The Guru Investor Blog

Paul and Simms look at some of the behavioral biases that underpin value investing approaches, including loss aversion, trend extrapolation, and short-term focus. All of these factors, they say, have been on display since 2008. “Investor loss aversion was heightened by the severe crash of 2008 and the ensuing volatility,” they say. “An abundance of bad economic and corporate news has made erroneous trend extrapolation even more ubiquitous. And as markets have lurched from crisis to crisis, with recurrent spikes in volatility, investors’ time horizons have become extremely short.”

Over the longer haul, however, these biases “are likely to eventually correct themselves and reward investors who have stuck to their knitting and dared to defy the crowd,” Paul and Simms write. They say, in fact, that many of the recent changes in the market — lower trading costs, technology that makes it easier to buy and sell stocks, and the instantaneous availability of information — “promote emotional reactions by investors”. Because of that, they say they believe “that traditional research-driven behavioral investing makes more sense than ever in the 21st century.”

Tagged: John Reese, Validea

“While the broader economy continues its muddle-through advance, many individual companies are putting up some very impressive growth numbers,” Reese writes. “And with so many fearful about the overall economy, a lot of these fast-growing firms’ shares are available for significantly cheaper than they might otherwise be.”

Reese says his Guru Strategies, each of which is based on the approach of a different investing great, have been finding a number of growth plays lately. He looks at five of them, including MWI Veterinary Supply.

“A deliberate, lifelong effort to find people to tell him why he might be wrong is one of the keys to Mr. Buffett’s success,” Zweig writes on WSJ’s MoneyBeat blog, discussing how Buffett took the rare step of inviting questions from a bearish investor at Berkshire Hathaway’s recent shareholder meeting. “It doesn’t come naturally to most investors.” (Hat tip to The Stingy Investor for highlighting the piece)

Buffett, Zweig says, once noted about scientist Charles Darwin that “whenever he ran into something that contradicted a conclusion he cherished, he was obliged to write the new finding down within 30 minutes. Otherwise his mind would work to reject the discordant information, much as the body rejects transplants. Man’s natural inclination is to cling to his beliefs, particularly if they are reinforced by recent experience.”

Dalio, meanwhile, believes in “thoughtful disagreement”. He told Zweig that “when two intelligent parties disagree, that’s when the potential for learning and moving ahead begins. The most powerful thing that [an investor] can do to be effective is to find people you respect who have opposite, different points of view [from yours] — and have an open-minded exchange with them about what’s true and what to do about it.” Dalio says investors could improve their chances of being right by 30% to 40% by seeking out those who disagree with them in an intelligent way, and trying to understand the opposing argument.

Cabot Research Chief Executive Mike Ervolini recommends that investors look back through their account statements to see how long it typically takes for their average winners to stop outperforming. When future winners reach that average, he says to seek out a contrary opinion to re-evaluate whether the stock is still a good one to hold.

Hulbert writes in The Wall Street Journal that it’s been “nearly impossible lately” for investors to consistently beat index funds, and just as difficult to predict which managers will be able to do so. “Consider the 51 advisers out of more than 200 on the Hulbert Financial Digest’s list who beat the market in the decade-long period that ended April 30, 2012, as measured by the Wilshire 5000 Total Market index, including reinvested dividends,” he says. “Of that group, just 11 — or 22% — have outperformed the overall market since then.”

Hulbert says that computerized trading has been winning out over traditional advisers in large part because computers can process vast amounts of financial data very quickly, which most people cannot do. He also says that investors “unwittingly let their emotions dominate their intellect”, something that is not a problem for computers. He references the work of behavioral finance pioneer Daniel Kahneman, who, in his 2011 book “Thinking, Fast and Slow,” reviewed more than 200 academic studies that analyzed competitions between human beings and mechanical algorithms. Whether the subject was medicine, economics, business, psychology, sports predictions, or the quality of Bordeaux wine, “the accuracy of experts was matched or exceeded by a simple algorithm,” Kahneman said.

Hulbert says all this means that investors should trade as infrequently as possible. Computer trading now dominates Wall Street so much that even professional managers “will lose out to them over time”. He recommends low-cost buy-and-hold index funds.

Hulbert does say that there may well be a place for human investors amid an increasingly computerized Wall Street. Brad Barber, a finance professor from the University of California, told him that computers cannot do some things, like determining whether a pattern makes sense. “If you don’t understand the reason for a pattern, you’re vulnerable to following a mindless algorithm that is quite likely to perform poorly,” Barber said.

In his latest Forbes column, Oberweis says that small-caps (those with market caps under $1 billion) that are growing both earnings and revenue at a pace of 30% or more are trading at a median forward earnings multiple of just 13, well below the 10-year average of 17. “Some of the difference may be explained by slower growth expectations for the overall economy, but some of that discount stems from good old-fashioned fear,” Oberweis writes.

He says he thinks smaller stocks will fare “considerably better” than large-cap value stocks going forward. He offers four of his current favorite small-caps, including Stamps.com.