I found that nearly everything was fairly valued. When a stock had a low P/E, it was nearly always for a reason, like it being a homebuilder or financial or having a shaky economic position. No way was I going to invest in those. When I did invest in one that looked like it didn't fit in those categories, they missed earnings the next quarter, reported a loss, and haven't gotten back to profitability yet. Again, the market was smarter than me.
The trick to making money in the stock market seems to be to invest when the big boys are constrained not to. They realize that they should be putting money in, but can't, for whatever reason. The best example is if they're a mutual fund and their clients are all pulling their money out. Doesn't matter how many bargains are out there, they still have to sell to honor redemptions.
As I tell one of my hedge-fund-employee friends, "You're only as smart as your dumbest creditor."
Eg. you think Morgan Stanley is dirt cheap at current levels ($10) and you are willing to invest $100,000 in them.
Action 1: You bought $100,000 worth of MS shares at $10 each
Action 2: You bought $90,000 in bonds that yields 11%. You bought $10,000 worth of Jan 2010 MS 5 call options at $7 each.
Scenario 1: MS gets nationalized or goes bankrupt Action 1: You would have lost almost all of your $100,000 investment. Action 2: If you hold out until your bond mature, you'll get back your $100,000 principal after 1 year. Your options is worthless.
Scenario 2: MS goes up to $30 Action 1: Your investment is now worth $300,000 Action 2: You get $100,000 from your bonds and your $7 options is now worth $18. So your investment is worth $125,000.
So Action 1 is very volatile and risky. Your profit range from -100% to 200%.
Action 2 allows you to sleep soundly at night, even during current market conditions. Your profit range from 0% to 25%. Hey not bad at all. In the worst case, you'll have at least preserved your capital.
Woopsie daisies.
Option 1 Average ROI = 50%
Option 1 Average ROI = 12.5%
The probability of MS getting nationalized or going bankrupt is 90%. So it's 0.9 * 0 + 0.1 * 3 = 0.3 = -70%.
Whoops.
Fear is, for the moment, outweighing greed.
Does this still hold in light of the stock market crash this last week?
http://www.economist.com/finance/displaystory.cfm?story_id=E...
So... it seems as if people really do think of everything - why wouldn't they, with millions or billions on the line. What hope does an individual have?
More than you think. Especially if you change your attitude towards the problem a bit ;-)
A whole lot of people support themselves by trading successfully. The thing is, making decent money by trading is a full time job, not an after-hours hobby.
You CAN make money designing trading strategies. People do it. The question is simply whether the EV returns on your time will be higher than working on an actual job or businesses. Someone smart enough to make a winning trading system is also smart enough to get paid a lot in other endeavors. So more often than not it's a wash. Except traders get to work in their underwear...
Going to an index is usually a safe bet. I think it still is. But that's long term. You could end up waiting ten years just to double your money. I'm just talking about a quick hit. Now you could combine the approach and go with an sector index. But the more you spread it out the more of a slow response you're going to get, in my opinion.
> So I'd be looking for value stocks that have a P/E ratio that's overly low
The thing that makes me nervous about that kind of thing is that there are people who have written code that knows a lot more than my sum total knowledge of the stock market to look for those sorts of factors. Given actors like that, is there any reason to invest in anything but broad index funds?