Dumpster Diving In The Stock Market

I’m hoping Paul, a Portfolio123 colleague of mine, doesn’t read this because I’m about to mention something he would likely find embarrassing. In the early 2000s, back when I was at Reuters, I interviewed him for a job as an analyst-blogger. I was intrigued when he told me his approach to finding stocks was to look for companies with “sustainable competitive advantages.” I had been lightly acquainted with him when we both worked at Value Line and he came highly recommended, so the interview was something of a softball exercise (and I suppressed the urge to laugh out loud). After I hired him, I promptly cured him of his addiction to corporate excellence.

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In Search of What?

I didn’t hold Paul’s philosophy against him because I knew how easy it was (and still is) for many in the investment community to get lulled into innocently spouting it without realizing the implications of what they’re saying. Excellence is for billable-hour consultants, motivational speakers, seminar sponsors and non-fiction authors.

Is excellence for real?

Excellence

Darned if I know. I checked up on In Search of Excellence, by Tom Peters and Robert Waterman, the 1982 title that was all the rage shortly after I got into the investment community. But its staying power seems to have been questionable. It has only 108 reviews on Amazon.com and 133 on Goodreads (which may or may not overlap). And although the Kindle version is fully priced ($13.99), if you want buy a hard copy through Amazon, you’ll have to settle for second hand copies priced below $2.00.

Still, the idea of excellence remains out there in the collective imagination of the investment community. We’re taught to love companies that grow, that are financially sound, that gain market share, that have pricing power, that have great management, that have . . . drum roll please . . . economic moats, etc. (How dumb a metaphor is the latter! Can you guess how many Medieval moat-protected castle-centered power bases survived? Answer: Zero!)

Yeah, although Peters and Waterman may be passé, excellence is still very much in among investors.

We’re Investors, Not Management Gurus

It looks like for the second post in a row, I’m going to have to invoke Shark Tank’s Kevin Oleary with a reminder that we’re here to “make money” (imagine the “o” being drawn out slowly). We cannot make money on excellence unless the stock can be purchased at a price that reflects market assumptions that the company is less than excellent. It’s OK if the market assumes pretty good, or decent. All we need is a gap between whatever the market assumes and what is real. That, essentially, is the basis for Joel Greenblatt’s Magic Formula.

By the same logic, we can make money on bad companies if the stock is priced on the basis of a market assumption to the effect that the company is horrifying or dreadful (or anything else so long as one can argue it’s worse than mere “bad”). And actually, if you observe the world long enough, you pretty much have to conclude that nothing stays the same. Everything changes over time. Accordingly, some of the stock-market money-makers can be found among shares of companies that progress from awful to merely mediocre.

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Disclosure: None.

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