Here's a humbling (and utterly meaningless) statistic: If you'd invested only in companies with single-letter tickers -- Agilent Technologies
More incredibly, companies with animal tickers -- Caterpillar
That beats the market by 19 percentage points!
But don't get me wrong. Neither buying shares of companies with single-letter tickers nor those whose tickers are animal names, cute as that last one may be, make for viable investing strategies.
Thank you, Captain Obvious
Nevertheless, there is buying in the stock market that takes place for reasons that are just as random or absurd -- even more so! Ever buy a stock on a tip from a spam email? A recent study showed that on the day when a spam email is sent out touting a penny stock, that stock was 13 times more likely to be the most actively-traded stock on the pink sheets.
On plaids and pinstripes
Then there are the investors who swear by technical analysis -- the strategy where one looks for patterns in stock charts in order to time buys and sells. Sure, there are people who have made lots of money this way. But that's why it's so dangerous. Like any successful investment strategy, it takes time, expertise, and patience to succeed. While the simplistic versions that are touted on the Internet may seem clear cut, that's almost never the case. The strategy relies on being able to detect patterns, and as Michael Shermer wrote in Scientific American last year, our brains are quite good at that. What our brains are not good at, however, is differentiating meaningful patterns from false patterns.
So if you make money on an uptrend one, twice, or even thrice, you might be tempted to start putting more and more money behind your buys. Unfortunately, if the pattern fails, you'll be out big. In billiards parlance, that's called getting hustled.
There's a better way
Lest you think I paint a dismal picture, know that there are ways to make money in the stock market that are not random. Most involve a bottom-up analysis of a business, an understanding of its financial statements, a conservative valuation of its prospects, and the patience to allow your analysis to run its course. This is how we find companies in our Motley Fool Hidden Gems investing service, and we're beating the market by 16 percentage points since our inception in 2003.
Today, I'd like to share with you a few of the traits we look for in outstanding investments:
- Founders or CEOs with large personal stakes in the businesses they run. We believe that a substantial ownership position and long management tenure help align the interests of business leaders and their shareholders.
- A stock that is mispriced relative to the strength of a business. By paying less than fair value for a stock, we believe that we significantly increase our ability to outperform the market over the next decade.
- Companies that are not actively followed by hordes of Wall Street analysts. We believe that by fishing where the big money is not, we gain an incredible informational advantage over the rest of the market.
To be sure, there are many other traits we look for, but these three can help make every investor a better investor.
The Foolish bottom line
In a choppy market like this one, it's more important than ever to make sure that your investments are made based on sound reasoning and solid math. This means ignoring stock tips and questionable schemes and focusing instead on time-tested, bottom-up fundamental analysis. If you'd like some help doing just that, consider joining our Motley Fool Hidden Gems service. In addition to specific stock recommendations, we offer daily updates, active and civil discussion boards, and updated lists of our best picks for new money now. Click here to learn more.