Commentary On Beating The Stock Market

Commentary On Beating The Stock Market

The question of whether investors are able to consistently beat market averages over the long term is a debate in the field of finance. On side of the debate, proponents of the Efficient Market Hypothesis argue that investors around the world are all battling one another for profits. This fierce competition makes stock prices rapidly reflect public information, and getting excess returns is quite difficult. Random Walk Model supporters align with this side as well. They show that as a result of this stiff competition, any anomalies are rapidly traded away, and stocks tend to follow a random path with an upward trend over time.

In May of 2009, the Journal of Business & Economics Research published an excellent paper on the topic called Can Individual Investors Capture The Value Premium? Value stocks have decades of well-documented research showing high returns compared to growth stocks. Folks debate this phenomenon. Is it due to higher risk or not? Regardless, the researchers writing the aforementioned paper demonstrate an ability of investors to profit from this anamoly.

The authors looked at a period from 1998 through 2006. They broke the period down into ninety seven groups of one year periods. They found that the value strategies did outperform the market during these periods. The authors find it noteworthy that even though these methods have been public knowledge for many years, they continue to persist. Every method analyzed had higher returns than a value index through the same time period. The good news is that individuals have an advantage here. Many of the stocks were small market capitalization value stocks. Issues of liquidity make it difficult for mutual fund managers to buy small stocks such as this because they have to invest massive amounts of money and are unable to purchase stocks of smaller companies. As they saying goes, to beat the market, you have to go against the market. Fund managers have a difficult time going against the market due to their size.

Some of the methods analyzed include Joel Greenblatt’s Magic Formula from his best-selling book, stocks with a high return on assets, high return on equity, high earnings yield, low price to earnings ratio, low price to book ratio, and small size. Breaking stocks into categories by deciles, they found that stocks in the value category as opposed to the growth category tended to perform better. Also, stocks with higher earnings efficiency tended to have higher returns as well.

All of these conclusions make sense. Stocks with a better chance of performing well are those that you have paid less for, and stocks which are better able to produce high profits with what they have.

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