To Those Looking To Invest In Stocks (Part 1)

Hi Mel and Jesse, and everyone interested in stocks....

When you get me talking about stocks, I can get pretty excited. I really enjoy the stock market!

I'm going to say something a bit controversial, though....

I started looking into the stock market in 1996, and tried to read whatever I could. Fortunately, early on I came across a textbook....

Unfortunately, I don't remember the name of this finance textbook. But what I remember is what it said....

This textbook mentioned a university research study which had been published in the 1980s. It compared the results from a variety of stock trading methods....

I think they evaluated them for a year or possibly two. From what I remember, they picked stocks using several methods, including Technical Analysis, Elliot Wave theory, Benjamin Graham's approach, etc. etc.

Out of these, they found that ALL these techniques were NO BETTER than throwing darts at a board. (That is, they did no better than choosing stocks at random.) Every single technique! EXCEPT for one....

That single exception was the approach used by Benjamin Graham. That's the approach I've mostly been talking about, where you find "undervalued" stocks....

Warren Buffett was Benjamin Graham's student, both at university and he also worked for Benjamin Graham after he graduated. He's modified Benjamin Graham's method, in that Warren Buffett narrows down his search to "growth" stocks (which are growing in their earnings) which have strong monopolies or brand names....

However, to me this was enlightening. Technical analysis, for example, is a very widespread method. On the basis of what I've read, I don't believe it works. (That's the controversial part.)

In fact, I think because they make mistakes, these traders often drive the price of stocks down too low, or up too high. When they're down too low, an "intrinsic value" investor will buy. When they're up too high, an "intrinsic value" investor will sell (and make a profit).

An "intrinsic value" investor makes money from the "mistakes" that many others make in the stock market.

The bottom line is.... Looking at "intrinsic value" works!

So why are all these other methods still around? Here's why I believe they are....

An "intrinsic value" investor buys and sells infrequently, because they will hold on to their stocks for several years (typically). That's bad news for the stock brokers, since they make their money through commissions on every trade....

On the other hand, approaches like Technical Analysis encourage frequent trading! So, I believe that....

Stock brokers are probably encouraging these other methods!

That's because, by doing so, they increase their own profits.

That's why I believe you should take your stock broker's advice with a grain of salt. I don't believe they are impartial. It's better to master "intrinsic value" investing and make your own decisions (or find an impartial financial advisor who has mastered it, though I'm not sure if there are many of these around).

- Dien Rice