William Bernstein, is his book The Intelligent Asset Allocator, made me ponder this when he profoundly stated:
“Good companies are generally bad stocks, and bad companies are generally good stocks.”
You may remember the best selling book back in 1982, In Search of Excellence, by Tom Peters. This book objectively discussed the characteristics of what Peters considered the best companies at the time. Peters cited 40 companies who, by his criteria, were “excellent” companies.
In 1994, a researcher named Michelle Clayman from Oklahoma State took the same criteria and made a list of “unexcellent” companies or, in other words, companies which would have scored the lowest based on the criteria set forth by Tom Peters.
Clayman discovered that if an investor would have bought one portfolio of excellent companies and another portfolio of “unexcellent” companies, the “unexcellent” portfolio would have outperformed the excellent portfolio by an amazing 11% per year over the next five years!
Similar evidence is apparent in the Dogs of the Dow Theory. The dogs, as represented by the ten highest dividend yielding stocks, have generally outperformed the overall Dow 30.
This notion may be at the heart of why so many professional money managers and individual investors under-perform versus their benchmark. As William Bernstein stated:
“No matter how many finance journals they read, they cannot bring themselves to
buy bad companies.”
Indexed-based Exchange Traded Funds do not take a position on whether the companies in the underlying index are good or bad. They have a broad representation of both “excellent” and unexcellent” companies.
The positive stock market move in recent years has made a lot of professional managers look smart. But do not be fooled. Ask the question, “How much of the return generated by a money manager or mutual fund can be directly attributed to the underlying market?”
You may be surprised when you discover that the underlying market actually produced higher returns than most active money managers and mutual funds!
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