Wiley has been publishing a “Little Books Big Profits” series for a couple of years now. I have read the five available as of May 2008. The books invariably are well written and interesting. All of the authors are big names in the investment industry. The books themselves are inexpensive, which is fair given the size and nice given the importance of the subject. Each of these books is short and to the point.
The advice in the books is contradictory. This is not surprising. Operators in financial markets have different strategies, and obviously, everyone thinks their strategy is best.
But what is an investor to make of it? Who's right?
In this review essay, I discuss the books, some general implications from them and my own take on the analyses. Reviews of each book are available in the links at the bottom of this summary.
The types of investing covered in the little books include value investing, growth investing and index investing.
Value investing basically is investing with the expectation that the price of a firm's stock will increase when other people realize that the firm's stock is too low. A value investor looks at the value of the underlying or "fundamental" business and then compares his estimate of the firm's value to the current price. If the current price is low, then the stock is a good deal.
Growth investing is investing in stocks of firms likely to grow relatively quickly. Today, a growth investor is more likely to invest in Internet companies than in automobile companies. The stock price rises as the firm grows and the investor gains from this price rise. A more sophisticated version of growth investing dictates buying stocks when the investor thinks that the firm will grow faster than other investors think.
Index investing is investing on autopilot. For example, there are funds that invest in the S&P500 stocks. Index investing is investing in a fund that holds stocks of firms in the S&P 500 index or some other index with the same weights as in the index. It has been described as dumb investing because the investor buys blindly, paying no attention to the prospects of the individual firms being purchased.
In addition to these styles included in the Little Books series, another style is technical investing. Technical analysis uses information from past price trends to forecast future price trends. Suppose that stock prices have increased substantially after they fall for the prior six months. A simple version of technical analysis would be a prescription to buy the stock after a stock price falls for six months. While it is possible that technical analysis is profitable on an intra-day basis with relatively large trades and low costs of trading, it is extremely unlikely to be profitable for those of us reading the Little Books series.
Joel Greenblatt (2006) offers The Little Book That Beats the Market, Louis Navallier (2007) wrote The Little Book that Makes You Rich and Pat Dorsey (2007) provides The Little Book that Builds Wealth. All three books' titles promise a lot, more than can be delivered really. Christopher Browne (2006) wrote The Little Book of Value Investing, which doesn't obviously promise anything other than being informative about value investing. John Bogle's book (2007) has the unpretentious title The Little Book of Common Sense Investing.
Is there a little book that beats the market or makes you rich? No. While there are useful hints in these books about ways to beat the stock market's overall return or become rich by buying and selling stocks, overall there is no quick and easy way to become rich.
If you want to try to get rich quick without any effort, buy lottery tickets. You have a better chance of getting rich quick with lottery tickets than with stocks. You also have a better chance of being struck by lightening than of getting rich with lottery tickets. Sorry about that, but it's true and has to be said.
These books don't promise quick riches, but two do tend to suggest easy, predictable riches.
Greenblatt's book actually introduces a “magic formula” no less to “beat the market” based on core indicators for value investors.
Navallier goes through an analysis of firms' finances similar in many respects to Greenblatt's, but he emphasizes the information related to growth combined with more judgement.
Both Greenblatt and Navallier created websites with statistical information related to their recommendations. Both have done well with their investment styles.
Christopher Browne provides a quick tour of a value investor's analysis of firms' fundamentals. He doesn't provide any magic way to get good results, instead explaining the hard work necessary for a value investor to do well.
Pat Dorsey provides a general way of deciding which firms are worth the hard work done by a value investor. The basic idea is to find "wonderful companies" (Dorsey 2008.)
John Bogle argues that common sense leads to index investing. This does not require computing statistics informative to a value investor or a growth investor. He presents quite a bit of evidence about the advantages of index investing.
Why can't you do as well as Joel Greenblatt or Louis Navallier? Maybe you can, but it is extremely unlikely unless you first quit your day job and start investing as a full-time job.
They invest and trade for a living, as do many others. Playing the stock market is playing a game against people with a great deal of money available who devote full time to the activity. It is unlikely that you can beat them by reading the Wall Street Journal in the evening, going to one or more free websites in your spare time and executing trades through a broker.
You are as likely to beat them at their game as you are to beat a teenager at computer games. You might have a shot if you devoted as much time to it as they do, but you have other things to do.
In this regard, Christopher Browne outlines a more sensible strategy. If you are willing to devote time and effort to learning about some companies – I would suggest preferably smaller ones that are not worth a professional's time – then it is possible to do well. I have a friend who has done this for years and has done quite well. He thinks it's fun to read financial information about firms. I don't. It's hard work for me; it's boring. I like economics and finance, not reading detailed accounting information about individual firms. So I don't try that game.
The metaphor of playing a game against a teenager applies here too, the point being that you might have a shot at beating him if you play a game that he generally doesn't play and you put time and effort into being good at it.
For most of us, John Bogle's suggested strategy is the best one. Mutual funds do not require you to invest much time and effort in your investments. If the firm running the mutual fund has low costs and buys a diversified portfolio of stocks, then you are likely to do as well as the stock market overall. Being average may seem like a low goal, but most individual investors do worse than average. As many research papers and books have documented, you are likely to do much better with this strategy than trying to find the next Microsoft.
Some mutual funds are actively managed funds and some are index funds. Actively managed funds have an investment manager who attempts to pick stocks that will do better than average. The large majority of these funds do worse than the average return on the market. Bogle's explanation of this point is clear and correct.
Index funds have lower costs because they trade stocks less than actively managed funds. They do almost as well as the index the manager is attempting to track. They do not earn quite as high a return as the index because purchases and redemptions generate transactions costs and require the fund to hold some cash. But index funds can come close to the index.
It might seem that an actively managed fund would be better, for example if you have Peter Lynch – a famous manager who did very well – running the fund. The problem is, you have to pick the next super-star fund manager before he has super-star performance and then retires. This probably is harder than picking the best stocks, and certainly is no easier.
While you will not get rich quick with index funds, you can become rich over time. Becoming rich over time is better than most people manage. This is unfortunate but true.
It is easy to focus on the differences between these books. There is a very important similarity.
Diversifying your portfolio of stocks is a message in all of these books. As my mom used to say, “Jerry, don't put all your eggs in one basket.” Buying one stock is just that. If the stock does well, you will too. If the stock does poorly, you will too. If you buy quite a few stocks, your investment return will not be as high as the best firm. Your return also will not be as low as the worst firm.
Enough.
This is a nice series of books. They are interesting reading, clearly written and not so long as to be merely repetitious, and they are not mostly war stories that have little or no relevance to an individual investor. They are very worthwhile books to read about investing. After reading them, you will have a better idea why you are managing your savings they way that you're doing it. They can help you wisely manage funds you're saving for college educations, retirement or maybe a sailboat.
More detailed discussions of each book are
Greenblatt's Little Book that Beats the Market
Navallier's Little Book that Makes You Rich
Browne's Little Book on Value Investing
Bogle's Little Book of Common Sense Investing
Dorsey's Little Book that Builds Wealth
