My observation has been that analysts, money managers, OPMIs, bloggers, etc., cannot consistently select issues with above-market returns. I believe this is due to a feature inherent to all parimutuel systems, viz., calculations of expectancy should vary only slightly from one person to another—with any major difference resulting from some unknowable factor. The selection of securities is often akin to a shell game.

We should not conclude from this that securities markets are strong-form efficient. On the contrary, investors with access to material non-public information have earned high returns without bearing commensurately high risk. In 1925 Ben Graham learned that Northern Pipeline—selling at only $65 per share—had “$95 in cash assets for each share, nearly all of which it could distribute to stockholders without the slightest inconvenience to its operations.” Major brokerage firms were never aware of this information; Graham found it at the Interstate Commerce Commission in Washington, D.C. A more recent example is Bill Ackman’s MBIA short position, which is predicated on special knowledge of reserve adequacy, unusual insurance transactions, etc. (Ackman supposedly went through 140,000 pages of internal documents.)

Allied to the foregoing are situations involving neglect of public information. This has been especially persistent in the field of distressed debt, where vulture investors profit from claimholders unwilling to interpret bankruptcy documents. (Seth Klarman, Michael Price and Marty Whitman owe a great portion of their returns to this activity—and not to common stock investments exclusively.) Many of the opportunities mentioned on stableboyselections.com tend to be neglected because they fall outside the scope of traditional equity investment.

I do not believe that passive “value investors” as a class will yield above-average returns by focusing on large U.S.-based companies. The investment community has wised up to the extent that apparent bargains now involve greater risk. This is a natural consequence of the increasing popularity of “value investing,” which seems to have reached an historical peak over the past few years. (Most worrisome is the crowding in such stocks as USG, SHLD, FMD and Mortgage Originator X, Y, Z.) You can take it as an axiom that strategies become less effective as they become more popular.

The really spectacular returns will come from investors who discover unpublicized or underpublicized inefficiencies. At present, auction-rate securities, distressed debt, arbitrage and certain Chinese stocks seem to offer the most favorable mathematical expectation.

“If the reader interjects that there must surely be large profits to be gained from the other players in the long run by a skilled individual who, unperturbed by the prevailing pastime, continues to purchase investments on the best genuine long-term expectations he can frame, he must be answered that there are, indeed, such serious-minded individuals. But we must also add that… investment based on genuine long-term expectation is so difficult today as to be scarcely practicable. He who attempts it must surely lead much more laborious days and run greater risks than he who tries to guess better than the crowd how the crowd will behave; and, given equal intelligence, he may make more disastrous mistakes.”
- J. M. Keynes