A Simple Way To Gain An Edge Over The Market

In 2011, Jeff Bezos, the founder and CEO of the US online retail giant Amazon.com, was interviewed by Wired. During the interview, he said (emphasis is mine):

“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that.

Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.”

What’s an edge?

I believe Bezos’s quote above applies to stock market investing too. By simply lengthening our time horizon when investing, we can gain an edge and eliminate our competition.

Investor John Huber from Saber Capital Management, who has an excellent – albeit relatively short – track record,  explained in a 2013 presentation that there are only three sources of edge: Informational; analytical; and time. I agree.

A difficult source of lasting edge

The informational edge refers to having access to information that most others do not have. In his 2013 presentation, Huber shared the story of how Buffett uncovered Western Insurance as an investment opportunity in the 1950s.

Western Insurance was a profitable, well-run insurance company and was selling at a price-to-earnings ratio of just 1. Buffett found the company by poring over Moody’s, a print magazine that listed financial statistics of stocks in the US. It would have been painstaking work in those days to look at every stock individually.

With the birth of the internet, the informational edge has mostly disappeared since information is now easily and cheaply available. The Internet – and the growth in software capabilities – have levelled the information playing field tremendously. This makes having access to information difficult to be a lasting investing edge for us.

Another difficult source of lasting edge  

The analytical edge is where you’re able to process information differently and come up with better insights compared to most. I believe, like Huber does, that this is still possible. Give two investors the exact same information about a company and it’s highly likely they will arrive at a different conclusion about its attractiveness as an investment opportunity.

As a great example, we can look at Mastercard and how investors Chuck Akre and Mohnish Pabrai think about the credit card company.

Akre runs the Akre Focus Fund, which has generated an impressive annual return of 16.8% from inception in August 2009 through to 30 September 2019. Over the same period, the S&P 500’s annual return was just 13.5%. Pabrai also has a fantastic long-term record. His fund’s annual return of 13.3% from 1999 to 30 June 2019 is nearly double that of the US market’s 7.0%.

At the end of September 2019, Mastercard made up 10% of the Akre Focus Fund. So clearly, Akre thinks highly of the company. Pabrai, on the other hand, made it very clear in a recent interview that he wouldn’t touch Mastercard with a 10-feet barge pool. In the October 2019 edition of Columbia Business School’s investing newsletter, Graham and Doddsville, Pabrai said:

“Is MasterCard a compounder? Yeah. But what’s the multiple? I can’t even look. Investing is not about buying great businesses, it’s about making great investments. A great compounder may not be a great investment.”

The fact that two highly accomplished stock market investors can have wildly differing views on the same company means that it is possible for us to develop an analytical edge. But it is not easy to achieve. In fact, I have a hunch that the ability to consistently produce differentiated insight may be an innate talent that some investors possess and others don’t.

A simple but lasting edge

Huber’s last source of edge, time, refers to our ability to simply adopt a long time horizon in the way we invest. It sounds simple, but it’s not easy to achieve. Because like Bezos said, not many people are willing or able to be patient. This makes time a lasting edge we can have in the market.

You may be surprised to know just how short-term minded many professional investors can be. A recent article from Huber showed how the hedge fund SAC Capital was predominantly focused on short-term stock price movements (emphasis is mine):

“The firm spent hundreds of millions of dollars they collectively spent on research [sic] was all designed to figure out if a stock was going to go up or down a few dollars in a short period of time, usually after an earnings announcement or some other significant event.

These traders were moving billions of dollars around with no concern for what the company’s long-term prospects were, other than how those prospects might be viewed by other traders in the upcoming days…

… The traders at SAC weren’t even discussing this type of edge [referring to the time-related edge]. It wasn’t even on their radar, because they had no interest in the long game.”

Another example can be seen in a story that Morgan Housel from the Collaborative Fund shared in a blog post (emphasis is mine):

“BlackRock CEO Larry Fink once told a story about having dinner with the manager of one of the world’s largest sovereign wealth funds.

The fund’s objectives, the manager said, were generational. “So how do you measure performance?” Fink asked. “Quarterly,” said the manager.

There is a difference between time horizon and endurance.”

Since many investors are more concerned with short-term price movements than long-term business value, this creates an opportunity for us if we’re focused on the latter. In the same article on SAC Capital, Huber explained:

“[T]he investor who is willing to look out three or four years will have a lasting edge because the more money that gets allocated for reasons other than a security’s long-term value, the more likely it is that the security’s price becomes disconnected from that long-term value.” 

The curse of patience, and a switch in mindset

Although having time on our side is a simple way for us to gain a lasting edge in the stock market, it is not easy to achieve, since we have to pay a price – of enduring short-term volatility. History bears this out: Even the biggest long-term winners in the stock market have also suffered painful short-term declines. 

Take the US-listed Monster Beverage for instance. I’ve written previously that from 1995 to 2015, Monster Beverage produced an astonishing total return of 105,000% despite its stock price having dropped by 50% or more from a peak on four separate occasions in that timeframe.

But a switch in our mindset can make the sharp swings over the short run easier to manage. “Fees are something you pay for admission to get something worthwhile in return. Fines are punishment for doing something wrong,” Morgan Housel once wrote. Most investors think of short-term volatility in the stock market as a fine, when they should really be thinking of it as a fee for something worthwhile – great long-term returns.

So, fee or fine? I love paying fees. Do you?

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.