“Indexing is counter-intuitive. Doesn't it seem reasonable that if you bought the companies in the S&P 500, then sold off high flying market darlings and poorly-managed businesses, and used the proceeds to double up on the best run companies that you would beat the market? The evidence is no; professional managers who spend 40+ hours a week doing just this cannot consistently beat the index. What gives?”Let’s start with the high-flying stocks. Nothing is flying as high as Apple right now. I have no idea if Apple is currently a good buy, but no doubt some people think it’s destined to drop. Let’s go back to 2000 when Apple was also on good run. Anyone who excluded Apple from their portfolio then would have missed out on a 25 times increase in its stock price. The truth is we can’t be sure if a high flyer will fly higher or crash.
As for the businesses that aren’t doing well, their stock prices are usually low as a result. Even a terrible business may be a good investment if the market is too pessimistic about the stock. In fact, value investors seek out stocks where other investors have driven its price too low.
Stock-pickers need to consider more than a company’s business prospects. They need to consider the current price. A business’s success or failure does not necessarily reflect how investors will fare. What matters are the business’s prospects compared to its current price. It is this type of analysis that is very difficult to do better than investment professionals.
It’s always possible to look into the past and see which stocks you wish you hadn’t owned. But when we look at today’s stocks without the benefit of hindsight, it’s far from obvious which stocks will be the stinkers.