The Best Way to Pick Stocks

stock chart rising

Everything is always changing.

OK, well not everything.

Universal truths and the laws of mathematics aren’t going to change tomorrow or likely ever.

Most things do change though.

The rise and fall of nations, our understanding of the world, fashion trends.

Even how stock pickers look at stock changes over time.

Did you know the earliest stock market investors were technical traders?

It wasn’t for another 100 years or so that investors started to emphasis business fundamentals. These are things like earnings potential, assets and debt.

Many believe a fundamental view rose to fame on the back of Security Analysis. The book written by two men on Wall Street, Ben Graham and David Dodd.

Quickly after Security Analysis, economist  John Burr Williams added to Graham and Dodd’s ideas.

Rather than look at a company as the average of its past, Williams thought a company was worth its future earnings discounted to the present.

It’s a method many investors still use today, and for good reason.

Is it really all about the numbers?

Today, asset managers are again changing how they look at stock.

Not only are they looking at charts and earnings expectations. Fundies are using mathematics to find non-correlated bets, risk adjusted returns or factor-based models.

It’s not necessarily a method I agree with.

Yet it seems it’s what the industry wants.

Bridgewater Associates, the world’s largest hedge fund, rose to fame using such methods.

Kip McDaniel writes:

The success of the firm is now largely attributed to two products. In 1991, the strategy most associated with the firm was launched: Pure Alpha, which allowed Bridgewater to dabble in almost any asset class it desired, with the goal of producing a return that was uncorrelated to other markets.

If beta is the risk associated with financial markets, alpha is the return above that risk (a 10% return in a market that returns 6% equates to 4% alpha). Pure Alpha, like the purest of hedge funds, sought to have positive returns regardless of market ups and downs. Since its inception, remarkably, it has largely done so, despite extraordinarily choppy markets.

The second key product is known as All Weather, launched in 1996 and meant to be the passive sibling to the active Pure Alpha. The All Weather portfolio— commonly referred to as risk parity—is meant to be balanced across risk exposures, with the implicit effect being a large bond exposure. This is at odds with the traditional portfolios of the large clients Bridgewater works with which, since the 1990s and until very recently, have been stock-dominated.

I don’t know about you, but this sounds like taking investment decisions out of human hands and leaving it with computers.

After all, machines can consume far more information than you or I. Why not hand the job over to the machines?

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As of 2018, there was close to a trillion dollars in quantitative hedge funds. That’s a trillion being actively managed by computers.

And if investing is simply mathematics, then all that matters is the numbers.

So why aren’t asset managers rushing out to buy bitcoin?

Crypto, or gold for that matter, doesn’t pass the Ben Graham or John Williams test. Both assets don’t produce anything.

But to the data-driven asset manager, bitcoin looks like an obvious buy. It’s an asset uncorrelated to any other, and has the potential to rise or fall on speculation.

Even a former analyst of Bridgewater was considering a bitcoin purchase in 2017. After calculating bitcoin’s correlation with other assets the analyst concluded:

Doing this analysis has given me conviction that bitcoin should be a part of my passively held, long only portfolio. First, there aren’t that many store of value assets in the first place. There’s gold, US sovereign debt, safe haven currencies, and that’s it. Second, it’s surprising that bitcoin’s correlation is this low, even among other store of value assets.

While he might be down today, it’s a bet many asset managers would in all likelihood take given a glance at the numbers.

Sticking to the old ways

You can probably tell I’m not on board with this new way of stock picking. I couldn’t even tell you the beta values of any stocks I recommend in my advisory service, Wealth Eruption.

I also have no clue as to where the options of these stocks trade. I don’t even know if the small-caps I follow are closer to their support or resistance levels.

The reason why is because I don’t believe it’s important.

If you’re trying to find stocks that rise significantly, all that matters is how the business performs in my view.

If sales and profits rise, then my take is that the stock price should take care of itself. If you ask me, there’s no need to be a math wizard if you want to make money from stocks.

Your friend,

Harje Ronngard,
Editor, Money Morning

PS: If you’ve got an interest in the share market, but completely new to the whole deal and don’t know where to start…this report is for you. Get started now.

Harje Ronngard

Harje Ronngard

Harje Ronngard is the lead Editor at Money Morning. With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation.

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