what do horse races a Janet Jackson
wardrobe malfunction and Warren Buffett
have in common
well sounds like a started a bad joke
probably not much but they're all going
to help me demonstrate my point here
today now when I was first talking to
Brian about this concept I wasn't sure
if he'd want this on his channel but he
is nothing if not open-minded and I
respect and appreciate that about him so
thank you Brian and I look forward to
sharing this idea with you Brian's
viewers now for those of you don't know
me my name is Steven Spicer I'm a
certified financial planner and the
founder of Spicer capital and I am a
passionate advocate of a very specific
style of investing where I seek
opportunities with 100% or greater
upside potential and very limited
downside risk and it's not that I
intentionally rule out large cap stocks
as potential investments it's that they
very rarely
except maybe immediately post-crash have
this combination of characteristics at
extreme upside and limited downside
frankly I'm surprised and a little
concerned by the number of individual
investors who exclusively focus their
research efforts on large cap stocks or
who have a rule that they will only
invest in stocks found in the S&P 500
for example and at the same time they
have a goal of outperforming the market
unfortunately if that's the only place
you're looking for opportunities I think
you'll be sorely disappointed if you're
only investing in large United States
companies I don't think you can beat the
market over the long run at least not to
any meaningful degree
here's the problem think about the
number of eyes to many and money devoted
to this single cramped area of the
investment universe with the
proliferation of stock information more
people than ever are getting involved
in point you're watching this right now
a fact that wouldn't have even been
imagined by most just a decade ago
Jeremy from financial education has
almost two hundred thousand subscribers
listening to his daily stock market
rants Ryan has a quarter of a million
subscribers many of whom are here
know that's anecdotal evidence and I
could go to greater lengths to cite data
proving this point but I can't imagine
many would disagree with me here and
that's just the hobby investor on the
other end of the spectrum consider the
money dedicated to beating the market
and the volume of highly paid experts
whose job it is to stare at market data
every waking hour to pour over company
reports to find anything and everything
that might give their firm even the
slightest edge What did he say he said
an H is an energy and consider how the
amount of money in mutual funds and
hedge funds continues to increase over
the years by the end of 2017 they were
managing almost 19 trillion dollars and
over three trillion dollars respectively
and many of these funds and the research
firms and banks supporting them are for
the most part focused on larger stocks
because for many of them that's the only
place they have room to play once a fund
gets too large it can't efficiently
invest in smaller companies so it
definitely doesn't research them or pay
for research on them as an example if
the ten billion dollar fund took a 10%
stake in a 50 million dollar company and
even assuming that company actually goes
up by one hundred percent after one year
a significant increase write a win by
most of our standards but that's only a
half of 1/10 of 1% increase for the fund
as a whole
surely a 0.05 percent annual return is
not worth the time required to sift
through the tens of thousands of smaller
companies out
not to mention how difficult it would be
and how long it would take for the fund
amass such a meaningful position in such
a small company here's what I mean the
process of quietly accumulating enough
shares to be a 10% owner of a company
without meaningfully and unintentionally
ramping up the price of those shares
takes some time possibly even months and
with smaller companies generally less
shares are exchanged each day so those
markets and those companies tend to be
more sensitive to large shareholders
amassing large positions in other words
they're more likely to cause the price
to unintentionally spike up and draw
attention to that stock as they move in
my point is that all this hassle for a
large fund to get into a position that
even if it performs splendidly will have
a negligible impact on the funds bottom
line it just doesn't seem worth it and
that's why they don't do it they focus
almost all their research time money and
effort on the large caps but for you
unless you're managing hundreds of
millions of dollars you can enter and
exit most stocks relatively nimbly and
the doubling of that 50 million dollar
company could be significant for the
long-term performance of your portfolio
but that's the topic for another video
but these funds research institutions
and banks they're all committing their
hoards of research analysts and
dedicating hundreds of millions of
research dollars to those same us large
cap companies the most individual
investors look at what do you suppose
the odds are that you or I will discover
something that they haven't now I can
hear several of you screaming at your
screen
that I'm wrong and perhaps you've
already and the kindest way possible I'm
sure type to that sentiment into the
comments and I welcome that feedback
honestly I do that's one of the best
ways to learn by openly exploring
opposing viewpoints but I hope you'll
hear me out as I explained a little
further this phenomena and how you can
adjust your strategy in order to
outperform first I want to give you a
couple examples of what can happen when
you understand this concept Joel
Greenblatt managed a hedge fund that
focused on smaller cap companies
throughout the decade starting in 1985
his average annual return was around 50
percent per year but as his fund got
large and he became more restricted he
had a decision to make
continue to grow and collect even more
money from management fees or stop
growing and return capital to investors
in order to continue focusing on those
smaller companies well he made that
difficult decision to close his fund he
returned capital to investors so that he
wouldn't end up being constrained to
larger markets due to his fund size in
an interview with Jack Swagger and hedge
fund market Wizards he reveals that his
performance over the following decade
was similar another example one that you
are likely very familiar with is Warren
Buffett's look at his performance in his
early years when the assets he managed
were smaller and he was able to invest
in smaller companies as he grew his
performance clearly began to suffer over
the last decade for example he's really
just kept pace with the market and don't
misunderstand me having to decide where
to invest almost half a trillion dollars
would be very difficult so that feat is
much more impressive than it might sound
but back when he wasn't limited by his
size when he could invest in any
opportunity he found he and
primarily in smaller companies his most
impressive decades of returns came when
he was managing much less money and
investing in that way and that should be
good news for you that's where the
opportunity really is and you I'm
assuming aren't restricted by your size
now Berkshire Hathaway Buffett's company
has become so large that it's actually
absorbed a lot of those smaller
companies and the big positions that you
hear about like coca-cola or Apple have
become his best available choices
because of his size in fact you can see
another example of this when you study
his investment history as he was growing
and started to run out of lesser covered
investments in the United States
he started investing heavily in other
countries he started reviewing the
financials of every company from South
Korea for example because there weren't
near as many eyes and research dollars
dedicated to finding opportunities in
that market so he was able to capitalize
on miss pricings when you analyzed his
investing patterns from the beginning he
clearly prefers to operate in markets
with less coverage and it makes sense
that's where the opportunities are
hidden waiting to be discovered and his
track record during those times when he
was actually able to do that is what
really brings up his long term average
now a lot of people confuse the relative
short-term performance of a high-growth
stock with their ability to outperform
long term by picking large cap stocks
it's hard to ignore those crazy growth
stories like Amazon or Netflix
there were people invested in those
right and they made it killing on the
climb right so doesn't that prove me
wrong doesn't a 100 percent increase or
however much in a single year prove that
those stocks were mispriced no it
doesn't the market will always have
those stocks that are likely to move
quite a bit in one
or the other that's the nature of a
growth stock and it's the nature of
probability I'm suggesting that because
of all the eyes and research dollars
devoted to researching those companies
the price at any given point time more
or less
accurately reflects the probability of
each of those moves up or down a lot of
people seem to confuse
finding a good company one that has a
lot of positive things going for it with
finding a good mispriced investment
opportunity those are not the same thing
and not making that distinction is one
of the most common mistakes I see
investors make even the professionals in
fact I just released a video on my
channel
to help you recognize that and once I
walk you through it it's so obvious a
mistake but you'll start seeing it
everywhere after that you'll see what I
mean so I posted that video on my
channel over the weekend it's way
shorter than this by the way so you may
want to make a note to check it out
after this one I'm sure Ryan will link
out to it in the description or in his
comments now
with all this I'm not suggesting that
markets are 100% efficient but I am
suggesting that the more visibility a
particular market has the more efficient
it will inevitably be large US companies
are highly visible almost every piece of
meaningful information is known and
widely available every conceivable
analysis has already been run and
evaluated the natural consequence of
this is that the sum total of all that
information and analysis is reflected in
the current stock price celebrities now
bear with me here
celebrities are all too aware of this
phenomenon wardrobe malfunctions for
example happen every day but when it
happens at the highly visible Super Bowl
during the highly visible halftime show
and concerns two highly visible figures
like Justin Timberlake and Janet Jackson
everybody knows I can't do that he's
gonna kill me if you if you were of age
when that happened you probably heard
about it the world knew about it because
it was so highly visible it was a highly
visible event and concerned a couple
highly visible individuals when you have
that level of visibility it's hard for
much to go unnoticed when something
happens with a large US company
everybody's watching
when researching and analyzing stocks in
highly visible markets like these it's
rare that you'll uncover something
significant that people don't already
know about and not impossible but rare
you can't uncover a hidden gem when
nothing's hidden let's apply this
visibility concept to an activity where
detailed analysis could actually give
you an edge I'm talking about horse
racing consider the Kentucky Derby one
of the most visible races with many of
the most famous and best performing
horses from the season the most seasoned
and professional horse race betters are
there even deep pocketed amateurs are
there with modern analytical tools that
help them quickly calculate these
statistical odds now if you're a normal
person
betting on the Kentucky Derby what do
you suppose the odds are that you'll
discover and capitalize on an anomalous
mispricing before one of those more
experienced to better stuff and what's
more how big do you suppose that
mispricing could be before one of them
notices it is it worth the time and
effort required for all your research
and
alysus whether your answer to that
question was with yes or no
I think this analogy would be even
stronger if we add in an alternative
place for you to deploy your research
efforts pretend there is a smaller track
in your hometown and maybe in cities all
across the country
these tracks host lesser-known horses
and jockeys and let's assume that they
limit the amount that any one individual
can bet on a particular race thus
limiting the amount that any one person
could win if that limit is set low
enough it's not worth the time and money
for those industry professionals the
ones from the Kentucky Derby to travel
to even one of those small-time venues
due to the restrictions they can't make
enough money to justify their time and
effort so they aren't there now what do
you suppose that does to the accuracy of
the odds at these smaller venues
compared to those at the Kentucky Derby
whether or not you know anything about
horse racing and I certainly don't
as I'm sure some enthusiasts will point
out in the comments thank you very much
but regardless if you decided to invest
some time to learn the sport where do
you think you would have the best odds
of identifying and capitalizing on a
significant mispricing the highly
visible Kentucky Derby or the smaller
venues with individual betting
restrictions now stocks don't come with
printed odds of winning they come with a
stock price a price that is set by all
the investors who are participating in
that market Benjamin Graham the father
of value investing said in the short run
the market is a voting machine but in
the long run it's a weighing machine
when you have more experienced
professionals involved in this boding
process just like the Kentucky Derby how
much more efficient do you suppose that
market is there is an inverse
relationship a negative correlation
between visibility and opportunities for
you to capitalize on a significant
mispricing the higher the visibility by
definition less opportunities like that
will exist the lower the visibility
that's where the opportunity is but in
case there's some confusion let me try
to fill some of those holes in that last
analogy by using a simplistic stock
example because with stocks the range of
possibilities is much more significant
there's not just one winner one
runner-up but and so on but the idea of
visibility and opportunity still applies
here's a binary stock example that I
hope makes this all more relevant to you
for your investment goals when a company
is waiting on SEC approval for a merger
for example that news will absolutely
cause the stock to jump one way or the
other let's make this easy and say for
example an approval by the FCC would
cause this stock to be worth $75 based
on your and everyone else's calculations
but a denial would cause the stock to be
worth only $25 $75 or $25 now if the
odds are split right down the middle
there is a 50/50 chance for either
outcome then the fair value today while
we wait would be $50 and if we're
talking about a huge company that
everyone's watching if it gets out of
alignment by even a few cents a big
investment institution will swoop in to
take advantage of that mispricing
long before you even see it not that you
would care about such a small
differential but they do because with
their size that speed is often the only
advantage they can get in fact that's
the reason that some high-speed trading
firms will place their headquarters as
close to the Nasdaq as possible so they
can receive data and can fill orders
ever so slightly faster than anyone else
it's that imperceptible to us difference
begins them their edge so you're not
going to beat them at their game and
that price will stay relatively
based on the probability of each of the
variety of outcomes now in our
simplistic example there are inevitably
going to be some people on both sides of
that bet right that that means flip a
coin
since the odds here were 50/50 and some
people will see their position increase
by 50% and others will see it cut in
half that doesn't mean that the ones on
the right side of the bed whichever that
was were particularly prescient that's
just how probabilities work if you beat
me at a coin toss that doesn't prove
you're better at Queen flipping than I
am beat me 10 times in a row still
although it's small there's a
probabilistic chance of that happening
win the lottery that doesn't mean you're
a particularly good number picker
although it may feel that way at the
time of course the probabilities in the
world of stock investing aren't as
straightforward as all this they are
very complex but when you understand
probabilities what I'm suggesting here
is that over a long enough time horizon
most everyone who is playing exclusively
in this US large-cap sandbox will find
themselves unable to outperform the
sp500 when you have such high visibility
it's inevitable that markets will
operate like that that they will be much
closer to efficient to be clear I'm not
saying that there can't still be
opportunities here but any opportunity
that you might chance upon that a large
investment institutions somehow
overlooked likely wouldn't be very
significant this also doesn't mean that
a growth company can't go up by a few
hundred percent over a few years it
doesn't even mean that that's unlikely
in fact it's very likely that some
companies will do that what this means
instead is that for those highly visible
companies that possibility along with
the relative probabilities of a range of
other outcomes are essentially price 10
so if you've had
success in Amazon or Netflix as of late
and here's where I'm probably going to
get some hate comments or thumbs down
sorry Ryan but just because you've
experienced that success that doesn't
mean you necessarily noticed something
that wasn't already priced in when you
bought your shares there was a chance
that could go up absolutely there was
also a chance it could go down and that
full range of possibilities coupled with
all the data research and analytics you
could possibly imagine
was actively being processed and
considered by the professionals at large
institutions as well now when I'm
talking about this I'm talking about
most of the time because most of the
time markets aren't really relatively
speaking that chaotic and that's when
you're hearing about all these
undervalued large cap stocks to buy when
in reality they're likely priced
relatively fairly for that time now that
doesn't mean that whole markets can't go
through periods of euphoria that
absolutely happens or that during and
after a crash that people even the
professionals act irrationally and if
you can maintain a better composure than
they can then sure there are
opportunities there even among those
large US corporations and these extreme
euphoria and panic scenarios can happen
for individual stocks and sectors as
well but for the most part most of the
time that's not the case and so if
that's where you're spending all of your
research time instead of just stepping
in during those rare moments of chaos
then I'm afraid you're participating in
an exercise in futility
so here's a takeaway from this complex
subject the more money and eyes devoted
to researching a stock the less
opportunity you'll find that doesn't
mean you won't ever have any wins that
it doesn't mean that you won't ever find
something but if you do find some
anomaly or miss
in the world of large caps and the
opportunity for outsized returns will be
limited because although I don't believe
markets are 100% efficient the more eyes
and money paying attention to them the
more efficient they inevitably are now
I'm not saying that you shouldn't keep
up with these companies they're huge and
affect our everyday lives and affect
some of the smaller companies that I
invest in I don't think it's a bad idea
to know what they're up to and even how
they're doing that's why I put together
my 90 second analyses on these larger
companies I think that's all the time
you need to get caught up with what
they're doing and how it might affect
your world and if you want an even
deeper dive hashtag stock radar right
and that's okay
Orion does a great job at bringing you
fully up to speed with what's going on
with these larger companies but my point
is you should manage your expectations
if your goal is to pace the S&P 500 over
the long run with companies in which you
truly believe and want to support I
think that's great I support that I
think that's a better idea than just
blindly funneling money into
exchange-traded funds for example but if
your goal is out performance if your
goal is Buffett like returns and I know
there will probably never be another
Buffett that probably can't be with the
way things are now but that can still be
your goal and if it is you're not going
to get there investing exclusively in
u.s. large cap stocks I'm sure a lot of
you have a lot to say about this subject
I look forward to continuing this
conversation with you in the comments
below and I'll do my best to keep up
with the volume of comments that Ryan
receives I'll also be active in the
comments of that companion video that I
talked about that's on my channel where
YouTube will actually send me
notifications when you comment so I
I don't think I'll miss any of them
whether you agree or disagree with me
that's okay but I hope this has given
you some things to think about and
helped you at least in some way on your
investment journey once again I want to
thank Ryan for this opportunity to share
with you I wish you all the best
take care
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