How I Beat the Index by 2x... And Why I Believe This Could Happen Again - Smart Contrarian by Equitymaster
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How I Beat the Index by 2x... And Why I Believe This Could Happen Again

Feb 12, 2018

Rahul Shah, Editor, Smart Contrarian

There is a reason why the coin in the movie Sholay was rigged.

Jai, Amitabh Bachchan's character, was rigging the game in his favour. Had it been a normal coin, it's quite possible the movie may have taken an entirely different turn. Maybe Jai would have taken Basanti to safety instead of Viru, and Viru would have met with a tragic end.

Coin-tossing is purely about luck. No matter how skillful you are, you cannot guarantee winning a coin toss.

What you can do, if you're smart like Jai, is rig the coin.

Thankfully, the stock markets are not like a coin tossing game. But there is still some luck involved in investing. Not to the same extent as, say coin tossing, but to totally deny the role of luck in investing is being too cocky in my view.

I don't intend to be cocky at all. Which is why when I was up on the dais yesterday for our annual Equitymaster conference, I admitted not really knowing whether my Microcap Millionaires service would be able to beat the Sensex 2x... again.

When we launched the service back in 2014, we had a feeling that the service would do really well.

But we didn't expect the massive 2x outperformance over the Sensex, or that we would be closing more than 90% of our recommendations at a profit.

Our focus was on following the process, no matter what, and firmly sticking to the rules.

After all, this is what matters in an activity where both skill and luck are involved. When luck plays a role, no matter how small, a good process leads to the highest probability of success over time.

Follow the right process and the results take care of themselves.

Below is one of my favourite tables from my presentation yesterday...

Year Winning Percentage Average Gains Sensex PE Cheap/Expensive
2014 91.0% 123.0% 16.7 CHEAP
2015 38.5% 1.5% 20.0 EXPENSIVE
2016 73.2% 73.2% 17.4 CHEAP
2017 87.0% 56.7% 21.8 EXPENSIVE

You just had to do two things to make big money from stocks over the last four years. Have maximum exposure to stocks when the last column in the table said cheap and invest only in stocks that passed the filters we have set for Microcap Millionaires.

There isn't any foolproof way to make money from stocks in the long run. But if there's something that comes close, it is this method.

This method forces you to be in stocks when the upside to downside ratio is in your favour, but also asks you to take maximum exposure when the broader markets are attractive from a valuation perspective.

Look at those winning percentages when markets are cheap!

9 out of 10 Microcap Millionaires type stock would have made you money in 2014 and 7 out of 10 in 2016, with an average gain of 123% and 73% respectively. Of course, the ratio drops to a mere 39% in 2015.

But mind you, this is the year when the stock market in India was expensive and the strategy would have recommended you to reduce your exposure to stocks.

But pick any 4-5 year period from the past and I am reasonably sure the results won't be any different.

In the years where markets are cheap, the winning percentage would have been high more often than not; and in years where they are expensive, the winning percentage low.

Microcap Millionaires merely intends to exploit this pattern and has been doing a great job of it so far, outperforming the Sensex by 2x.

Whether it will be able to repeat this performance in future is something I can't answer. But if one continues to do all one can to exploit this pattern, there's a strong chance one may outperform the index by a considerable margin, if not beat it by 2x.

Good Investing,

Rahul Shah
Rahul Shah (Research Analyst)
Editor, Smart Contrarian

PS: The Microcap Millionaires service that Rahul Shah created and that beat the Sensex 2x since inception in 2014 is celebrating with a special offer. You will receive it on Wednesday but it's open for a very brief period. So keep your eyes on your inbox...

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