Nobody's better than academics at creating theories that are scientifically supported, sensible, creative, and completely useless when it comes to the real world.
Take the academic perspective on the correlation between risk and stock market returns. To an egghead, the higher the risk, the greater the returns. To outperform the market, buy the riskiest stocks.
How do these guys arrive at this conclusion? Using back testing. Take all the stocks in the universe, divide them into groups based on risk, and see which group did the best.
Now, call me a Fool, but that sounds to me like the way a computer, not a person, would manage a portfolio. Why arbitrarily buy a fifth of the stocks in the entire market when you can cherry-pick the best? And with individual stocks, low risk can equal high return.
A simple principle
This is true because each stock has an intrinsic value. The farther a stock descends below its fair value, the less likely it is to fall farther, and the greater the upside when it bounces back to what it's actually worth.
Apple isn't the only example. Most great investors use this technique to achieve their extraordinary returns. I'm thinking here of Warren Buffett with Moody's
So, if you're looking for the sweet spot where you get both lower risk and higher returns, look for stocks trading at a discount to their fair value. Inside Value can help you find them. Click here to learn more.
Fool contributor Richard Gibbons is a member of the Inside Value team and considers it risky to go anywhere without an umbrella. He does not have a position in any of the companies discussed in this article. The Motley Fool has a disclosure policy.