5 Investors that Prove You Can Beat the Stock Market

Famous investors prove that a combination of strategy and analysis can help you beat the stock market, but should you?

Talking with other financial bloggers recently, the old debate of whether it’s possible to beat the stock market came up. It felt a little odd because I’m usually arguing for a passive investing strategy here on the blog but I do believe you can beat the market.

If you’re thinking regular investors can’t beat the market, you’re probably thinking of the many studies showing asset managers don’t consistently beat their index.

The problem is, there are two misleading facts that are often left out of these studies.

Let’s look at why those studies are flawed, some examples of investors that prove you can beat the stock market and how you can do it with your investment strategy.

Why the Market Efficiency Studies are Wrong

There is some truth to the market studies and investor performance but two huge flaws hide the fact that it is possible to beat the market.

First is that they report that investment managers do not beat their index after costs but leave out the fact that many are able to beat the market before costs are removed.

While that may be little help to investors paying those costs, it does show that it’s possible to beat the market or an index of stocks.

Second, many of these studies don’t account for risk management. This is the idea that individuals can beat the market on a risk-adjusted basis even if returns are a little lower compared to the index.

Imagine if a manager is able to reduce the ups and downs in a portfolio to half that of the market. Even if the manager’s performance comes in a percent or two below the index, I’d still say they beat the market by generating most of the return with much less risk.

If you still don’t believe it’s possible to beat the market in theory, how about a few famous examples?

5 Famous Investors that Prove You Can Beat the Stock Market

Five famous investors immediately come to mind when talking about whether you can beat the market. There are obviously many more but studying just a few can give you all the ideas you need to invest your own money.

The most famous example of an investor beating the market is Warren Buffett and shares of Berkshire Hathaway which have produced an annualized return of 18.6% over the last 35 years, more than twice the 8.7% annual return on stocks in the S&P 500.

While Berkshire is also a management company, it’s Buffett’s keen stock-picking that has enabled it to buy great companies at a discount for eye-popping returns.

Peter Lynch managed the Fidelity Magellan Fund for 13 years to 1990, beating the market in 11 of those years with an average annual return of 29% through a combination of deep analysis and finding good companies with solid management.

One of my investing heroes and a fellow CFA charterholder, Bill Miller topped Lynch’s record by beating the market for 15 years in a row through 2005. His Legg Mason fund generated an annualized return of 16.5% versus 11.5% for the S&P over the period.

Miller’s strategy was a new twist on value investing with a diversified list of factors different from traditional measures like price-to-earnings. He argued that portfolio construction was just as important as stock-picking. Finding value stocks on different measures to create a diversified portfolio means your return doesn’t depend on just one measure so hopefully your winners will run faster than your losers.

100% of the information you have about a company represents the past, and 100% of a stock’s valuation depends on the future. – Bill Miller

A few less popular investment managers prove that beating the market is still possible today.

Samuel Isaly of the Eaton Vance Worldwide Health Science Fund has produced a 14.6% annualized gain over the 25 years to 2016 versus an annual return of 7.2% for the S&P 500. The fund holds just 40 stocks with upside catalysts in healthcare from new products to clinical events and M&A.

Isaly’s fund is a great example of investing in long-term themes, a strategy I use for most of my investing accounts. I spent nearly a decade as an equity analyst for venture capital and other institutional investors. I’ll be the first to admit that it is extremely difficult to pick stocks that can outperform.

Considerably easier is finding a long-term theme that has huge economic and demographic factors pushing it forward, then picking the best companies in that group. Examples of this would be healthcare, alternative energy and social media.

Jerome Dodson is arguably the father of socially-responsible investing, founding Parnassus Investments in 1984. The firm invests on strict criteria for stocks prohibiting companies in alcohol, tobacco, gaming, weapons or nuclear-power industries. His Parnassus Fund has beaten the market with a return of 11.8% over the 25 years to 2016. Besides the social-screen, Dodson also looks for value stocks and reasonably-priced growth companies.

Lessons on How to Beat the Market

Billion-dollar fund managers never talk about exactly what they’re doing to find stocks. They might appear on CNBC or Bloomberg to argue their positions but it’s only after they’ve bought shares and they still aren’t going to share all their criteria.

Still, there are some common themes we can find in a lot of the star investors that might help you beat the market.

• Look for value. You might be able to do very well with growth stocks and momentum investing for a few years but a market crash can wipe out years’ of gains quickly. Corrections usually don’t hit value stocks quite as bad because there isn’t the irrational wave of investors already holding the shares.
• Look for companies with strong brands and management that might be temporarily unpopular on short-term factors. Headlines and a weak earnings release are great opportunities to pick up stocks of solid companies that other investors have abandoned hastily.
• Take a long-term view of beating the market. You don’t necessarily have to beat the market every year. Pick solid investments at discounted prices and you’ll beat the market return over time as those companies rebound.

On top of these general investing themes, beating the market also means hours of analysis. I don’t mean the kind of superficial price-earnings or trend following you see on TV. I’m talking about recreating a company’s financial statements and reading through hundreds of pages of industry reports and 10-K releases.

Should You Try to Beat the Market?

The fact is that it’s entirely possible to beat the market but that may be beside the point. Most fund managers and investors don’t beat the market and unless you have hours a week to analyze stocks, the odds are against you.

I think a lot of investors miss a more important investing goal.

You don’t need to beat the market to beat your financial goals. Earning a modest 7% on your money turns just $3,000 a year into over $306,000 in three decades. That’s well over the amount retirement savings and on just $250 a month.

You can try beating the market, spending tens of hours a week studying stocks for a percent or two in additional return. Is it worth the extra time or stress though?

The flawed studies of investment manager performance hide the fact that it is possible to beat the stock market. Through a combination of investment strategy and analysis, many famous investors have been able to beat the market for decades. All this is indeed possible but maybe not practical for the average investor which only needs to beat their financial goals instead of chasing higher returns.

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