Investing shortcuts

A recent re–read of the remarkably successful, (in investment literature circles at least), “The Little Book that STILL Beats the Market” got me thinking once again about just how much effort is required to obtain a worthy return on one’s investment efforts.

Mr Greenblatt’s updated “Little Book” , now encompassing the great recession of 2008 suggests that in fact only a 2-factor model (going by the almost comical name of the “Magic Formula”) is required to extract out long term successful results. Doubters can refer to the following data to dispel any doubts:

Year S&P 500 returns Magic Formula Returns

2007 5,5% 7,1%

2008 -37.0% -38,8%

2009 26,5% 58,9%

1988-2009 (AAGR) 9,5% 19,7%

These results and the whole notion of simple 2-factor models like Mr Greenblatt’s, (based on earnings yield as measured by EBIT/EV and return on assets as measured by EBIT/Net Working Capital+ Net Fixed Assets) fly in the face of the teachings of many so-called “active” value investors, for whom anything short of complete intimacy with the target company is but heresy.

On the other extreme (and as we discussed a couple of weeks ago) is the world of indexing. Successful of course, in the very long term; but hardly a recipe for stellar returns. So what is one to do?

My own inclination, as documented in this blog on numerous occasions, favors the dedicated effort to truly understand specific industries’ competitiveness drivers, financial health AND stability of the security issuer and, where possible, the interests and incentives of incumbent management. Notice, I used the words “where possible” for it often happens that access to management is not only difficult but in fact, on occasions counter-productive…

On this issue, I recall once asking a question at an annual shareholder meeting of a renowned mutual fund management company in Spain, regarding the value of talking to management, were the response was none other than:

“We (the fund managers) are most interested to hear from those companies that do not wish to speak to us”.

In order words, joining the ranks of your average cheerleading / analyst /sycophant feeding on media-friendly companies staffed with extensive Investor Relations departments serves absolutely no purpose at all. So far so good for us non-institutional investors with limited access to mighty “management”.

In this day and age, where abundant literature permeates our book-stores and public libraries enticing readers to benefit from low risk, low effort –high return strategies it is especially important to retain a generous dose of skepticism. In an attempt to strike at the elusive middle ground between achieving a reasonable amount of knowledge and competency and overdoing the research in an effort to find evidence supporting my pre-conceived notions, I will quite happily run of the risk of exceeding on the former.

Notwithstanding the fact that no substitute has yet been found to take the place of thorough, focused preparation as the basis for success, it seems that that patience, and disciplined persistence in the process, as shown with admirable clarity in Mr Greenblatt’s updated book, accounts for the lion’s share of most success stories.