ASX Education: Knowing the unknown
In order to make any money in the stock market you need to focus on the unknown and stop wasting your time on the known. Every year the top and bottom performing stocks are not the stocks the market predicts most accurately, those stocks will hardly move, the big money is always in the stocks that the market gets most wrong.
In other words you will not make money knowing what everyone knows. You will not make money listening to an adviser telling you about consensus forecasts, PEs and yields, or calculating valuations based on accurate forecasts. All that is valueless, because it is in the price.
The only thing that will make you money is knowing what is not in the price and that means working out what assumptions the market has got wrong, not right, because as it turns out all the money will be made in the stocks that the analysts get the most wrong.
Think about it. It’s what everyone else doesn’t know that moves a share price. If BHP hits its forecasts it doesn’t move. If it surprises it does. In which case, to predict a share price, you have to accurately deduce or imagine the things that others haven’t.
There is a saying, “If you are not on the inside you are on the outside” suggesting that the stock-market is a Machiavellian plot run by the “smart money” which is taking advantage of the “dumb money” and that the only people making money are those with illegal inside information.
Laughably I used to work with a stockbroker who would exploit this desire for an inside edge by whispering everything on the phone like it was a secret. The fact that we had all heard the same story in the morning meeting was irrelevant, his clients thought they were special. Very effective.
But let me tell you, by the time you or I hear what purports to be inside or illegal information we are the bunny at the end of the chain. What sounds like inside information is often fabricated to serve a purpose, to move the share price and as one seasoned stock broker once said to me resignedly, “If I’d never been told any inside information in my life I’d be a million dollars better off”.
On the contrary the only “dumb money” is invested by the people who think that you can find stocks going up in price by looking at a spreadsheet of numbers everybody else has got. That’s pointless. Far better you go looking for your own insights, or your own legal inside information.
On this front, it may surprise you to know, that a lot of investors don’t realise they have their own (legal) inside information but are not bothering to exploit it. Ask yourself, what industry do you work in, who do you know who is doing well, what business are they in? It’s all out there in plain sight if you bother to look and ask.
So what do you know? Ask yourself that. Ask around. Keep your eyes open. Read. You’ll be amazed what you know that the stock market doesn’t.
One way to generate your own ideas is to stop reading, to pour yourself a cocktail and lie back and imagine. As an example of what you are looking for, imagine if you can that you could go back a year and leave yourself a stock market tip or two written on a Post-it note plonked anonymously on your own trading screen. What would it say? Two or three themes in the last year would have delivered you a great edge. Like “The government will attack the banks to get votes”, “China will not drop in a hole and resources will bottom”, “Amazon will kill retail sentiment”, “Milk powder will continue to fire”.
Now ask, what will next year's Post-it notes say? What themes and events can you think of that will appear or persist beyond the expectations of investors this year, themes and events that will surprise the market and make you or save you money? The answer is in that cocktail. Walk away from your screen, get outside the stock market zone, be the man in the moon for a moment, look down and see what everyone else is missing.
They might be things like “Interest rates will rise and REITs and Utilities will be a graveyard”. Or “Amazon will actually arrive and retail sentiment will not improve”. Or “The banks will outperform as rates rise, margins expand and sentiment turns”. That's where the money is. In Post-it note predictions.
Think in themes rather than stocks. Speaking of the man in the moon, we used to have a client who had “vision”. He was an Australian living in Asia who saw Australia somewhat more objectively than the rest of us. In 2004 to 2007 he made a fortune. Stocks he bought were getting taken over, had better than expected results, landed contracts. He was always ahead of the game. In the end he developed a following (without knowing), all the advisers on our broking desk were you hanging on his every move thinking that he must have some sort of inside feed. But there was no magic, all he had done, from his position as the “Man in the Moon” looking at Australia from Asia was to realise a year after it got going that China’s infrastructure build would need a lot more Australian iron ore and coal. So he simply trawled the Australian market for the highest quality coal and iron ore stocks and bought them. That was all he’d done. The theme came first, the stock selection was secondary. All the other stuff that happened, the takeovers, the better than expected results, the success, were simply a function of the theme and of those stocks being in the right sector whilst that big theme played out. The profit upgrades and takeovers we thought he knew about were simply a consequence of getting the big theme right. Good things happen in good sectors. Get the themes right, the stocks will pick themselves and the rest will follow.
I have eight other things that don’t waste your time.