A couple of days ago, I read an article in the Wall Street Journal that I had to comment on. The article “Macro Forces in Market Confound Stock Pickers”, (http://online.wsj.com/article/SB10001424052748704190704575489743387052652.html)
argues that stockpickers are having increasing difficulties in beating market averages because stocks are now moving in correlation with the overall market at a very high level. In fact, the article states that correlation between individual stocks and the market have reached a peak of 74% within the past few months, compared to an average of 27% between 2000 and 2006.
I must confess that I cannot be categorized as a “buy and hold” investor. I try to hold onto my investments as long as it makes sense, but as soon as valuations reach the point where an alternate investment is likely to yield higher returns, I dump my investment and switch.
However, I think this article heralds a golden opportunity for long term buy and hold investors, despite James Bianco’s assertion that “stock picking is a dead art form”. My logic is simple:
We should chose stocks based on price compared to free cash flow. If a company’s free cash flow is growing at a greater rate than the stock market is pricing it up, than the company is slowly being undervalued. In this environment, where investors are ignoring stock fundamentals, than companies with low debt, who are successfully grabbing market share from failing competitors should become increasingly underpriced. This trend could go on for years, but the longer it goes, the greater the opportunities. Eventually, the mispricing will become attractive enough to investors to shift money out of their holdings in precious metals and bonds. Than the long term investor’s positions pay off.
The risks are obvious:
1. The correction takes years, and the company’s competitive advantage does not hold up, yielding the long term investor anemic returns when considered over the time period.
2. The investor picks the wrong stocks, mistaking financial strength for accounting shenanigans.
3. The trend continues and investment valuations are “changed” forever
Both risk 1 and 2 exist in any circumstance, and I believe careful stock screening and picking will minimize these risks. I’ve laid out my stock screen in the past post, and I think that it goes a long way in identifying survivable stocks that will pay you while you wait for prices to equalize. In addition, you will need to monitor the health of your holdings frequently to ensure you’re not holding a dud in the making.
As for risk 3, I don’t believe for a second that investor methodology has changed for good. In the long run, no one will pay less for a cash flow that is increasing at a greater rate than its peers and has more certainty of continuing to do so. Over the past 15 years, many people have asserted that the laws of supply and demand, and the laws of mathematics are dead. They have all proven wrong and have paid the price.
T.R.
P.S.
Here’s a link to a video on the same topic: (http://online.wsj.com/video/is-stock-picking-a-dead-art-form/7551169A-451A-4FA2-AE29-19E645303FCB.html)
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