Home | Help | Feedback | Bookshop
| Investment philosophy | Recommended reading | Frequently asked questions | Putting it all together |

 Investment Gurus

Reprinted with permission from the Financial Mail On Sunday

 Consistent Approach that Can Beat the 'Efficient Market'

I have just read an excellent American book, Investment Gurus, written by Peter Tanous.

He analyses the skills of leading US investors and tries to establish whether it is possible to beat the market consistently.

'Efficient Market' theorists believe the stock market is so efficient that everything that is known about a stock is already reflected in the price. To them, research departments, brokers, forecasts of earning growth, newsletters and other aids are a waste of time.

The superb records of great American stock-pickers like Warren Buffett and Peter Lynch provide powerful evidence against the efficient market theory.

If the market is so efficient, how have the portfolios of these investment managers beaten it so consistently and by such a wide margin? Theorists answer by saying that there will always be 'outliers'- investors who do exceptionally well or exceptionally poorly.

This seems unconvincing. I do not think that the market is efficient at any particular time. However, I believe that it is always in the process of becoming more efficient. The gurus look for shares that are in the process of being efficiently priced and there is a remarkable consistency in their explanations of the way they find them.

Most of those specialising in growth shares prefer to buy stocks that have low price price-earning ratios (PERs) in relation to their growth rates. The share prices of companies such as these are obviously more likely to benefit from upward status changes, if all goes well.

If a company suddenly announces excellent results well above the consensus forecast, it often takes the market a long time to assimilate, first the increased earnings per share (EPS), then the higher PER merited by the increased growth rate.

Revisions of brokers' forecasts and the announcement of company results should therefore be watched with an eagle eye. The key point is whether or not future EPS are likely to be increased beyond current expectations.

Directors' dealings are often the forerunner of superb results to be announced a few months later. A director buying or selling a few shares can be a none-event, but substantial cluster buying by three or more is usually a strong signal to buy.

The relative strength of shares against the market and the achievement of new highs are often the forerunner of major EPS increases.

A few people out there know what is happening and the share price is beginning to reflect better times to come.

A major technology breakthrough can have an enormous effect on a company's results. It is hard, however, to sort out the wheat from the chaff, so I tend to leave investments of this kind for the technically minded.

Judging a new major trend in spending or the future development of an industry can be a far sighted way of anticipating a coming uplift in a share price.

Warren Buffet bought Coca-Cola a few years ago on a PER of only 13. He could see that the management was selling loss-makers and beginning to concentrate on its core business.

More importantly, he also realised how strong Coca-Cola's expansion would be in the international markets.

Today, after massive earnings increases, Coca-Cola shares are on a PER of about 40, so the 'efficient market' has at last caught up with Warren Buffet's thinking at least as far as that company is concerned.

From a private investors' point of view, the easiest way to anticipate future share price increases is to concentrate on directors' dealings, relative strength, the announcement of a company's results and revisions of brokers' forecasts. In many cases, these four factors move together in a natural progression.

The directors buy, the relative strength improves, better results are announced and forecasts are revised upwards.

A classic case is Blacks Leisure. In January and February last year five directors bought shares at an average price of 67p.

The relative strength of the shares improved and a few months later, when they were about 130p, the company announced that EPS was up by more than 400%. Brokers' estimates for the following year were revised upwards again and a year later EPS increased by a further 175% - a wonderful example of keeping an eye on the directors' dealings. Today the share price is 443.5p.

Company REFS, the investment service I devised in conjunction with publishers Hemmington Scott, provides all these statistics once a month.

There are tables of directors' dealings during the previous six months, setting out their positions, the numbers of shares dealt in and their residual shareholdings. There are also tables of the shares with the best relative strength during the previous month and the previous year. Further tables show the results announced during the previous month and full details of brokers' consensus forecast changes.

The information is readily available.

If you want to keep up with the gurus and play your part in disproving the efficient market theory, you need to be aware of these investment pointers well before the market factors them into companies' share prices.

Back to: Recommended books for advanced readers