Suppose we create a game where the odds are exactly 50-50 with added feature that 1% of the time the house wins arbitrarily. Perhaps a board with 99 even chances and one where rage house always wins.
If you bet a dollar 200 times, 99 times you get back two dollars and 99 times you get nothing. The other two times you get nothing. Your long run expectation is that you will get back 99 cents each bet. Not much of an edge but a durable one
The house always wins.
But only in the long run. The game wins for them by reason of a tiny edge repeated many times. That is the way the stock market can work too.
Establishing an edge.
Suppose we notice that a stock always has two values. Its business value and its market value.
If we knew business value we could wait until the market price is lower and then buy. When it is substantially higher, sell. Pretty easy. Except.
Business value is not so easy to know.
You must work at it. Knowing it at a point is reasonably straightforward, but that is if no great use. Recall you want to buy low and sell high. That takes time. So you must learn a little about dynamics amicable business valuation.
Much more complex.
- Competitors action
- Potential new competitors
- Obsolete product
- Financing costs
- New methods
- Government action
- Mistakes like Volkswagen’s diesel or Takata’s airbags
- Social media attacks
Market value might be knowable
Not with precision but there are clues.
Guessing future market value has to do with psychology. Investment sentiment in the market. How do my fellow investors feel about the situation. Optimistic and greedy, or fearful. Market prices are emotional and fact based.
You have the same facts as others and if you can be more emotionally organized and disciplined you can gain an edge.
Sell to the greedy and buy from the fearful.
In everything a tiny edge matters.
Slot machines are about 10% or higher against you. Very negative. Even the 1% advantage in our mind game above, is huge over time. If the customer starts with $100 and plays 200 times, he should expect to have less than $14 at the end of it.
The house would have a profit of $86. Small edge, big profit.
Investing with an edge works.
You don’t need a big edge, you just need a little one for a long time. There are edges you can learn. Objective type and discipline are two.
Skill at valuation can be learned. Special industry knowledge is easy enough. Pay attention to what is happening at work. Open minded to new ideas and new information is very useful. Things change.
An important aspect is to have the discipline to refuse situations where you do not know if you have an edge. That is what managing risk is about.
Did you notice the subtlety?
If you have an edge you don’t need to be able to predict the future, you only need to participate steadily. You don’t win every time but the trend line is in your favour.
Use any edge to your advantage. Don’t discount little ones.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772