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Three Tips To Beat The Market

At Motley Fool Singapore, we champion investing in shares of individual companies because we feel it is one of the best ways to build lasting long-term wealth. While there are merits to investing with an index tracker, we aspire to beat the market by picking shares. But, it’s easier said than done and it entails a never-ending learning process.

Fortunately, there are great lessons we can pick up from those who’ve blazed the trails before us.

Famed value investor Mohnish Pabrai gave a presentation last month at Columbia Business School where he shared three tips on how he had managed to compound his own personal wealth with annualised returns of 26% since 1995.

It is worth noting his thoughts on investing because of his phenomenal track record – besides the gains from his personal wealth, Pabrai’s professional investing career had entailed compounded annualised returns of 13.3% for his clients from 1999 to Sep 2012 through his own hedge fund. That’s a smashing result, considering how the S&P 500 Index (a widely used US stock market index) only grew at approximately 1% per year during that period.

So, how did Pabrai grow his own money at such phenomenal rates for close to two decades?

1.    Have an absolute goal for investing returns that’s substantially higher than what an index can conceivably achieve

Pabrai preaches the need for absolute return targets that are much higher than a market index. He had set a 26% target in his case because he knew a market index can never perform in that manner over the long term. In other words, you can’t beat the market just by trying to beat the market – you need a fixed goal post to score against.

The Straits Times Index (SGX: ^STI) has had compounded annualised returns of about 4.5% since Dec 1987. Set a target that’s much higher; say a 12% compounded return per year over the long-term. That way, you can base your investing decisions with respect to your desired returns and work along those lines.

2.    Only invest in opportunities where it might be highly likely to deliver returns of 100-200% in 2-3 years

Value investors will normally calculate the intrinsic value of a business using available information about its qualitative factors and financials. Then, they invest in a company’s shares if its price is below their estimate of intrinsic value. What’s interesting here is how Pabrai only wants to invest in opportunities where the share price of company is at least 50% below its intrinsic value.

Such opportunities are rare. But even in Singapore, they do exist for companies that are able to exhibit sustained business growth. One such example is instant beverage manufacturer Super Group (SGX: S10). Its shares jumped by 370% from a share price of $0.825 three years ago to $3.85 today. Along the way, the company’s sales and profit grew by a cumulative 75% and 96% respectively from 2009 till 2012.

There are others too, such as vehicle and commercial inspection firm Vicom (SGX: V01), whose shares grew from $2.58 three years ago to $5.05 today for a 97% return. From 2009 to 2012, sales and profit rose by a total of 25% and 32% as its share price tagged along.

3.    There is a big universe of listed companies around the world. Your job as an investor is to find just 2-4 companies each year that can meet any one of these three criterion: 1) Cannibal, 2) Spinoffs, 3) Cloning

There are two key points here. The first is the need to find just 2-4 companies to add to your portfolio. It is not so much the need to have a concentrated portfolio of a handful of companies to beat the market, but rather, to have a portfolio that’s different from the market.

The three local banks, DBS, United Overseas Bank and Overseas-Chinese Banking Corporation make up almost 28% of the STI’s weight. If a huge chunk of your portfolio is with these banks, chances are, you might only achieve market-like returns.

The second point concerns the three criteria. “Cannibal” companies are adept at buying back shares to reduce their share count, thereby increasing the value of existing shares as they can claim a larger stake of the company’s assets, cash flow, profit etc.

“Spinoffs” can sometimes help to unlock value. That is why shares of newspaper publisher Singapore Press Holdings (SGX: T39) shot up to a five-year high last month as investors became giddy with excitement at the prospect of the company spinning off its properties into a real estate investment trust. More importantly for investors in a spin-off, the smaller ‘discarded’ company can sometimes be a great opportunity for investment as there might be severe mispricing between its share price and intrinsic value. For those interested to learn more, money manager Joel Greenblatt wrote a great book on how individual investors can profit from spin-offs and special situations that’s called You Can Be A Stock Market Genius.

Lastly, Pabrai holds companies that clone successful businesses in high regard. In Pabrai’s view, companies that are on the bleeding edge of something new entails risk of failures because there is nothing proven. As such, he prefers companies that look toward and replicate the strategies of other successful businesses. In fact, the set-up of Pabrai’s own investment fund was ‘cloned’ from Warren Buffett’s highly successful investment partnerships in the 1960s.

So there you have it, three tips to help you beat the market, coming from a tried-and-tested market beater himself!

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.