If you think what I'm about to tell you sounds too good to be true, I honestly don't blame you. I was a skeptic myself.
And I've been at this a while, including five years holed up with a "quant" nerd who couldn't so much as flip a sofa cushion without finding "alpha." Yeah, yeah, I know what you're thinking ...
What the heck is alpha?
Without digging myself too deep a hole, "alpha" is the excess return you're earning on your stock portfolio above what some academic would expect, given its level of risk. Put another way, alpha is the measure of your ability to pick better stocks than I can.
This much I know for sure: Alpha is the driving force behind a multitrillion-dollar hedge-fund industry. Kind of remarkable, given that I vaguely remember paying nearly that much for some white-robed professor to convince me that alpha doesn't exist.
And for years, that's what I believed. Sure, I'd seen investors beat the market. But I'd seen others get crushed. There just never seemed any rhyme or reason to it. Old Chet Hammersmith down the hall would get a hot hand one year -- then get his head handed to him the next. And so it goes in an efficient market.
Now it gets good ...
So when my friend and colleague David Gardner started telling me he'd captured the ever-elusive alpha -- and that he'd hired a NASA scientist to prove it -- I barely gave it a second thought. True, this was the guy who told me to buy Amazon.com (Nasdaq: AMZN ) back in 1997, before it went on a 2,700% run.
Not to mention Amgen (Nasdaq: AMGN ) in 1998 and AOL in 1994 at $0.43 a share -- long before the Time Warner marriage and divorce. The guy has a nice touch, but that's a far cry from true, positive alpha. And, remember, all I really cared about alpha was that I didn't believe it existed.
That's when the NASA scientist started playing hardball. First, he used his big brain to randomly generate 25,000 hypothetical stock portfolios. Next, he created a portfolio of his own, using David's proprietary, so-called "alpha-generating" model. Turns out the NASA guy's portfolio outperformed 99.4% of the random portfolios over the period.
Wait until you hear how he did it
Amazingly, that isn't what changed my mind. Before I tell you what did make me a buyer, you must be wondering what David Gardner and his colleague Jeff Fischer are feeding into his supercomputer to make it spit that alpha out. Oddly enough, it's you.
You see, David maintains that many smart, ordinary investors are smarter than any one "expert." He's been proving this in ad-hoc fashion for years. He used what he calls "community intelligence" to confirm his outlook on game developer Activision Blizzard (Nasdaq: ATVI ) , for example -- the pick has risen by more than 508% since. It was a similar story in 2001 with eBay (Nasdaq: EBAY ) and in 2005 with Intuitive Surgical (Nasdaq: ISRG ) , which has climbed by 598% since David gave the buy signal.
According to David, what's changed now is that he's found a way to collect his community intelligence on a mass scale and "quantify" it. In other words, he's transformed a disparate bunch of opinions, insights, and bits of knowledge from a vague signal into something a guy from NASA could stuff into a model.
The experiment that changed everything
We discussed how David's NASA portfolio outperformed 99.4% of 25,000 random stock portfolios. But if you're like me, that sounds like a lot of fancy numbers. Here's a second experiment that convinced me that he and his scientist might really be on to something.
This time, David's team applied its model to a handful of real-life portfolios -- namely, the stocks recommended in Motley Fool premium newsletter services. I like this approach for two reasons. First, these are real stocks, handpicked by real advisors in real time. Second, the folks who assembled these portfolios are good.
For example, when the analyst team ran the numbers in June 2009, David and Tom Gardner's Motley Fool Stock Advisor recommendations were up an average 32% since they launched the service in March 2002. That's darn good, considering the market was actually down for the period.
Yet when that "portfolio" of recommendations was optimized using just one filter from David's community intelligence model, the returns were boosted by another 15 percentage points -- and just as important, this was accomplished with significantly fewer picks.
This is no fluke
In fact, when taken across six different advisory services -- recommending stocks as diverse as Microsoft (NYSE: MSFT ) and Bank of America (NYSE: BAC ) -- the results held up. All told, David's "community intelligence" filter cut the number of picks nearly in half and increased the already blockbuster returns by an equally impressive 16 percentage points per pick.
So if you ever wondered how a NASA scientist would use your own intelligence to help you beat the market in theory, there you have it. Now, I'll show you how David Gardner proposes to do it in practice.
You may have heard that The Motley Fool has been collecting intelligence data from more than 100,000 visitors to The Motley Fool website. Last year, he assembled a team, including the NASA scientist I mentioned earlier, to help him analyze and back-test that data to see if it can consistently generate positive "alpha."
And he's done it!
Or so he assures me. David reports that he has finally tapped the collective intelligence of the world's smartest investors – and, more importantly, he can use this data to help you make money in your own portfolio. Here's how he plans to do it.
Along with longtime Motley Fool analyst Jeff Fischer, David has invested $1 million of his company's real money in a long/short portfolio of stocks, options, and exchange-traded funds. The idea is to prove that they can combine their community-intelligence data and portfolio-management skills to thump the market with that $1 million investment.
Why should you care? Well, here's the thing. Over the next six days, David and Jeff will invite a small number of investors to follow along with this unusual experiment in real time. They will even announce their portfolio trades in advance -- so that you can buy (or short) first. But be warned, spots will be strictly limited.
The goal is to protect and grow that million-dollar portfolio no matter what the market throws at us in 2010. This could be just the thing you need to make sure you do likewise. To learn more and be the first to receive a private invitation ahead of the crowd, simply enter your email address in the box below.
This article was originally published Dec. 24, 2008. It has been updated.