VALUE INVESTING
Logic, Faith and Time

By Stephen Bland (TMFPyad)
November 5, 2004

If you have a share strategy that you are following, how long does it take to know whether it has real merit or not?

During the last major bull market a few years ago, when mechanical schemes were very popular on the Fool, we had a substantial number of such ideas put forward by readers. Some of these claimed annual returns of as much as 70%. Back testing, that concept which I regard as decidedly dodgy when used to demonstrate the efficacy of mechanical approaches, indeed showed such figures in certain cases as I recall.

The clear flaw in all this was of course extrapolation. The idea that because you found a pattern in the past, it would in consequence repeat in the future. As we know now, that consequence never materialised when the bull market turned bear and I'm pretty sure that all the schemes which claimed gigantic returns proved worthless in the end. Common sense in any case tells me that there is unlikely ever to be a mechanical share system that repeatedly delivers huge annual returns through all markets.

Since mechanical strategies were so popular back then I featured my own system based on high yield and, demonstrating the true modesty with which readers have come to identify me, I called it the pyad26. I haven't followed it for years but a reader recently pointed out that it had been doing reasonably well. There was no back testing, my reasoning was simply that a strategy based on investment logic ought to work long term. Equally any scheme that lacked such logic, even though it showed successful patterns over a certain past period, was very likely to fail eventually.

My point is that almost any approach may work for a time. You can look at a graph of the market or a particular group of shares or whatever over a very short period of a day or a week and see a pattern. But then look at it over a slightly longer period of a month or two and the shorter term pattern may disappear and become part of a longer term pattern. Now look at the latter over a year or two and what you thought was a discernible shape now seems to be part of something bigger and different. Again do this over a few decades and the whole thing seems different again.

How long have you got? In practice you have only your investing lifetime which is a window, a snapshot of part an extremely long movement. If you are say 35 now and anticipate investing in shares for growth for 25 years before you start taking income, that 25 years will turn out to be just a portion of a picture that is centuries in length. What can you deduce about a 25 year portion of a very long line? Look back on the last 25 years and the one before that? Do they tell us anything meaningful that can be used to predict the next 25? I'm not sure.

If your particular strategy hits a duff 25 years you will not be too happy by the end of it but it will be too late to do anything about it. Ultimately all strategies come down therefore to faith because you cannot know for certain whether they will work into the long term future, however well they worked in the past.

If you wish to invest in shares at all you need to adopt some strategy so regrettably all we have to go in is what seems to have worked in the past. I temper that view though by adding that it must have a strong streak of investment logic, common sense if you like. I don't care what worked in the past if I can't see any obvious reasons, by my standards of what constitutes obvious reasons, for it to have worked.

Both value shares for short-term traders and high yield large cap portfolios for long-term holders are strategies that I believe work long term. There is the chance that these ideas have worked only in the past but in favour of them, they are very strong on investment logic. Buy good stuff cheap and good things may happen.

My monthly Value Investor newsletter features both value trading and long term hold high yield portfolio strategies. I think these are the two most powerful approaches to market success long term but you do need the faith.

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