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Here’s why stock-picking is hard (but you should do it, anyway)…

hand picking dice with happy face from selection of neutral and sad face dice
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I know, I know.

Play me the world’s smallest violin.

I’m about to tell you that stock picking is hard. And why.

So let’s get this out of the way first.

Yes, it’s what I choose to do.

Yes, I get paid to do it.

And yes, The Motley Fool gets paid for it too.

So, it’s important, up front, to tell you I’m not complaining.

After all, if it’s done well, the returns will more than make up for the degree of difficulty.

(And, at this point, it’s probably worth mentioning — for both credibility and to keep the boss happy — that the service I run, Motley Fool Share Advisor, is soundly beating the market, after making a Buy recommendation every single month since December 2011. Our average recommendation is up 46.3%, compared to 26.9% for the All Ordinaries Index (ASX: XAO), both including dividends.)

But that result doesn’t come easily.

And, whether you’re a member of one of our services, or a reader who invests, the same challenges that confront us, also confront you.

Let me explain.

See, if the market was perfectly efficient, all of the known data would already be in share prices. That’s the so-called ‘Efficient Markets Hypothesis’ advanced by academics (and criticised by no less than Warren Buffett).

But, of course, it’s not.

(If it was, Buffett would be a little-known, underperforming, fund manager.)

But that doesn’t mean just anyone can beat the market, nor that they can expect to do it over any time period.

Here’s why: if you’re going to beat the market, you must take a position that’s different to that of the market.

Why? Because if Woolworths Group Ltd (ASX: WOW) shares are fairly priced, they won’t — by definition — be market-beating.

(If the market prices things fairly, those shares will simply rise, slowly, in line with the market; which itself would just rise slowly.)

So, you’d only buy Woolies shares if you thought the market was getting the company wrong.

So far, so good.

Buy cheap shares, and make money, right?

Not so fast.

First, you might be wrong. Obvious, but worth remembering. Even the best investors are wrong sometimes.

But second, let’s think through the timeline here.

Say you think Woolies shares are $50, but they’re trading at $40 right now.

You buy the shares, and wait.

Nothing happens.

Or worse, the shares fall.

You know what — that shouldn’t be a surprise.

Indeed, it should actually be expected!

Why?

Because, as right as you or I might think we are, your purchase doesn’t exactly signal anything to the wider market.

To change disciplines for a second, let’s think about Galileo. It was his belief that the Earth revolved around the Sun.

And you know what? He was right. (And a big hello to all of the Flat Earthers reading this. Feel free to send me to my corner.)

But being right wasn’t enough.

The orthodoxy remained that the Sun revolved around the Earth.

The same is true of the stock market. If the sum total of all of the market participants’ views is that Woolies is worth $40 a share, why would the price move, just because you bought shares?

And, absent that, and with general volatility being what it is, there’s more than a decent chance the shares will actually fall.

Because you’re wrong?

Well, as I wrote above, it’s possible.

But maybe you’re right. The market just doesn’t know it yet.

Which is perhaps the best reminder that you really, really shouldn’t take your investing cues from the ASX.

I was buying in February and March, while the market was falling.

I ‘lost’ a lot of money after those purchases.

And now?

Some are up. A lot.

Others are still down.

I’m a pretty long way ahead, though.

Was I wrong because the share prices fell? No.

But am I right because share prices have risen since March? Not necessarily.

Because if I don’t let the market tell me I’m wrong, in the short term, I’m not going to be so arrogant as to believe that the market is correct when I make money in the short term, either.

And that combination is one of the investor’s worst enemies. In both cases, to listen to the market is exactly the wrong thing to do.

After all, we only buy shares in companies we think the market is wrong about.

Why would we, all of a sudden, then start referencing our performance against that same market — in the short term, at least?

It’s kinda nuts, right?

Now, I don’t want to be too harsh. Not only is it a natural instinct, but we’re encouraged to do it, by news media and market commentators.

And, to add more confusion, you really should compare your performance against the market in the long term.

After all, if you spend 20 years lagging the market, it’s cold comfort to keep yelling “Yeah, well the market is — still — wrong!”

If that sounds familiar, you’re right. Many a commentator — about shares, gold and property — has been echoing that refrain… sometimes for decades!

My benchmark is 3 – 5 years.

It’s been the stated goal for Share Advisor from the very beginning.

We’re prepared for it to take a while for the market to realise we’re right (or that we’re wrong!).

It’s not wrong to wish the process was faster, but it is wrong (and dangerous) to expect it to be.

Because when we do, we’ll start making the mistake of letting the market tell us how to feel, and what to do.

It’d be like me asking my 7yo the square root of 81.

He could guess 10, and I’d confidently say 9.

But if I asked him again in 6 months, and again he said 10, should I change my answer?

Of course not.

Why would we say ‘the market is wrong’ when buying shares, today, but then assume it was magically going to be right in 6 months’ time?

Instead, here’s what you need to do:

Buy, when you find a company you think the market is wrong about.

Then, keep doing it, to build a diversified portfolio.

After that, keep an eye on your companies, not just for their share prices, but for changes in their businesses.

Changes that suggest you’re right — or wrong.

Then, as long as the share price is a reasonable one, based on your assessment of the business, just hold on.

Eventually, my 7yo will learn the concept of square roots.

Eventually, when I ask, he’ll confidently answer ‘9’.

I won’t have been wrong all this time. 

The same applies to investors.

Invest. Keep investing. And be patient. 

Fool on!

Where to invest $1,000 right now

When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for more than eight years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

Scott just revealed what he believes are the five best ASX stocks for investors to buy right now. These stocks are trading at dirt-cheap prices and Scott thinks they are great buys right now.

*Returns as of June 30th

Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Woolworths Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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