Some people have all the luck. They win the lottery or find a $10 bill in the pocket of a pair of pants they haven't worn since last winter. They invest in a stock just as it takes off. They put seemingly no effort into their success.
Investors should remember that they can't count on being lucky.
This temptation is hard to avoid. Most people with any experience in the stock market know there's no sure-fire way to beat it in the short term, but there are always one or two investors who make winning look easy. They grab the headlines, and everyone else is left to wonder where they went wrong.
What investors forget is that there is no guarantee of continued success. Behaviourally, humans tend to rely on the most recent past as the predictor of future results. This can be a dangerous game.
Stocks become hot because investors chase performance. They are chasing luck, too. As the Collaborative Fund’s Morgan Housel explains, luck creates the false impression of control - A specific action (buy this hot stock) led to a desired outcome (outperformance in the short term). That’s difficult to replicate over the long-term.
Sure, sometimes there is a connection between action and outcome, but the world is far more prone to randomness.
Angel investor Naval Ravikant talks about different types of luck. The first is just blind luck, which is when something out of our control happens and affects the outcome of our actions.
This can be good luck or bad. Even an investor with a bad strategy can find temporary success every once in a while.
Luck also happens when someone is persistent, creating opportunities in the pursuit of other opportunities. And another type of luck comes from knowing enough about a subject to spot a good break when it happens before others notice it.
The fourth type of luck comes from creating your own luck from skills and knowledge that put you in a position to capitalize on it. An example Mr. Ravikant uses is when an expert deep sea scuba diver gets hired by a less experienced bounty hunter who has just found a sunken treasure. Having the expertise to recover that treasure puts the expert diver in the position to share the reward.
When it comes to investing, preparation should be emphasized over luck. And since it's so hard to measure the influence of luck and skill, the focus should be on process.
To limit the role of luck in your portfolio, a good idea is to follow a disciplined, consistent strategy, with goals and objectives that are clearly defined and a process that you can stick with over the long term. That last point is very important: You need to be able to stick with your strategy over periods where you appear to be losing more than you are winning, when your luck seems to be skewed to bad rather than good.
Sometimes a manager with a well-thought out process can fall short of the benchmark despite best efforts. And a manager with a solid track record will eventually be faced with reality: Returns will settle back to the average over time.
At Validea, we developed process-driven strategies inspired by the work of well-known investors, such as Warren Buffett and Peter Lynch. The strategies are built on financial data and focus on the long-term. Our approach allows us to filter stocks through mathematical models that screen for various attributes such as debt, price-to-book ratio, return-on-equity, and relative strength.
There isn't a sure-fire way to beat the market in the short-term, but using a careful, process-based approach to your portfolio will lead to success over the long-term.
Here are four stocks that score highly on our guru models:
Ulta Beauty Inc. (ULTA-Q) – Shares of this cosmetics retailer score highly on the models tracking five of our gurus, including Warren Buffett. It has long-term earnings per share (EPS) growth of 28.9 per cent and a relative strength of 91.
Boeing Co. (BA-N) – Shares of the airplane maker and defense contractor score highly on the models of three of our gurus, with a price-to-earnings ratio of 21.3 and long-term EPS growth of 27.6 per cent.
Tractor Supply Co. (TSCO-Q) – Shares of this retailer to the rural market score well on four of our guru models. It has a price-to-book ratio of 8.7 and a price-to-earnings ratio of 24.4.
UnitedHealth Group (UNH-N) – Shares of this health care insurer score highly on three of our models, with a price-to-book ratio of 4.7 and long term EPS growth of 21.5 per cent.
John Reese is chief executive officer of Validea.com and Validea Capital, the manager of an actively managed ETF. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service.
John Reese