Today's comment is by John Pugsley, Chairman of The Sovereign Society and editor of The Sovereign Society's new investment service, Stealth Investor.
Dear A-Letter Reader:
Are you wasting your time trying to beat the market averages?
It might seem so, considering the fact that around 80% of mutual funds under-perform the stock market's returns in a typical year. Such dismal performance by pros convinces many investors that they're better off accepting the averages. This idea created a niche for 'indexed' funds that simply invest in the market averages.
Lately 'quant' funds, or quantitative funds, have competed with the MBA- and Ph.D-managed funds. Quants use computers instead of analysts to make buy and sell decisions by churning numbers on the same things analysts watch... financial statements, share prices, volatility, etc. Vanguard has them. Janus Funds has them. Charles Schwab & Company has nine.
If the hordes of professional analysts have difficulty beating the broad market averages, and the majority of pros aren't much better than computers, does that mean that the individual might as well throw in the towel and buy the averages? Or, is there an opportunity to achieve better-than-average returns for the individual investor?
There is, primarily because there are outstanding, undervalued companies that stay off the beaten path. The idea won't work for mutual funds. It won't work for the masses. It's a path that's only available to the individual investor.
For the past two years I've been exploring it, and the results have been amazing. I call it 'stealth' investing. First, many of the best values are off limits to brokers by law. But they're not off limits to individuals.
But another reason many of these hidden values aren't open to the pros is they are too small. The bigger the investment fund, the bigger its investments must be in each individual company. A fund manager with a billion dollars to manage can't bother looking at small companies.
For example, it takes the same management effort and expense to interview the CEO of a NYSE listed firm with a $500 million market cap as it does to interview the CEO of tiny Podunk Industries with a $5 million market cap. Besides a 10% rise in a $500 million company is a $50 million gain, while a 100% rise in a $5 million market cap is only a $5 million gain. Furthermore, too many buy orders for a small company's shares causes the price to soar, but there's no one to sell them to at the distorted price.
Thus, size matters. As Warren Buffett said at the recent Berkshire Hathaway shareholder's meeting, "Given our size, we see a few good things [to invest in]. If we were smaller, then we'd see lots of good things."
The path to extraordinary returns for individuals is sprinkled with small, outstanding, undiscovered companies. But even I can't name them here. It's kind of a 'secret' path. Too many people read this A-letter, and too many investors trying to crowd into any stock at once destroys the opportunity.
How to find them? As I said in an earlier A-Letter, use 5 criteria;
- Look for companies trading at a substantial discount to intrinsic value.
- Search for smaller companies, micro-cap or even nano-cap.
- Watch for companies that are thinly-traded and not institutionally owned.
- Look for industries that are out of favor.
- Concentrate on companies that licensed brokers and advisors are prohibited from recommending because of regulatory censorship.
They are out there. If you're willing to look off the beaten path, you don't have to be satisfied with letting a computer do your investing. And with the right small companies you can consistently beat the averages by a very big margin.
JOHN PUGSLEY, Chairman
on behalf of The Sovereign Society
EDITOR'S NOTE: If you'd like to learn more about deep-value small-cap secret often overlooked by major brokers and the mainstream press, click here.