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Sunday, January 9, 2011

Investing Strategies (4)

To those who manage their own money, especially to those who buy individual stocks, the process can sometimes feel like wagering on the outcome of a beauty contest. No matter how much time and effort is expended on research to find good businesses in which to invest, the outcome - at least with respect to capital gains - will be determined by everyone else in the market.

To continue the beauty contest metaphor, the problem is that one of the beauty contests on which one can wager is for the Miss Afghanistan title where all of the contestants are wearing burqas. Another is for the Miss Africa title where the contestants are of many different ethnicities so their physical characteristics vary widely. To add to the difficulty in picking a winner, the judges in this contest all seem to be Chinese.

It is one thing to develop one's own opinion as to who should win. To predict the decision of the judges - which is how the bet is won - when many of the facts are hidden or when the criteria for victory are unspecified is an order of magnitude more difficult.

On the other hand, even though capital appreciation is uncertain, a modest hedge is available that can be identified by those that do their homework: buy good stocks that pay decent dividends. Even if it takes the judges a while to come round to your point of view, at least you will be paid - even if only modestly - to wait.

Note: In the interests of full disclosure, your correspondent manages his own money, buys individual stocks, favors - but not exclusively - those that pay dividends, and picked some beauty contest winners last year although he also picked some substantial losers.

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