Avoid the stock market casino by doing real company analysis

Fred Schwed was a professional trader who wrote Where Are the Customers’ Yachts? after losing a bundle in the 1929 stock market crash.

Maybe the modern equivalent of  Fred Schwed, having lost a bundle trading on zero fee brokerage systems, is today penning an expose of the worst shenanigans in the the stock market – using candlelight because his/her electricity has been cut off for non-payment!

People used to actually fund their retirement and kid’s education by diligently researching the fundamentals of a company and buying the company’s equity on the stock market. Warren Buffet did this so spectacularly well that he has also funded the retirement and kid’s education of many generations. Buffet is NOT a lone outlier; thousands did the same thing on a much smaller scale, researching the stocks of companies that made products that they liked and buying the company’s equity when it was fairly valued or cheap.

The reality today is that 75% of stock market trades are done by High Frequency Trading (HFT) computers and AI sentiment algorithms looking at words in a speech by central bankers and chatter from day traders on Twitter.

A lot of the remaining 25% is passive investing via ETFs and Robo Advisers.

To actually get humans doing hard core fundamental analysis, investors pay “2 and 20” (2% of funds under management and 20% of the capital gains aka profit) to intermediaries such as Hedge Funds and Private Equity.

Casinos give away free educational materials on how to beat the casino. They do this because the casino always wins or to quote Fred Schwed in 1929 “Where Are the Customers’ Yachts?”

Where on that spectrum from HFT (subseconds) to Buy & Hold (decades) are you most likely to make money? Or to ask it another way, where do you (as one human on a planet with over 7 billion humans) have an edge?

  • High Frequency Trading is good if you have a) a computer science degree b) a lot of capital. If you have both, read Flash Boys by Michael Lewis to get an entertaining manual. If you think you can compete without a lot of capital, read Flash Boys by Michael Lewis to get an entertaining warning to stay away.
  • Day Trading by humans is a losing game because the trading game is all about speed and computers are better than humans at speed. You can feel the rage of the day traders who get side swiped by the machines. As a  day trader, you simply choose which casino to give your money to. There is a big overlap between those traders who bought Tesla stock on Robinhood because it was “cheap” after a stock split and those traders who bought an ICO after reading a minimum viable white paper.

If you buy & hold, the casino makes very little money but they have to take your order.

Buffet’s most famous buy & hold is Coca Cola. It is an outlier. In this post I explain how Coca Cola Turn Secret Sauce Into Unfair Advantage.  There are not many companies like that, which is why Buffet’s Insurance cash cow is his real secret sauce as this interviewee explained to me in Zurich in 2017.

Today, with “software eating the world”, pure buy and hold is dangerous. The best place on the spectrum is buy & hold until something big changes. This recognises that a) change is a constant and b) even the best companies can get very overvalued and then it is better to sell. You don’t need a trigger finger, but nor should you dismantle the gun.

That buy & hold until something big changes type of investing has moved to private markets, to private equity (from VC to LBO). That is where the old fashioned analysis of company fundamentals takes place and that is where the money is being made. Private Equity (PE) investors might be comfortable waiting say 10 years for a return but they don’t wait “forever”.

The secret that many professionals don’t want you to know is that you can do what PE investors do in the public markets, if you are prepared to do some analysis. 

Investors who want to do their own analysis, need a bit of help. They can get this from XBRL, which can automate most of the fundamental analysis, without help from expensive Wall Street intermediaries.

Investors can use Fintech to take a passive or active approach. This is also a spectrum:

– Most passive is to invest in an ETF or Index Fund in your home market. For example, if you live in America invest in a S&P 500 tracker.

– Most active is to buy individual stocks.

In between these two extremes is:

– constructing a diversified portfolio from a number of different ETFs. For example diversifying by geography and market sector.

– Investing in a theme (such as Fintech) via a specialist ETF.

This portfolio construction using low cost ETFs is what Robo Advisors do well.

What we need is a genuine democratisation of markets that will enable millions of people to fund their retirement and kid’s education by diligently researching the fundamentals of a company and buying the company’s equity on the stock market. That is not rocket science. It is a simple information system problem plus the motivation to make it happen.

If you want to avoid giving your money to either casino, you can get a free meal in their restaurant. That is is what investors do. If you buy a stock and hold it for years, brokers make very little money from you, but they have to offer you the same price as the day trader gets.

Bernard Lunn is Editor and CEO of Daily Fintech and author of The Blockchain Economy

Daily Fintech’s original insight is made available to you for US$143 a year (which equates to $2.75 per week). $2.75 buys you a coffee (maybe), or the cost of a week’s subscription to the global Fintech blog – caffeine for the mind that could be worth $ millions.

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