No, that's not what mr. T is saying. He's saying that there are some stocks in indices that are overvalued, and he doesn't want to invest in those.
He is saying that in addition to what I quoted him as saying.
The problem with arguing that some stocks in the index are overvalued is that it implies you know better than the market. Yet we know that almost no one knows better (with the exception of the oft-sighted Mr. Buffet). The track record of professional investors simply does not bear out the notion that it's plainly obvious that some companies are overvalued and others undervalued. It's not enough to chalk it up to a lack of discipline. I mean really, there aren't a few more disciplined guys out there other than Warren Buffet?
market caps are much worse measures of a company than sales, earnings, or book value.
Perhaps. Care to offer a citation? This again implies that some simplistic measures of value are smarter than the collective "wisdom" of the market. I suspect such indices would outperform during bust periods and underperform during growth periods.
I could have written a much longer response to Mr T, but he touched on about ten major concepts and we'd quickly get into a debate about things like different forms of the efficient market hypothesis, which I have little interest in hashing out.
I'll broadly agree with Mr T that the best opportunity for individual investors to beat the market is to do in-depth research on small, illiquid, inefficient financial instruments where you're not going head-to-head with major institutional investors. This is, in fact, more or what I do for a living. However, even this takes a fair amount of financial acumen that goes beyond looking at simple metrics like P/E ratios and book value.
There is one thing on this board that I think is odd. On the one hand there's a very strong DIY mentality. The Mustache Man himself does some pretty advanced car maintenance based on watching a couple of youtube videos. I would be terrified to drive a car that I have been mucking around with after watching youtube. There's a tendency to claim that you can be badass at almost anything just by reading a book from the library, watching youtube videos and putting some effort into it. But with one exception: stock market investing. On this one single subject the Mustache Man makes a 180: you shouldn't even try, just buy a Vanguard tracker and forget about it. I think that's strange. Or maybe not as strange: maybe it's just a subject that this guy is not interested in. Maybe he's interested in building houses and reparing cars, but not in picking stocks. Fair enough. But the fact that the Mustache Man isn't into stock picking doesn't mean that
no-one can do it properly.
You guys assume the big majority of the population sucks at almost anything: they can't run their personal finances properly, they eat too much and too unhealthy, they pay people to walk their dog, they have clown-like car habits. But at the same time, in stock market investing, the wisdom of the crowd is supposed to be invincible. Again: strange.
Let me use an analogy: there's a huge number of people playing the piano. The vast majority is crap at it. Only a very small percentage can make a living out of playing the piano. Those people have a natural talent and beside that, they put a lot of effort into it. But no-one would claim that putting effort into playing the piano is useless because "most people suck at it". Of course, the odds that you're the next Horowitz are small, but no-one would claim it's impossible. For some reason stock market investing is supposed to be different.
Of course there is something different about stock market investing: it's possible to get mediocre results without any effort. And that service is cheap. That's amazing. If someone would invent a service that would guarantee anyone to be able to play the piano at a mediocre level without any effort, this service would be a scam or very expensive (or both). But with investing it's dirt cheap. That's why I say: if you don't feel like it, just buy an ETF. If you want to do better, that's possible (I didn't say it's easy), but you will have to put some effort into it.
Yes, I do imply that it is possible to know better than the market. Now you state that "professional investors" do not have a good track record of doing that. I will tell you why.
1- There are quite a few of them that do. Only that's a minority. Just like with any profession, there's a small high-end that's really good and a big low-end that essentially consists of salaried office workers who are just good enough not to be fired.
2- Professionals have a fixed cost basis that they have to recover before they start making money: there's their own salary (and salaries tend to be pretty high in this industry), there's corporate overhead, an office building, a Bloomberg subscription etc. For a private investor, the fixed cost base can be close to zero. That's a huge advantage.
3- Professionals are chased by their bosses to produce results on a quarterly basis. This induces short-termism that's very harmful on the long run.
4- Many funds have captive customers. There's huge amounts of money in funds that are tied to mortgages, life insurance policies, pensions and the like. Situations where the customers are bound by long-term contracts and getting out is prohibitively expensive. Not a very strong incentive to invest your socks off for an optimal result. But a very strong incentive for the company to just let some junior grunt do the investing for minimal costs.
5- Many funds are marketing-driven. When internet and tech were hot, every house started an internet and tech fund. When BRIC was hot, everyone started a BRIC fund. Do all houses have the specialised knowledge to get it right? Of course not. But they start such a fund anyway, just to get a piece of the pie.
6- Professionals get sucked into crazes too. It took a person with the stature of Warren Buffett to resist the internet craze. And even he was considered to have "lost it" because he didn't invest in tech back then. What if you are Mike, fund manager of a generalist equity fund at a medium sized bank in a medium sized state? Even if Mike didn't want to, he would be forced to be sucked in. Because he would be instantly fired if he didn't invest in tech. And because Mike has a mortgage, wife and children in college, he doesn't want to be fired. So he does what his boss expects of him and he goes with the flow.
7- The customers of the professional investors are lazy and the investment houses know this. A large amount of private investors just take the standard funds that their bank offers them. Of course, those are the funds that are good for the bank, not necessarily the funds that are good for the customer.
All these factors drag down the average performance of professional investors as a group.
And I didn't say that "some simplistic measures of value" are enough. If a company has a low p/e, there's a very good chance that there's a good reason for that. But there's also a good chance there isn't. To tell the difference, you have to dig deeper. It's easy to artificially pump those simplistic measures. So you always have to investigate where that fantastic growth is coming from. And why this company is so profitable.
A simple example. For fast growing companies, it's easy to pump growth by stuffing the sales channel. In the past, there was a company that sold their product to partly-owned distributors and booked it as sales. Easy peasy. Until the system broke down of course. But anyone could have detected that, by looking at the debtors in the yearly report, that ran up just as fast as sales. But most investors just looked at the headline growth figure and fell for it. Wisdom of the crowd. Yeah right.
Another example. Big oil companies essentially pump money out of the ground. They're very profitable, and have been consistently so for a very long time. Still, their shares are cheap. If you ask why, you will get a long treatise about Middle East politics, peak oil theories, troubles in Nigeria and many more things. But all that shit has been around for decades and still those companies are cash-fountains. I don't think there is a very good reason to assume that will end soon. So I just cash an easy 5% dividend. Again with thanks to the wisdom of the crowd.