How Do You Define a Winning Stock Pick?

Well, we're taking the risk of having our money outside the safety of cash,right? So we could say that any stock investment that outperforms 90-day T-bills and the like is a "winner."

But we should try to do better.

I like to keep an eye on two benchmarks in measuring the performance of stock picks.

First, I want the investment to do better than the S&P 500 index over the same period to time. Why the S&P 500? Because I reside in the USA and that's the index used to measure the performance of mutual funds and money managers here. So I look at that, but not only that.

Second, I want the investment to do better than a fixed benchmark -- the rate of inflation plus 10%. Southeastern Asset Management uses this as their measure of performance. And, while it was a yawner during the dot com bubble in the late 1990s, the wisdom of this yardstick has been proven over time.

Here's what I mean:

Let's say you and I are managing a pool of money in a year when the S&P500 is down. And our pool of money is down just half as much. Congratulations are hardly in order, amigo. Yes, we "beat" the S&P 500 -- but we have no reason to celebrate.

The fact is, if we can consistently achieve the fixed results desired by Mason Hawkins, Staley Cates and others, our portfolio performance will be outstanding. Over time. It won't be all that exciting for the most part. Yet value investing isn't suited to television, talk radio or video games.

It's a slow (painfully slow at times) approach demanding patience. And the only way I measure stock picks is how they perform against the two benchmarks above. I hope to beat both by the time I unload a position. But until I do, most of what goes on is just noise.

Comments

[Moon]

Superb post, all your points.

I hadn't heard of inflation + 10%, but I like it. My floor benchmark has been the 10-yr bond yield. I don't like the S&P 500 as a relative benchmark, but as you say, it's what's widely used in the US so I guess it is what it is.

Have to admit I've never really looked into Longleaf funds, as I haven't put new money in a fund since 1996-7. What is their record of exceeding their inflation + 10% measurement? For that matter, how often has the S&P 500 index beat inflation + 10%? (That's a rhetorical question unless someone has the answer handy. Otherwise, I'll do my own homework.)

[hopton]

I vote for the second, in that it fits better within an absolute return framework.

[HS]

A long-term return of inflation + 10% would be fantastic. Just curious, how are you measuring up to that yardstick so far?

[Moon]

HS, see the Performance section in the upper-right corner of the blog. Appears that John has done 38.4% over 23 months. That's about 1.4% per month, annualized to just over 18%. By most measures of inflation, that exceeds it by more than 10%.

[Self-Directed Investing]

Be wary of investing processes which rely heavily on the "tea leaf" reading of stock charts or graphs. Technical analysis can be valuable but ultimately there should be a foundation of solid, clearly understood metrics.