Four ways to beat the market

Over the coming weeks, I’m going to share the secrets of four investment strategies that can improve the odds for any investor to substantially boost returns.

Everyone that invests directly in the shares of companies, whether seasoned pro or newbie private investor, wants to beat the market. A quick glance at the performance of the average actively managed equity fund tells us this isn’t easy. But certain investment approaches can radically increase our chances of success.

During a decade at Investors’ Chronicle magazine, I applied the four stock-picking methods we’re going to explore in UK markets in a simple and mechanical way. Stock screens I created produced stunning outperformance ranging from 242% to 388%.

The common-sense ideas that underpin the strategies draw on the most-recognised and well-tested sources of stock market outperformance: quality, value, low-volatility/dividends and momentum investing. 

Let’s briefly meet these four strategies, then in the coming weeks we’ll go into more depth to find out: (i) why each strategy works and the evidence of long-term outperformance; (ii) when the strategies have historically done best; (iii) traps to avoid; (iv) and then we will bring it all together by looking at the mechanics behind each approach.

Quality

Quality investing involves hunting for companies that make a lot of money from investments made in their own businesses. If such companies have an opportunity to grow, they can plough the cash they generate back into very profitable expansion.

Companies that do this grow shareholders’ wealth from an ever-larger base each year. These kinds of companies act like money-making snowballs, rolling down a hill and collecting an ever-increasing amount of “money snow” with each spin - a process known as compounding.

Value

Benjamin Graham - aka the father of value investing - introduced the idea of the manic-depressive Mr Market in his classic 1949 book The Intelligent Investor. His observation was that the market swings between extremes of euphoria and pessimism. The same applies to shares in individual companies.

Value exists when there is excessive pessimism towards a company and its shares. There can be huge upside from these situations when a recovery sets in and expectations readjust.

Low volatility/dividends

In investing, as in life, people love excitement and hate to be bored. This means we tend to overvalue risky companies promising high growth and undervalue low-risk, conservatively run, dull businesses. That makes the stock market one of the few places where taking less risk often results in higher rewards over time.

Many conservatively run companies opt to pay money out as dividends to shareholders rather than take the risk of reinvesting it in growth. This adds to the relatively steady returns a low-risk strategy has historically tended to generate. 

Momentum

When a share price has gone up, it can feel like we have missed the boat. However, one of the most exhaustively tested stock market phenomena is the habit of shares that have been rising fast to continue to do so.

This often reflects the fact that one good thing for companies leads to another. This can also be seen in strong and persistent trends in the upgrades brokers make to sales and profit forecasts for some companies.

Targeting share price and forecast-upgrade momentum can unearth genuinely exciting opportunities.

Lifting the screen

Over the coming weeks, as we look more deeply at each strategy, we’ll also explore stock screens I tracked over a decade while writing for Investors’ Chronicle magazine.

Stock screens simply look for companies and shares that display certain financial characteristics. By looking for the right characteristics, we can home in on stocks that are likely to fit with our market-beating strategies.

The screens themselves should be seen as a way of generating ideas for further research rather an end in themselves. I’ll list the UK stocks currently being highlighted by each screen as we go.

My book Four Ways to Beat the Market, published by Harriman House, provides more in-depth explanations of the four. It is also written to equip readers with an understanding of company accounts, financial ratios, and the equity investment research process, all of which is crucial for anyone investing directly in shares as well as building screens.

Investors don’t have to use stock screens to harness the powerful ideas that sit behind the four strategies. But for those who want to, screening offers a great starting point in the hunt for promising ideas, as well as a really good way to illustrate the type of things we should look out for to find stocks that fit each strategy’s brief.

Algy Hall is an award-winning journalist and author of Four Ways to Beat the Market which can be bought by ii readers from all good book shops including Amazon.