How to Beat the Market
Jan 09, 2014 | Shirley M. Mueller, MD
Financial heavyweights Eugene F. Fama and Kenneth R. French are sharing some very important information from their data: it is how to beat the market. When the two speak, it is similar to the old E.F. Hutton commercial, “When E.F. Hutton talks, people listen!" Just change the name to Fama and French.
Fama won a Nobel Prize Winner in 2013 in economics and is a Professor of Finance at the University of Chicago Booth School Of Business. French is a Professor of Finance at the Tuck School of Business at Dartmouth College.
Research from two academics suggests there are sure ways to beat the market. Photo from iStock.
The areas of investing that the two academics identified as exceling over other sectors long term are value, momentum and quality.
A value stock is a company with firm fundamentals priced below its peers, which is based on price/earnings ratio and yield plus other factors. A momentum stock is one that is moving upward rapidly judged by technical market analysis. This type of analysis does not endeavor to determine intrinsic worth used by value forecasters. Instead it uses market statistics such as past prices and volumes to identify patterns that might predict future stock activity. Day traders often participate in buying and selling momentum stocks. A quality stock is one that consistently increases dividends and has steadily rising revenue along with earnings.
Of the three, value and quality stocks are more approachable for individual investors as neither requires knowledge of technical analysis needed for momentum investing.
According to Investopedia, a good example of a value stock in 2013 was Macdonald’s (MCD). Their logic:
“This stock was trading at around $90 per share in January 2013, and some analysts felt that the stock was properly valued at $97 a share due to its projected 5% growth of corporate revenue and 9% growth of company earnings. By July 2013, the stock reached this target price.”
Interestingly enough, this stock is also considered a quality stock because it has a high yield of 3.4% which has consistently increased along with earnings. Other quality stocks are cited on the Kiplinger website.
Investing in mutual or exchange-traded funds that are value or quality is another way to go. Of course funds without loads are more cost effective as well as passive funds that do not have the actively managed funds expenses. One such value mutual fund that is passive is Vanguard Small-Cap Value Index Fund (VISVX). A dividend-producing exchange-traded fund that is passive is Vanguard High Dividend Yield Index Fund (VYM). There are many others, of course, which simply requires a search on the internet.
My perspective is that it is hard to acquire unbiased information on how to beat the market that these two academics provide. Most of the time, it is someone with a vested interest who is promoting his or her stock or fund.
For this reason, "When Fama and French talk, people listen!" Or, at least a lot of investors do.
The Nobel Is No Crystal Ball