old folks that go beyond just time, individuals have major advantages of their own: They won't move the market executing their trades, they aren't subject to institutional short-term pressures to perform (which can lead to selling at inopportune times), and they don't have to constantly fight "group-think".
So, while this list isn't exhaustive, here are five of the tips I would offer to someone who wants to excel at stock-picking:
Build a watchlist
Develop a playbook
Focus on smaller companies
Combine multiple approaches
Read SEC filings and listen to calls
I always tell people to build a watchlist. I have one, and what works for me may or may not work for you, but the point is to have a process that allows you to gain knowledge over time and not make rash decisions. My watchlist has 100 stocks, but the list isn't set in stone. There are so many stocks out there - one can never follow them all. I think focusing on a small amount, probably less than 100 unless your are full-time, makes sense. For you, 'follow' may be different that what it means to me. When I follow a stock, I regularly review the charts, valuation and news.
When I look at a stock, I like to think of how it might fit into an investment theme that I like. I have had great success over the years with certain types of investments. One that comes to mind that is more recent is the management change. Here, I am looking for a catalyst that might not be immediately perceptible but rather more qualitative. I can remember when Chico's FAS (CHS) hired its CEO in 2009 - what a great fit it was. He has lived up to his billing, especially when it comes to growing the direct-to-consumer efforts, which isn't surprising given his record at Land's End. Another "play" is what I call "short-term pain, long-term gain." In this case, I find a company which makes an investment that depresses near-term earnings but boosts longer-term prospects. Wall Street tends to be impatient with these situations, selling them off due to the immediate impact on earnings. An example that I shared several times was the company Synovis Life Technologies (SYNO), which was acquired by Baxter (BAX) earlier this year.
This one may be the very best advice I have for those trying to pick stocks: Go small. There is a lot less competition. Here is where you can be one of only a small group of people who really follows the company closely.
Many investors, professional or otherwise, focus on technical analysis, valuation or fundamental analysis. I say go with all. Using multiple approaches can force a discipline upon you. It takes longer to develop a multi-pronged approach, but ultimately it allows you to make better decisions.
Finally, while SEC filings and transcripts are basically free, it seems so few investors actually bother to read them (or listen to the calls). Press releases get read, but they are not as complete as filings nor as revealing as conference calls. I would also suggest visiting the company websites, as you can learn a lot from the investor relations section, where often there are presentations or webcasts from industry conferences.
So, again, my suggestions are not meant to cover all the bases, nor do they guarantee success. I will share a single example that hits perhaps all of these concepts. In my Top 20 Model Portfolio, where I have been actively looking for perhaps underappreciated growth stories, I added a company called Envestnet (ENV) a few months ago.
I had added the stock to my watchlist when I heard that it had acquired a company that a client of mine thought was a "best-in-breed". I realized quickly that it fell into one of my favorite plays (short-term pain, long-term gain). It's a smaller company, with a market cap below $400mm. Interestingly, only 18 people in the Seeking Alpha universe have chosen to receive email alerts, surely a sign that there isn't a lot of investor competition. I liked the valuation, the fundamentals and the chart, so I wasn't relying on a single perspective. Finally, I carefully reviewed SEC filings and was quite impressed by the CEO before I heard him on a conference call.
If you want to beat the market, you will need luck, in my view. Luck alone, though, most likely won't cut it. I have shared five ideas that can help you develop a process. Luck, process and judgment are all essential, in my view. The first, you can't control, but the second you can. Judgment is the hardest one, and it takes years of practice! I wish I had advice for that one.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: CHS and ENV are in one or more model portfolios managed by the author at InvestByModel.com.