In 2006, the financial publication Trading Markets and the risqué men’s magazine Playboy teamed up for a stock-picking competition. 10 Playboy models participated in the competition and they were made to pick stocks and have their returns pitted against the S&P 500 – a widely-followed American market index – as well as professional money managers. In a rather sad but obvious way, I’m guessing that you’ll pick the Playboy models as winners for the competition and the thing is, you’re not far off the mark. According to Trading Markets, the winner of the competition was Deanna Brooks,…
In 2006, the financial publication Trading Markets and the risqué men’s magazine Playboy teamed up for a stock-picking competition. 10 Playboy models participated in the competition and they were made to pick stocks and have their returns pitted against the S&P 500 – a widely-followed American market index – as well as professional money managers.
In a rather sad but obvious way, I’m guessing that you’ll pick the Playboy models as winners for the competition and the thing is, you’re not far off the mark.
According to Trading Markets, the winner of the competition was Deanna Brooks, whose portfolio returned 43% in 2006. In fact, she had done enough to “beat all but five out of 9,734 U.S. stock mutual funds [the equivalent of unit trusts here]”!
All told, out of the 10 models who participated, four had ended up beating the S&P 500 for the year, while five had bested the average returns for all US stock mutual funds. Given the dismal statistics of fund managers’ ability to beat the market – for instance, only 39% of US fund managers managed to beat the S&P 500 in 2012 – it’s likely that a higher proportion of the models had trumped the market as compared to professional money managers.
So, what can we take away from all this?
1. Luck rules the stock markets
First, it shows how important the element of luck is in the stock market. An amateur footballer couldn’t possibly out-dribble or out-score someone like Cristiano Ronaldo; no couch potato is expected to sprint faster than Usain Bolt; and, I couldn’t possibly hope to win a single chess match against Garry Kasparov. The reason for all that is because an individual’s skills in those activities overwhelmingly dictate the outcome of the event.
But, it’s entirely possible for a rank-amateur in the stock market to beat highly-seasoned professionals at times because of the element of luck, which somewhat negates the impact that skill brings to the eventual outcome. Think of how Deanna Brooks proved that (to be certain, I’m by no means disparaging her intelligence or ability).
2. Differentiate luck from skill
Second, for an outcome, it’s important to differentiate between what was due to luck and what was due to skill. 2006 was part of a bull market in the US that eventually culminated in the Great Financial Crisis of 2007-2009. In a bull market, everyone can look like a genius. But as billionaire Warren Buffett says, “You never know who’s swimming naked until the tide goes out.”
Bad investing strategies can make a person look like the next Warren Buffett when luck’s on his side, giving him confidence in his abilities that are unwarranted. But when the tides turn – and it will – things can and do end badly (or he might end up naked).
Investors who bought shares of Blumont Group (SGX:A33) and Cosco Corp. (SGX: F83) back in 2013 and 2006 respectively just to chase ever-higher prices in their steep ascents without any thought for a sound investing strategy would have done very well for some time. Blumont’s shares climbed almost 4,000% to a high of S$2.45 in slightly more than a year from August 2012 to Sep 2013 while Cosco gained 630% from S$1.08 at the start of 2006 to almost S$8.00 a share on Oct 2007.
But at their respective peaks, both shares were at very high valuations; Blumont was selling for some 500 times trailing earnings and 60 times book value, while Cosco was at a slightly more palatable valuation of 66 times earnings and 15 times book value. The reality of over-stretched valuations eventually took over – as it does more often than not – to bring both shares down to earth and they are now more than 90% below their peak prices, trailing the broader market, as represented by the Straits Times Index (SGX: ^STI), by a horrendous margin.
3. Insist upon a good process
The third takeaway ties the first and second point together. Knowing that luck is an important driver of stock market returns, it thus makes it important for investors to focus on the process (i.e. utilising a good investment strategy) more than the outcome.
With a good process, it’s like playing a game of black-jack where luck is also an important driver of outcomes. You know you shouldn’t draw a card when you’ve 19 points, but when you do and somehow manage to win the hand, that’s luck at work. And you really shouldn’t be doing it again because luck runs out.
It’s the same with investing. Stick with strategies that has historically given someone an edge in doing well and do not be disheartened just because a few calls had turned against you. That’s just luck at work.
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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 writer Chong Ser Jing doesn’t own shares in any companies mentioned.