Why the stock market is still the best place for your money

One way of making money on the stock market is to ride a wave of sentiment. You buy into the hot shares of the day… and flip them on to the next man to join the party. That’s the quick way to make money. But it’s also the risky way.

What I prefer to do is try to identify value-creating companies while no one else is looking. The aim is to hold these stocks for the long term, letting them multiply the value of my investment while I sit back and admire them…

But lately this approach has been getting a bad press. Last week I criticised MoneyWeek’s Tim Price for telling people to “forget shares”, but he is certainly not a lone voice. American mutual fund managers who try to beat the index are described as “a dwindling collection of old people who don’t know better, contributing monthly to a comically inferior product”.

Why old timers are throwing in the towel

Bill Miller, one of the USA’s most famous fund managers, has thrown in the towel. He reckons “it has become more difficult to make money from good stock-picking in recent years because changes in the market – notably the rise of index funds and automated trading – mean that shares tend to rise or fall together”.

I think this is absolute nonsense. To start with, shares don’t all go up and down together anyway. But even if they did, such gross market inefficiency would play into the hands of stock pickers.

In fact, four factors have brought us to this moment when shares are seen as nothing more than an outright gamble. 

The rise of index funds

Before the 1990s, index funds (which simply buy a basket of whichever shares constitute a certain index) did not exist. They were the result of some number crunching made possible by the new computing age. This proved that the average fund manager underperformed the index (as he inevitably would have done, given fund management costs). Latching on to this new marketing opportunity, financial advisers began to push the line that it is impossible to beat the market, touting index funds as a sensible way of accessing the stock market.

An excess of caution

If you invest in ten shares and seven do well and the other three badly, you should make a good return. But you will still have to endure some losers. Given the inadequacy of most people’s life savings and the impending pension shortfall, our government hates the idea of anybody taking a risk that could end in loss. So it clothes equity investment in health warnings, denies us the right to hold many small company shares in our ISA and ties the hands of private client fund managers.

When professionals and committed private investors are discouraged from stock picking, is it any wonder that the habits of rigorous research and balance sheet analysis seem to have been consigned to history?

Over-trading

The digital information age has, on balance, been great for investors. It has enabled cheap dealing services and delivered a mass of information to our finger tips. But its advance has been mirrored by a rapid increase in portfolio turnover. These days, people can monitor share prices every second of the day, buying and selling instantly at the touch of a button. So it’s inevitable that they get fixated on share prices and forget that behind that share price is a real company striving to slowly create some value.

Hedge funds

Hedge fund managers were also born of the digital age. Rather than being ‘masters of the universe’ able to spot great investments denied to us mere mortals, they have in fact simply crunched a lot of numbers very fast and spotted anomalies. Sooner or later all of these anomalies were going to be arbitraged away, and now that this has happened, hedge fund gods need to find an explanation. Rather than say anything that might detract from their own reputation, they blame circumstances beyond their control – that ‘the market’ has made the whole job more difficult. And the implication is: if they cannot beat the market, what hope is there for you and me?

Individual stocks are the best way to make money in the market

I’m here to tell you that stock picking is not a dead art. In my opinion, you should forget what these people say. If you want to make some money in the markets, I believe buying individual stocks is your best bet.

With a basic understanding of valuation techniques, an appetite for time-consuming research and a reasonably long-term view, it is no harder to beat the market now than it ever has been.

The hunt for great shares is hard work, but I love it. I also love those exciting themes that sometimes take hold, gripping the attention of traders and racing share prices higher. We’ve seen it this year in commodities, and with the pharmaceutical sector, too.

The point is, if you can spot great companies, the stock market is still the most rewarding place for your money. And I don’t care who says otherwise.

• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by MoneyWeek Ltd.