Most Investment Systems Won’t Work… but This Will

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Editor’s Note: Today’s guest article comes from Chief Investment Strategist Alexander Green.

He’s here to remind us that though there are limitless ways to take a beating in stocks, there are only a few methods that work well over time.

This is one of them.

Read on…

– Rebecca Barshop, Senior Managing Editor

Early in my career on Wall Street, I made an astonishing discovery: The overwhelming majority of my colleagues – bright, educated, experienced and articulate – didn’t have the foggiest idea what they were talking about.

This only became obvious in retrospect when I saw how their carefully constructed financial theories and investment forecasts turned to dust rather than generating any significant profits.

(You’d be surprised to learn how many investment “pros” lose a substantial percentage of their own money in the market each year.)

The truth is that there are limitless ways to take a beating in stocks – and only a few methods that work well over time.

These few methods are codified into more widely recognized investment principles, something I try to emphasize in my columns.

I was fortunate to realize this early in my career, although it still stings to think about the chunk of change I lost 35 years ago buying my own firm’s “Strong Buy” recommendations.

However, things finally began to turn around for me the day I read Harry Browne’s Why the Best-Laid Investment Plans Usually Go Wrong – sadly, it’s out of print, but you can find a few used copies on Amazon.

(I loved the title, but Harry, who ran for president twice on the Libertarian ticket, told me over dinner one night that he regretted the choice. “Too negative,” his publisher told him.)

Browne argued that the odds are stacked against the typical investor, who is overwhelmed by Wall Street’s technical jargon, market volatility and the business of money management. (Read the investment classic Where Are the Customers’ Yachts? for details.)

There are exceptions, of course, but the nation’s brokerage firms are filled with well-dressed, smart-sounding men and women spouting a lot of self-serving nonsense.

As Vanguard founder John Bogle once remarked, “It’s amazing how difficult it is for a man to understand something if he’s paid a small fortune not to understand it.”

The overwhelming majority of economic theories, market forecasts, trading strategies, hot tips and surefire speculations never pan out.

Fortunately, we have the accumulated wisdom of history’s greatest investors to guide us.

I’m talking about people like Warren Buffett, Peter Lynch and John Templeton, individuals whose audited track records speak for themselves.

Even though these individuals used very different approaches, they agreed that in the end there is only one thing that dictates where a stock will go: earnings.

Earnings are the net profits of a business. They are what ultimately drive share prices.

I challenge you to find a single company that increased its earnings quarter after quarter, year after year, and the stock didn’t tag along.

Conversely, try to identify a single company whose earnings declined quarter after quarter, year after year, and the stock advanced anyway. It just doesn’t happen, even in a rip-roaring bull market.

The reason is simple. A share of stock is not a lottery ticket. It’s part ownership of a business.

And just how much investors are willing to pay for those profits will determine what a company is worth in the market.

Although there are always bumps along the way, you’ll find there is a near-perfect correlation between a company’s growth in earnings per share and the movement of its stock from quarter to quarter and year to year.

So forget all the technical mumbo jumbo about market breadth, trading volume, put-call ratios, short interest, mutual fund inflows, advance/decline numbers and other market trivia.

And instead remember that share prices follow earnings. Period.

Stamp that on your forehead – act on it – and you’ll be using the one tried-and-true investment discipline that always pays off in the end.

Despite economic turbulence and volatility in the markets, there are plenty of companies in technology, e-commerce, food, pharmaceuticals, medical devices, healthcare services, defense contracting, gold mining and other recession-resistant industries that are currently making money hand over fist.

Those companies are outperforming. And they’re likely to keep outperforming in the weeks and months ahead.

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