7th graders beat the market with simple principles

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Sep 04, 2011
Investing is really simple? Outperforming the market is that easy? Is it? If we, serious and patient investors follow the certain rules and not break it, we certainly can have fun with our investments in very joyful way.

Peter Lynch once described it in “Beating the Street” when he observed seventh graders pick their portfolio in 1990. Their teacher and the CEO of St. Agnes School in Arlington, Massachussetts, Joan Morrissey was inspired with the idea that you do not need Quotron or Wharton MBA, to be very good in investing in equities.

After two years period of holding stocks pick, around 15 positions in all outstanding companies with strong franchise and business models such as Wal-Mart, Nike, Walt Disney, Limited, L.A Gear, Pentech, Gap, PepsiCo, Food Lion, Topps, Savannah Foods, IBM, NYNEX, Mobil. And over 02 years, the portfolio has returned a gain of 70%, while S&P 500 gained only 26% over the same period. So the return outperformed the benchmark at the whopping nearly 3 times. And that performance at that time outperformed 99% of all equity mutual funds as well.

For the secret of the success, the group is invited by Lynch into the Fidelity’s executive dining room. Ms. Morrissey, explained that the classes divided into teams and each was funded with theoretical $250,000 then compete to each other to see what team can make the most of it. The students learn to read newspaper Investor’s Business Daily. Then they came up with the list of companies, did the research on each one, and checked the earnings and relative strength of the companies. She mentioned: “I try to stress the idea that portfolio should have at least ten companies, with one or two providing a fairly good dividend. But before my students can put any stock in the portfolio, they have to explain exactly what the company does. If they can’t tell the class the service it provides or the products it makes, then they aren’t allowed to buy. Buying what you know about is one of our themes”.

It is such a really simple idea, and as Warren Buffett often suggested investors “You should be able to write down on a yellow sheet of paper, ‘I’m buying General Motors at $22, and GM has [566] million shares for a total market value of $13 billion, and GM is worth a lot more than $13 billion because _______________.” And if you can’t finish that sentence, then you don’t buy the stock. All this requires some temperamental detachment from other people’s behavior. Both Charlie and I have a natural instinct in that direction. We value our opinions more than others’ — perhaps to an extreme!”

And buying what you know is really important concepts. It’s like you have to be very smart in the games to drive out all the competition. But if you get into the games you don’t know how to play, you are going to be beaten quite badly. It is one of the three legs of investment taught by Benjamin Graham and Warren Buffett: the circle of competence.

So the group of seventh-graders portfolio “manager” has the maxims in unison recorded in the tape sending to Peter Lynch. He mentioned that this should be the chorus that we should all memorize and repeat in the shower, to save ourselves from making the simple basic mistakes:

Ø A good company usually increases its dividend every year.

Ø You can lose money in a very short time but it takes a long time to make money

Ø The stock market really isn’t a gamble, as long as you pick good companies that you think will do well, and not just because of the stock price.

Ø You can make a lot of money from the stock market, but then again you can also lose money, as we proved.

Ø You have to research the company before you put your money into it.

Ø When you invest in the stock market, you should always diversify

Ø You should invest in several stocks because out of every five you pick one will be very great, one will be really bad, and three will be OK.

Ø Never fall in love with a stock: always have an open mind.

Ø You shouldn’t just pick a stock – you should do your homework

Ø Buying stocks in utility companies is good because it gives you a higher dividend, but you’ll make money in growth stocks.

Ø Just because a stock goes down doesn’t mean it can’t go lower.

Ø Over the long-term, it’s better to buy stocks in small companies

Ø You should not buy stock because it’s cheap but because you know a lot about it.