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Thanks so much. Thanks for coming out today. I really uh appreciate it very much. Uh never been here before, so I'm looking forward to my tour right after. So, thank you. Uh so, even Warren Buffett says, uh the vast majority of people should index, and I agree with him. So, are there any questions or do I have any time?
Then again, I get well, I have time. So, uh, then again, you know, Warren Buffett doesn't index, and neither do I. So, I thought I'd tell you why. Uh, and then maybe you'll have some more information to decide for yourself what makes makes sense for you. And in a sense, it shouldn't be that hard. I actually I had a friend uh who's an orthopedic surgeon and is in charge of an a group of orthopedic surgeons.
and he asked me to uh speak to them at a dinner uh about the stock market. And I said, "Okay, these are smart, educated guys. They can understand this stuff." And I uh spoke for about 35 minutes explaining how the stock market worked and everything else. And then I started getting questions uh along the lines of oil went down $2 yesterday.
What should I do? Or market was up 2% yesterday. Uh what do I do about that? So my interpretation of those questions was I had just crashed and burned. So, if this content helps you, like the video, subscribe, and turn on notifications so you don't miss what's next, and let us know in the comments which company or topic you'd like us to cover.
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And if you'd like to support the channel further, check out our trusted partners in the description. So, uh, last year, uh, I was lucky enough to be asked to teach a ninth grade class, uh, a bunch of, uh, kids, uh, mostly from Harlem, and I had just sort of crashed and burned with the orthopedic surgeons, and I didn't want to do that with the kids.
Uh, and so I started to try to think of what could I do uh, to explain the stock market a little bit better. Uh, and so I walked into class the first day uh and I handed out a bunch of 3x5 cards and I asked uh I brought in this jar of jelly beans right here and uh I asked uh the students uh you know passed around the jar of jelly beans, asked them to count the rows, do whatever they wanted to do and write down their best guess for how many jelly beans were in the jar.
Collected the 3x5 cards. Then I went around the room one by one to each one of the kids in the room uh and I said listen you can keep your guess you can change your guess that's up to you and I went one by one around the room asked people how many and wrote down the the various guesses. So it turned out the uh guess uh the average of the guesses for the 3x5 cards was 1771 jelly beans.
Uh there are 1776 jelly beans in the jar. So that was pretty good. Uh the guests when I went around the room uh that was 850 jelly beans. Uh and I explained to them that the stock market's actually a second guessed. Okay? Because everyone knows what they just read in the paper, what the guy next to them said, what they saw in the news, and uh are influenced by everything around them.
Uh and that was the second guess, and that's the stock market. The cold calculating guess when they were counting rows and trying to figure out what was going on. Uh that's actually was the better guess. That's not the stock market, but that's where I see our opportunity. You know, once a year in my class at Colombia, I uh at least for the last five, six years, somebody raises their hand and asked a question that goes something along the lines uh something like this.
Hey Joel, congratulations. You've been doing this for 35 years. Uh and you've had a nice record, but now there are more computers. There's more data. There's more ability to crunch numbers. and uh kind of isn't the party over for us, isn't it? Just a more hedge funds. There's there's just a lot more competition.
Isn't the party over for us? So, my students are generally secondyear MBAs. I'd say average age 27 or so. Uh so, I just answer it this way. I tell them, let's go back to when you learn how to read. Uh let's take a look at the most followed market in the world. That would be the United States. Let's take a look at the most followed stocks within the most followed market in the world.
Those would be the S&P 500 stocks. Let's take a look at what's happened since you learned how to read. So I tell them from 1997 uh when they were nine or 10 uh to 2000 the S&P 500 doubled. From 2000 to 2002 it have hald. From 2002 to 2007 it doubled. From 2007 to 2009 it have hald. And from 2009 to today it's roughly tripled.
Which is my way of uh telling them that people are still crazy. that was just the last 17 years. Uh and I'm way understating the case uh because the S&P 500's an average of 500 stocks. If you lift up the covers and look underneath what's going on, there's huge dispersion of those 500 stocks between those at any particular time that are in favor and those that are out of favor.
And so there's a wild ride going underneath the covers. If you look under the covers, there's a wild ride of those 500 stocks at any particular time. And that doubling and having doubling and having with the average of 500 stocks really smoothing the ride. So [snorts] there should be uh an opportunity and uh if you understand what stocks are and I uh guarantee my students first day of class uh I make a guarantee every year they walk in and I guarantee them this if they do good valuation work I uh of a company I guarantee them the market will agree with them.
I just never tell them when could be a couple weeks could be two or three years but if they do good valuation work the market will agree with them. Stocks are not pieces of paper that uh bounce up and down and you put uh complicated ratios on like sharp ratios or certino ratios. Stocks are ownership shares of businesses that you are valuing and if so inclined tried to buy at a discount.
So if you believe what Ben Graham said that this horizontal line is fair value and this wavy line around that horizontal line are stock prices and you have a disciplined process to buy perhaps more than your fair share when they're below the line and if so inclined sell or short more than your fair share when they're above the line.
The market is throwing us pitches all of the time. uh the reason people don't outperform the market there are behavioral problem there are agency problems but it's not because we're not getting those uh opportunities uh I will show you uh briefly let me tell you how we value stocks uh it's not very tough and I think most of you will understand it uh and I think the best example that resonates seems to resonate with most people is uh thinking about buying a house.
And to keep the numbers simple, let's say that someone is asking a million dollars for the house they want to sell. And your job is to figure out whether that's a good deal or not. So there's certain questions you would ask. First, one of the first questions I'd ask is, well, how much rent could I get for that thing?
Okay, so in other words, if I rented out that million- dollar house, how much rent would I collect? If I uh were going to collect 70 80 90,000 a year, 78 n% yield on that house, that's one way I might go about valuing it. And what's the next question you would ask? I'm pretty sure I know what it would be.
Uh what are the other houses on the block going for in the block next door? In the town next door? How does this compare? How relatively cheap is this relative to all my current choices? So that's what we do. We look at how relatively cheap is this business relative to other similar businesses relative to a whole universe of choices that I have.
We do that. We also go back in history. Look at how this company or uh this house has traditionally been valued versus other ones in the neighborhood or versus uh other communities and how is it being valued now. So measures of absolute and relative value, absolutely cheap, you know, on a rental basis, absolutely cheap or relatively cheap on all different kinds of measures that that make sense to you.
Now, you wouldn't use any of these measures all by themselves. If you just use relative cheapness, uh if some of you remember the internet bubble and you bought the cheapest internet stock, that wasn't cheap. It was just cheap relative to all the other crazy priced uh stocks at the time. But we uses our we use our measures of absolute relative values, checks and balances against each other to try to zero in on fair value.
So when you do this uh just want to show you a simple chart. Uh this is actually a study we did of our valuation methodology very very similar to the way I just said we value uh a house. This is how we we looked at the 2,000 largest companies in the US over a 20-year period. This was 1992 to 2012. And we rank them on a daily basis from 1 to 2,00 based on their discount to our assessment of value using these metrics.
The x-axis here, you probably can't see it, uh is just a valuation percentile. All this means is if you were in the bottom lefthand corner and you were in the first percentile, you're the 20 companies at any particular time out of those 2,000 that measure cheapest according to our measures of absolute relative value.
uh go to the 99th percentile uh you would be the 20 companies that measure most expensive out of those 2,00. The y ais is uh the year forward return on average during those 20 years. What this chart simply says is on average stocks that fell in our first percentile the cheapest 20 uh averaged a one-year forward return during those 20 years of 38%.
Stocks that ranked in our second percentile averaged a one-year forward return of about 37%. And then we drop down to this best fit line, which we always say we don't mind missing when we're making extra money. And then as we measure something more expensive, the year forward return drops. And if you were sitting in my class at Colombia and I said, "Hey, does anyone see a long short strategy you might pursue if you could predict ahead of time which stocks would do best, second best, third best in order?" And you did not say, "I guess I'd buy these guys up here in the upper leftand corner and short these guys in the bottom right hand corner." If you didn't say that, I'd probably throw you out of class because it's very straightforward.
That's what you should do. And by the way, that's what we do. The important thing to understand is that stocks are ownership shares of businesses. Okay? Now, uh, by the way, that beautiful chart I showed you with the 90% fit, you know, why doesn't everyone do this? Uh, well, unfortunately, it doesn't look like that when you're living through that.
That's an average over 20 years. If I showed you a snippet of three or four years, uh, fit would be nice. It might be 0.55, 6, something like that. But uh it's uh not going to be very cooperative. Right? If what we did worked every day and every month and every year, uh everyone would do it. It would stop working.
But but it uh it it doesn't unfortunately. Uh but the reason that we stick to what we're doing even when it's not working is that chart meaning the way we value companies are measures of absolute and relative value or approximately how the market values them over time. If we were for instance momentum investors, okay?
And I will tell you that uh for those of you who know what that means, uh momentum has been studied uh across the globe over the last 30 40 years. In the US, it's worked pretty much everywhere. Uh not all the time, but on average, it's worked very well over 30 40 years. And not just in this country.
But here's the problem. What if it didn't work over the next two or three years? It could be uh that we just have to be patient. You know, it's it works over time and it's cyclical and so it's out of favor and we just have to stick to our guns because it's something that's worked. Or it could be if it didn't work in the next two or three years that the explanation is, hey, it's not so hard to figure out a stock used to be down here and now it's up here.
It's got good momentum. And with all the data and the ability to crunch numbers and computers and studies that have come out, it's a crowded trade. It's degraded. It's not as is not as uh good as it used to be. And if that's what happened over the next two three years, I wouldn't know the answer to that question.
I didn't know which one it was. Should I just be patient or has the trade degraded? But if you view stocks as ownership shares of businesses that you value and try to buy at a discount and that doesn't work for a couple years, I'm not going to change what I'm do. I'm not going to buy the bottom uh right hand corner, you know, buy all the money losers and the companies uh that don't earn anything or trading at 100 times free cash flow.
I'm not going to buy those even if it works in one particular year and then sell the ones that uh are cheap relative to everything get me high rents and everything else. I'm not I'm not going to change my strategy. Uh and I believe that uh stocks will eventually, not right now, but eventually uh people will get it right and I may have to be patient.
That's really what I have to do. What that chart tells me is I'm on the right track. Meaning that's sort of our true north and we just have to be patient to get there. Uh the reason that these simple metrics don't get arbitrageed away is the example I uh usually use for arbitrage is uh oh, you see gold in New York at $1,200 and and it's selling at London simultaneously at 1201.
Well, an arbitur sitting on a trading desk someplace will see that and buy up gold in New York at 1200 and push the price up a little bit. He'll simultaneously sell gold in London at 1201, push the price down and they'll convert someone somewhere in the middle and it'll happen so fast on a trading desk that you don't really even get to see that.
But what if I told you you could buy gold in New York today at 1,200 sometime in the next two, three years, you're going to make money, but you could lose 20% of your money while you're waiting. There's no guy sitting on a desk anywhere that really uh can do that. And in and frankly uh time horizons are getting shorter.
Uh it used to be when I was uh younger used to get quarterly statements and most people would throw them in the garbage. Now you can check your stock price 30 times a minute on the internet. Maybe some of you do. Uh and time horizons are shrinking and we're just playing time arbitrage. We're being uh patient buying cheap good businesses and waiting for the market to recognize the value we see.
Uh, but it takes some work to value companies and let's say you don't want to do that. You know, you have a day job. I guess everyone here has a day job. So, you don't want to do that. So, one thing you could do is try to find someone good to do it for you, right? I'm showing you there's this opportunity.
Maybe someone can do it for you. And what you should probably look for when you're looking for that person is someone who has a good investment process. Okay, that makes sense to you. The problem is uh for most active managers, uh if you think of their challenge when they're picking an individual stock, they must think that they have a variant uh hypothesis as to why that stock is priced differently than the way it should be.
And I can tell you I've been doing this over 35 years and it's very rare almost never have I bottom ticked a stock bought bought it at the ex absolute bottom. So 99.9 plus percent of the time a stock is down after I've bought it. And there are really only two reasons why. One is I was wrong. The other is I just need more time for my thesis to play out.
Okay. Now, as an outside allocator, you don't really know what the thesis for the individual stock was. Even the allocator himself, the manager, I mean, I'm sorry, the manager himself sometimes doesn't know. When things are going against you, there are all kinds of agency problems. You know, you got people to answer to, you have behavioral issues.
Just naturally, you start to doubt yourself. It's very unclear sometimes even to them what their biases are and what they're doing. You know, they did studies that you guys are familiar with probably of why the home team always wins in sports, okay? Or at least wins more than it should. And the original thesis was generally, oh, they're used to the court, they slept in their own bed, you know, the fans, you know, they they jazz them up, whatever it might be.
And when they controlled for all these variables, uh the answer turned out to be that the refs don't like to get booed. Okay? So they don't think that they're being biased, but uh I'm sure in 99.9% of the cases they don't, but they don't like to get booed. And so they're being influenced by. And so this same problem with an active manager, he's got agency and behavioral issues uh that he's not uh sure of.
So the allocator doesn't really understand the thesis behind each pick. It's not clear that the manager uh is totally unbiased when he has a variant thesis that's going against him. Um and so since you don't need know the thesis as an allocator, most people uh all they have are the returns and that's what they used.
So, in an interesting study uh that came out the day after Thanksgiving, so it was interesting to me, probably not interesting to the guys who did the study, uh Morning Star put out a study of their star system. And my interpretation uh and their star system is based on past returns, letting you know who's done the best over the last 1, three, and five years.
Of course, the study, my interpretation of their study was that our star system doesn't work. uh we can't discern uh the last 135 years of returns has not much to do with the next 135 but that's what everyone uses. I wrote a book uh I hold it up here uh it's called the big secret and I always say it's still a big secret because uh no one read it.
Uh and in that book um I talked about a few studies. Number one, uh, it talked about the best performing, uh, manager. I wrote in 2011, so it talked about the decade 2000 to 2010. Looked at the best performing mutual fund, a study of the best performing mutual fund for that decade. Uh, that fund was up 18% per year, 100% long the US equities.
The market was flat during those 10 years. So 18% up a year is pretty good. Unfortunately, the average investor in that fund on a dollar weighted basis managed to lose 11% a year because every time the fund uh the market went up, people piled in. When the market went down, they piled out. When the fund outperformed, they piled in.
When the fund underperformed, they piled out. And they took an 18% annual gain and turn it into an 11% annual dollar weighted loss. Why? Well, to beat the market, if you're beating by 18 points, you're doing something different than the market. You're going to zigzag differently. You can't do the same as the market.
you have to do something different. You're going to zig and zag differently. Uh institutional managers are no different. Here are the stats on the uh if you just took a look at the top institutional managers for that decade, the ones who 2000 to 2010, the top quartortile managers, the ones who ended up with the best 10-year record, here are the stats on them.
97% of those who ended up with the best 10-year record, top quartortile, spent at least three of the 10 years in the bottom half of performance. Not shocking, but everyone, right? To beat the market, you have to do something different. You're going to zigzag differently. 79% of those who ended up with the best 10-year record spent at least three of the 10 years in the bottom cortile performance.
And here's the stunner. 47% roughly half of those who they ended up with the best record, but they spent at least three of those 10 years in the bottom desile, the bottom 10% of performers. So, you know, no one stayed with them, but they ended up with the best record. Uh so it's very hard uh very hard to pick an allocator because you don't know the thesis.
So you're using past returns but when you do that all you're doing is chasing your tail going in and out at all the wrong times. Uh so it's it's very hard. uh what a good allocator usually an institutional allocator and there are a few of them should be looking at process and do you stay with your process but of course there's agency problems on the side of uh those people allocating because even if you're on a really good investment board uh and you're an allocator and you're head of US equities or you're head of uh uh alternatives or or uh bonds or whatever it might be you have a benchmark and if you haven't beaten your benchmark for the last three years.
I'm not saying you know at the good places they throw you out but I am saying they don't throw you a parade. Okay. So it's very very hard on that. So one thing you can do is do it yourself. And and I wrote this other book that you have the little book that beats the market and I just did a simple uh formula that sort of was like the jelly beans counting the rows going across and just picking the cheap companies to buy.
uh very simple and uh I wasn't running outside money at that time that I wrote the book in 2005 just wrote up the very first study we did of doing some uh something cheap and uh cheap and good businesses just uh made it pretty easy for you to buy a handful of those and uh I kept getting phone calls hey could you just do this for us and so what I did is I set up a website uh that listed the top stocks that's still going around magic formula uhinvesting.com Uh, and people said, "Yeah, that's fine, but could you still do this for us?" So, I set up something called Formula Investing.
And, uh, I gave people two choices. I said, "Uh, well, I I sort of viewed it as a benevolent brokerage firm. I said, listen, we'll let you do this yourself, but you have to choose from this uh top list of 30 or 50 stocks, and you have to choose at least 20 of them, okay? Stay out of trouble. And you you're supposed to invest every quarter, update your portfolio, and just, you know, mechanically do this.
Uh you don't have to buy everything, but you have to buy at least 20. Uh and then the uh person uh who was running this for me said, "You know what? How about you just add a checkbox, which said just do this for me, just automatically buy." So as an afterthought, I said, "Fine, we'll do that, too." So we ran this for a couple years, and let me tell you the results.
uh the people who chose their own stocks, you know, from the pre-approved list of the top stocks, uh they did pretty well for the two years, they were up uh 59%. Roughly. Unfortunately, uh the S&P was up 62%. Uh during those uh two years, uh the automatic, you know, just do it for me, that was up 84%.
So uh the automatic uh had beaten the uh in other words just buying the list uh had beaten the market by 22 points. But by giving people any discretion even though the list was preapproved just by picking and choosing the ones that uh they didn't like but they had to buy at least 20 they managed to take a 22% outperformance in a couple years which is pretty good and turn it into a 3% underperformance.
So do it yourself. Uh I wrote a I wrote a piece for Morning Star called Adding Your Two Cents May Cost You a Lot. And uh and uh so I just wanted to caveat that. So uh so another way uh let's see, I'll do this fast. Uh I I wrote a book uh so Rob mentioned called You Can Be a Stock Market Genius. World's Worst Title of All Time.
But uh in it it said sort of what Warren Buffett calls why don't we look for one foot hurdles. Okay. And I open the book with a story about my in-laws uh who uh used to spend uh they they had a house in Connecticut and they used to spend the weekends going to yard sales and country auctions uh looking for bargains.
Okay. Paintings or sculptures. They they were uh art collectors. Uh, and uh, I described what they were actually doing. And they were not going to these yard sales and country auctions looking for to, you know, seeing a painting that was discarded, saying, "This guy's the next Picasso." That's not what they were doing.
What they were looking for are uh, pieces of art or sculpture that they uh, know uh, the artist. some of his similar work had just gone for auction for a lot more than they could buy it for. Right? They can buy it for 30 or 40 cents on the dollar of what it just went to auction for. That's a lot different question.
And so what you can be a stock market genius was was showing you these areas that are ignored. These are the country auctions and the yard sales of the investment world. And these were uh you know I talked about different areas spin-offs bankruptcies uh um you know uh small cap stocks uh you know uh companies going through recapitalizations anything weird complicated situations.
Uh so that's another way but you guys have a full-time job. That is a full-time job. Let me tell you that's a full-time job. So right now we run mutual funds. Uh I can just tell you some of the struggles that we have with investors. Uh we do uh follow that chart. Uh choose from the 2,000 largest companies.
But the and uh we've had a nice record, but there are years like 2015 where uh there's a benchmarking issue, meaning the S&P 500 in 2015 was up roughly 1.3%. The equally equally weighted Russell 2000 was down 10. The equally weighted uh weighted Russell 1000 was down four. So if you're picking from roughly the 2,000 largest stocks, you know, uh an even performance would be down six or seven, not up 1.3.
So there's a benchmarking issue, but to beat the market, you have to do something different. You're going to zig and zag. Everyone knows that. Uh we're now uh working on something. We've had something open a couple years where we sort of say, okay, we'll start with the benchmark and then we'll value add and we'll make some compromises so that we don't it's called index plus and so that we don't vary uh too much from the index.
So you can stay with us and the thesis was basically the best strategy for you which is how I'll end before I take questions is not only one that makes sense but one you can stick with. Okay? So you have to understand what you're doing number one if you give it to someone else you have to understand what they're doing and you have to be able to stick with it.
So you have to understand it well enough to stick with it. So that's I guess before I take questions what I I uh will leave you at and uh maybe s Yeah. Thank you so much. This is great. So, if this video brought you more clarity about your money, like it, subscribe, and turn on notifications so the next lessons reach you.
And tell me in the comments what you want me to cover next. Kumlucro Investor is the investing branch of the Kamlucro family. Our first channel, Kumlucro Trader, is where we teach trading, smart money concepts, ICT, technical analysis, trading psychology, and Wyoff. If you also enjoy charts, the link is in the description.
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