market vs. limit orders

I haven't read the article, nor will I, but it is my opinion that uninformed investors shouldn't be investing in individual stock issues. Investors who are unwilling to keep themselves informed about the individual companies in which they have ownership are better advised to purchase mutual funds.

Elizabeth Richardson

But doesn't this presume an Informed Investor as opposed to an Uninformed Investor?

Elizabeth Richardson

To implement the strategy, the investor needs to be aware of the low P/ E anomaly but not details about the indidividual stocks. Closely following dozens of stocks is not feasible for most non-professional investors, but running a stock screening program is not difficult.

A reading of Ken Fisher's "The Only Three Questions That Count" may convince you that the P/E ratio of the market, or individual stocks, is not a predictor of future returns. That scatter plots of P/E and return show no correlation that one can use to make money looking forward. His data, sourced from our friend Robert Shiller, shows an R^2 of .03 which, if my stats classes taught me anything, is close to random.

Note - I haven't stated I am convinced either way, I offer the above remark as 'recommended reading' (I need to add to my list) and the suggestion that conventional wisdom isn't always true. JOE (currently reading the new Greenspan book, in case you are wondering)

The efficient market hypothesis (even in its weaker forms) suggest that if the "everyday", "uninformed", or otherwise "average" investor began widespreadly engaging in this method, the method would no longer work. This can be evidenced by the decline of both the "small firm in January effect" and "dogs of the dow" strategy.

In this case, I would think that if everyone were seeking out the stocks that had low p/e ratios demand would drive up prices of those stocks up and destroy the strategy. To make things even simpler, if it is so easy to outperform the market/index, why do most people, in fact, not?

I am a value investor preferring low p/e and low p/b stocks. I did better than average over the past 3 years in 3 accounts (regular and two IRAs). The problem is that most of the value stocks are in the small cap category and the amount of stock in dollar terms is limited.

People aren't willing to invest in companies that they haven't heard about, so small caps don't attract the capital even if they have some good products.

-- Ron

There are many different kinds of mutual funds, doesn't it take expertise to pick the right ones?

-- Ron

The efficient market hypothesis (even in its weaker forms) suggest that if the "everyday", "uninformed", or otherwise "average" investor began widespreadly engaging in this method, the method would no longer work. This can be evidenced by the decline of both the "small firm in January effect" and "dogs of the dow" strategy.

In this case, I would think that if everyone were seeking out the stocks that had low p/e ratios demand would drive up prices of those stocks up and destroy the strategy. To make things even simpler, if it is so easy to outperform the market/index, why do most people, in fact, not?

I, too, cannot find the original post. Although I did find the article mentioned by doing a Google search.

--ron

Reasonable people can disagree in their expectations of the strength of the "value effect" going forward. It will fluctuate over time. Early 2000, a time when many investors were infatuated with growth stocks, was a good time to be a value investor.

I think it's because many individual investors do not diversify properly and do not follow a systematic strategy.

On Oct 17, 12:13 am, Ron Pthose

Congratulations. However, I was commenting on the OP's statement that EVERYONE, even the uninformed, could regularly outperform the market. A wealth of historical studies and the S&P Index versus Active (SPIVA) report has repeatedly shown that active funds have not kept up with their respective benchmarks. There are obviously funds that do outperform, and I commend you for your ability to choose them. Data suggest the Average Joe will not be so fortunate.

I agree that many investors prefer to go with the larger companies that they know. Investor aprehension is probably one of the reasons this strategy has historically worked. My point was that IF everyone began investing this way, as the OP suggested, simple economics would eliminate the "advantage". Everyone seeking out the limited number of stocks that have low p/e would increase demand and drive up the price, thus eliminating the ability to "get in cheap". A few investors that were ahead of the curve would still make a tidy profit, but the masses would not.

The real question should be that if everyone begins using your method (i.e. stock screeners), what then are you going to do to not become one of the unfortunate masses? I've read some novel insights on why the informed investor NEEDS the uninformed investor to maintain his market advantage (and profits). IOW, if everyone were exactly as smart and informed as you, how would you then "get in cheap" on an investment?

The vast majority of equity mutual funds are not run in the formulaic manner I was advocating, so this data is of questionable relevance. Also, an individual investor would not be paying management fees (but could be paying for screening software and data).

By the right ones, do you mean those that are high earners? I think it takes less expertise to pick a half dozen or so mutual funds and be successful, than it does to pick 20 or so individual issues and be successful. Also with mutual funds, the less one is willing to be involved with tracking progress, there are now a number of "buy it and forget it" types. You may hold your nose at these, but the OP was speaking of uninformed investors. I think even uninformed investors owe it to themselves to save and invest for retirement.

Elizabeth Richardson

"Ron Peterson" wrote

"Value stock" has a fairly malleable meaning, and so a lot of gray area exists. I would not generalize that most "value stocks" are in the small cap category without qualifying further.

I think they do attract the capital. Some of the evidence lies in the fact that micro-small cap companies often grow quickly to mid cap or larger companies. It's one reason why micro-small cap stock mutual funds tend to have difficulties staying micro-small.

"kastnna" wrote

A small cap strategy, when applied long enough, has done even better, historically.

I think what is more accurate is the observation that any long term strategy of buying a fairly diverse basket of stocks will work. Proposition: We need to get away from trying to plug strategies other than holding diversely and for the long term.

I increasingly think my investing success has indeed been due to there being a lot of fools investing; buying baloney products (I own Phillip Morris); selling low and buying high; etc.

IIRC sage Ben Graham touches on how his "value stock" strategy depends on panics, which of course are fueled largely by the naive.

"Tad Borek" wrote

So he was wrong to set a limit order at a price somewhere between $65 and $69?

In the long run, he'll be fine, and even a little better off than the guy/gal who bought at $69.

I set good-til-cancelled orders frequently (though in the last year or so, on less than three stocks on any given day). A minor, mass panic occurs sometime (one that is related to the stock market as a whole and so mass hysteria as opposed to the particular company), and I grab up a deal. Of course if the price falls further, I "coulda" had a better deal. So why do I do this? Because the better deal requires 20/20 hindsight and so is a figment of one's imagination. No one can say with any statistical confidence how much further a stock will fall when there is a panic. As a stock is falling in price, only numerology will forecast the actual, exact, /best/ price at which to buy. As a well-read person knows, this sort of forecasting depends on the alignment of the stars (that is, luck).

The point is to pick up a stock at what one thinks is a reasonable enough price. Fortunately, time has proven that not getting enmeshed in woulda-coulda-shoulda ("Gee, I could have been wealthy if I only bought xyz... ") and just being patient pays.

Especially if one narrows the field to one or two companies and just follows a simple asset allocation and uses a couple of low-cost index funds. The universe of thousands of funds collapses to, say, 20 or so. (ie. vanguard or the fidelity index funds).

And many of them would do way better to simply choose one of those target retirement or simple balanced funds and set it and forget it than they'll ever do chasing performance, juggling asset classes, etc etc.

It doesn't have to be difficult. There's a huge business to be made *convincing* folks that it has to be, though.

A relative novice can put together a very simple portfolio with a very small handful of funds (perhaps with a little bit of help) and manage/rebalance it yearly fairly trivially. I do *not* believe the same can be said of doing so with individual stocks.

Even the most simple portfolio of individual stocks - say

20 or so pulled up mechanically by a screen - will require orders of magnitude more management than a simple index fund asset-allocation portfolio. I'd be very surprised if things like tax-loss harvesting can be profitable enough to justify this for a relatively passive investor unless that investor has a very high income, a lot of wealth, and most of it in taxable accounts. And in that case, chances are he or she has more profitable things to do with his or her time, too, except for a very few very very wealthy.

Because it was a cash buy out offer, the long run does him no good. He was basically buying $65 cash for between $65 and $69 dollars. Not a road to riches.

-- Doug

Elle, he was wrong to place a GTC without monitoring the company for news, because it turned him into an "uninformed" trader and resulted in a trade with a guaranteed loss. That's a contention of the study Beliavsky posted, that limit orders placed by individual investors get executed, despite news that would make a rational order-placer adjust their limit price. And the reason is simply that they're not watching the company while the GTC sits out there.

Most instances of "uninformed" investors, whose limit orders reflect stale information, will be much more subtle and leave room for interpretation of how much it affects the fair price. The cash merger is an easy example because the "guaranteed loss" is clear-cut. No rational investor will place a trade that leads to a guaranteed loss, and if the merger is $65/shr anything above that is such a trade.

If this effect happens a lot, and especially among individual investors, perhaps the contention of the study is correct -- that it's a contributing factor to the sub-par returns observed among individual investors who pick individal stocks (these studies have been discussed many times on MIFP).

If I read your post correctly, you may not be monitoring company news while you have a GTC limit order open, which reinforces their point. If so, it has a simple solution -- as Beliavsky said -- just keep an eye on the news while a GTC sits out there, and be ready to cancel or adjust it if something big happens (like a cash merger at $10 below your limit price).

-Tad