Fool's Eye View

[ September 26, 2000 ]

Trackers and Value

By Maynard Paton (TMFMayn)

Carburton Street, London -- From reading the Foolish discussion boards, I know that many private investors have difficulty in forming an investment strategy when starting out on the rocky road to stock market riches.

And who can blame them?

For the novice, there is a bewildering array of options that can supposedly make anyone an investment fortune. Typically, the first step through the shares jungle is a tipsheet. Following the charts, punting on penny shares or searching for the next ten-bagging tech share -- various investment newsletters will imply that their underlying philosophy will always make you money.

Of course, a far better course of action than simply following the tipsters would be to read through the Introduction to the Foolish Investment Strategies. There, you'll find another five, but very different, approaches to aid you in your quest for stock market success.

So, with numerous sources all advocating plenty of diverse investment methodologies, what's the best way for the beginner to proceed?

Here's my take.

The Foolish Favourite

Firstly, consider forgetting about selecting individual companies and trying to beat the stock market. Instead, cast your thoughts towards a low-cost index tracker. I'm a big fan of index trackers. In this feature, I wrote the following on the Foolish favourite:

"In my book, the greatest decision any novice investor can make is the low-cost index tracker. It's the investment no-brainer. There's no need to swot up on accountancy, no need to continually "watch the market", no need to consider the merits of particular industries and no need to get bogged down in tedious company comparisons. All in all, the performance-to-effort ratio for the passive (index) investor is much greater than for most aggressive (stock picking) investors."

Yes, trackers are safe and boring. But over the long term, you'll do better than the vast majority of managed funds, very likely do better than trying your own hand at stock picking and also save lots of time and money on company research.

Think Value

But if you must try to pick individual shares yourself, which of the plethora of methodologies is best suited for the novice? I would suggest contemplating this short-term value approach as endorsed by TMFPyad.

Now that may be surprising to some, especially as I co-manage the Qualiport, a portfolio that attempts to buy companies and subsequently hold for the long term. Surely I should be enthusing about Warren Buffett and pointing beginners to his legendary Shareholders' Letters?

Well, yes, every investor should read the words of Buffett. But properly evaluating a business, its competitors, its management, its accounts and its products isn't for the feint-hearted stock picker.

Instead, the short-term value approach places a company's low valuation above the quality of the business and its products. The theory goes here that the very depressed ratings will eventually be recognised in some way and then the value will be "outed". I think this style of investing has a number of advantages that suit the investor with a lack of stock market experience.

Easier stock selection

There are over 2,000 companies listed on the London Stock Exchange. The business-focused investor will initially start to think of companies or industries with great potential. Difficult questions such as "what will the future hold for media companies?" will have to be asked. None of this matters to the value investor. Here, the share filtering process is initially done via basic valuation measures with help from publications such as the Financial Times (beware of FT "bargains" though) or the Investors' Chronicle.

Less time is required

With the initial ease of stock selection comes the benefit of time spent researching. If you stick to reasonably tight filters, then you're not going to get too many potential value investment candidates to contemplate.

And given that the value approach places little emphasis on a company's products and their potential, directly opposed to the business-focused philosophy, the investor can win in two ways. A quicker filtering system that has no need for constantly keeping updated with specialist industry goings-on.

Have you got it right?

Investors starting out and buying companies to be held for the long term is fine in principle. But there are obviously going to be mistakes made. When will the longer-term investor realise the blunders? We've only got one shot at stock market investment glory, typically lasting for about 30 years. So, if after five years, you come to the conclusion that your initial long-term stock picks were dogs, then that's one-sixth of your investing lifespan gone. Remember the miracle of compound returns!

Going down the shorter-term value route should highlight your talents in a more timely manner. Given that value plays typically have their value "outed" in 1-2 years, there's going to be much more time to tweak your strategy, or switch to a tracker, should you discover your initial selections were howlers.

A conclusion

So that's it, my own personal brief and simple guide for those starting out on the stock market. Essentially, use an index tracker as the core foundation of your portfolio and consider short-term value "side bets" as your initial foray into individual stock selection.

Where Next?

TMFJimmyC tells all about Index Trackers
TMFPyad answers the question "What is Value?" and outlines his latest Value Investing thoughts.
Read the introduction to the Foolish Investing Strategies
Visit the Fool's School -- discover how to value shares and the miracle of compounding