In the investment world, it is rare to be able to invest using the outliers of the normal distribution in statistics. Jordan Kimmel is one of them.
“Outliers” on the Bell Curve
In his “Investment Alchemy”, Kimmel said that he was interested in the “bell curve” when he was still in college. Carl Friedrich Gauss is the creator of the bell curve. By definition, a bell-shaped curve (also known as a “normal distribution”) arranges all its values in a symmetrical fashion, with most outcomes lying around the mean probability and only a few outliers lying on either side of the curve. end. This means that the majority of any data set will be at or near the mean, while a select few will be above or below the mean.
The prominence of the bell curve in its simplifications, and its widespread application, had a profound impact on Kimmel. By its very nature, there will be some outliers on both the winner’s side and the loser’s side, while all other points will basically fall in the middle region. Using the bell curve and a statistical method suitable for identifying top-performing companies, Kimmel created what he called a “magnet stock selection program.” “Magnet” means top, leader, or great. Based on this business model, Kimmel believes it makes for a great company — stellar revenue growth, profit margin acceleration, low selling prices, price momentum, and so on. Various stocks are then screened and analyzed by market and market capitalization to find the true top companies in each market niche, the statistical outliers on the bell curve.
Efficient market theory assumes that all information about a company is already in the public domain, so that the sum of all buyers and sellers together creates the correct (or “efficient”) price. However, when analyzing price movements, it became clear to Kimmel that markets were far from efficient. There are simply too many price fluctuations within companies for the market to be truly efficient.
The observation that markets are inefficient is supported by something called “chaos theory.” Advocates of the theory believe that prices are the ultimate reflection of changes in a stock, bond, or other security. Kimmel believes that it is very reasonable to apply chaos theory to the fundamentals of stock selection. So he collected all the data he could get on public companies and sought to develop a model that could identify stocks on the verge of large explosive growth.
At that time, he also read the book “The Prophet” by Thomas Bass. This book uses chaos theory to analyze the stock market, exploring the patterns within the stock market with the aim of predicting the movement of the stock market and using these predictions to actively trade. With the beginning of quantitative analysis of “quants”, some quants have used chaos theory to trade the market. Kimir, however, doesn’t do that. He simply uses pattern recognition to find the basic characteristics that only the best companies share. He found that the truly top companies often share certain basic characteristics. He understood that there could only be a few “best” companies in the market, and then looked for a model by which to identify the true top companies in the market.
There are only a few good ones
The concept of excellence is not confined to the stock market alone. When we analyze anything in nature, there can only be a few good ones, whether architects, painters, musicians – you name it. An unbiased approach to finding great performers is key to success.
The bell curve is simple, but the concept is extraordinary. According to the law of large numbers, when we measure any group in nature, 90% of its members fall into the average. Only 5% of members are below average and 5% are above average. In essence, there are only a few top individuals in everything, and listed companies are no exception. This is the natural law of things.
So Kimmel took a different route, using a rigorous screening process: owning shares in fewer but clearly top-tier companies. His approach is to rank companies’ balance sheets and other facets of fundamental and technical indicators, then combine them to give each company a final score. This singles out outliers, companies that are at the absolute apex of the bell curve. While 90% of corporate stock opportunities are average, there will always be extreme underperformers and excellent investment opportunities. Only a handful of companies can truly be on top of things, as with anything.
The same is true. A study in the United States analyzed a total of 25,332 listed companies in the US stock market from 1926 to 2016, and found that the total wealth creation of 24,000 of them was almost zero, that is, about 96% of the listed companies basically did not create value; The top 1,000 companies have created all the added value; the most outstanding 90 companies, although accounting for only 3‰, have created nearly half of the total wealth of the entire US stock market.
For such problems, even William O’Neil discussed in his “24 Basic Experiences of Successful Investment” and “Successful Investors”. O’Neill pointed out that for individual investors, if they want to obtain real wealth, they should first buy the stocks of the best companies in the field, and second, they should concentrate their investment portfolio on a limited number of stocks and pay close attention to these stocks.
The result of all the greatest investments
The S-curve is a well-known phenomenon within biology: an organism initially grows slowly, and when a stage of development emerges, it can be seen growing rapidly, followed by a period of maturity, stabilization, and slower growth. Eventually, the organism becomes too large or too old to continue growing, after which time the organism enters a period of decline. Often, the best companies to invest in are those that are entering a rapid growth phase.
Why do we see various indices continue to rise over the long term? This is because the various components in the index are constantly changing. Many former index constituents, such as Pan Am and Bethlehem Steel, have gone bankrupt. The index creator simply replaces the names with new companies, which makes the index go even higher. All indices are actively looking for new leaders to replace companies in dying industries. Once the small car was born, the maker of the best buggy whips became a bad investment. There are fewer than 50 companies left in the S&P 500 30 years ago today, and only a handful of those companies outperform the index itself. Most companies are wiped out due to their poor performance. New industries are constantly emerging, and new market leaders are quietly appearing. Thus, the leader of a previous bull market is usually unlikely to be the leader of the next bull market.
That’s because new breakthroughs don’t usually come from larger companies, which are too rudimentary. Investors looking for real growth must look at breakthrough, innovative companies. At first, these niche companies were small but were able to create new, dynamic industries: Microsoft in 1987-2000, AOL in 1992-2001 or Google in 2000-2008. In the early part of the 20th century, Ford and American Radio were the leaders of their time, but they eventually lost their leadership positions.
In this regard, Charlie Munger said in the “Distinguished Investor Digest” in August 2008: “You have to remember that most small businesses will never grow into large businesses. This is the natural nature of things. Big It’s the nature of things that most big companies end up being mediocre or worse. So it’s a tough game. Plus, the players in the game are going to die. Those are the rules of the game—you have to Get used to it.”
Similar to Pan Am and Bethlehem Steel, these previously great companies have dominated industries that are now bigger than ever. Over time, however, these companies, and countless other glamorous success stories, have faded. If we bought and held the shares of these companies, we would definitely lose all the money invested in them. To cling to them, therefore, can only be detrimental to wealth.
To avoid such a fate, Kimmel reminds us to realize that there are always many companies leading the future market, and they may just start to rise. For a brief period, these companies experience rapid growth. When they hit the sweet spot of their S-curve exponential growth, they throw off Free Earnings and fire in full force.
Kimmel argues that individual investors don’t need to follow the largest crowds in order to be profitable. Because of their sheer size, most mutual funds buy shares of the same largest publicly traded companies. For this reason, individual investors today have a distinct advantage over institutional investors. Individual investors who invest in the best small companies and operate them for 3-5 years will have the opportunity to reap the most superior returns among all investment types. If the number of followers is low, undervalued companies are identified. However, a certain amount of patience is required and it will take time. A healthy tree does not grow overnight. Once these companies show consistent revenue and profit growth, it’s only a matter of time before institutions start to board the stock’s boat (it’s just a matter of time) and they can deliver superior returns. All of the greatest investments are the result of investing in fewer companies using superior stock selection methods.
Rainbow swans versus black swans
Two of Nassim Taleb’s books, The Black Swan and Idiots Walking Randomly, both discuss the application of bell curves and the treatment of outliers. His focus is on unanticipated and unexplained obstacles to success. He named these highly unlikely events “black swans”. The point he makes is that while it is true that 90% of the time things are average, the other 10% of the time things are not so calm and often very uneven.
Although statistically speaking, 90% of expected events fall within a normal expected range, real problems can arise in those times when actual events fall outside the expected range, that is, even if the event occurs slightly More than expected, and probably okay. It is on those few occasions when outcomes deviate far from expectations that disaster can easily strike. Unforeseen external events occur more often than models predict, and when they do occur, havoc often erupts. One of the most important realities that Taleb reminds us of is that complex strategies are extraordinarily fragile because they often seem so safe, and thus are often severely marginalized—even more so when disaster strikes.
One of the most important concepts proposed by Taleb is to separate the process from the benefit. What he means is that luck (for better or worse) is often the underlying cause of an outcome. In David Aaronson’s book “Evidence Based on Technical Analysis”, he uses empirical scientific testing methods to prove that the success of most trading and investment strategies is the result of luck, not the result of superior methods. Bill Miller is a prime example of a man who, after 14 consecutive years of outperforming the S&P 500 record, failed flawlessly. This shows that you should not confuse human wisdom with the bull market. That’s what Taleb meant when he said that luck sometimes plays a big role when it comes to investment returns. However, Kimmel believes that Bill Miller is as smart and more experienced today as he was 15 years ago, but he is currently being judged completely differently.
In Black Swan, Taleb often challenges his readers. He said that after someone read his book, he would quickly come up with “white swan”. Not disappointing him, Kimir really came up with “Rainbow Swan”. “Rainbow swans” are the colors of the rainbow because Kimmel uses multiple factors to rank companies, like the many colors contained in the spectrum. “Rainbow swans” When compared to the average company, those few companies often look so much better, it’s unbelievable. Typically, a “rainbow swan” company has a great idea and the quality management methods needed to execute it well. The company’s sales and profits are ballooning, and Wall Street and institutions are taking notice, and the company’s stock will experience a rapid price increase.
Undoubtedly, in every year and every market environment, some companies are the clear winners, but these companies are by no means guaranteed continued success. The challenge is to identify them, invest in them, and replace them before they succumb to competitive pressure. It’s a change in the investment landscape, or often even the hubris that stems from their early success.
Focus on a handful of top companies
In “Supreme”, John Boick researched and documented the successful experiences of top investors over the past 100 years. What sets these investors apart is their unique way of patiently waiting for the right market setup—the right market with the right portfolio. When the market is not moving forward, they can sit there and watch the market. And when the market turns bullish, they’ll be fully invested in a handful of well-known companies (maybe 10 at the most), the real market leaders. Their absolute focus on a small number of companies is what sets them apart and allows them to produce outstanding results.
To that end, Kimmel pointed to a discussion of Microsoft. Microsoft was founded in 1986, and anyone lucky enough to recognize the company in its early growth stages would be advised to keep selling to protect their gains. There were a couple of notable exceptions among those investors who took this poor advice, namely Microsoft’s founders and early employees. In an interesting twist, the few who cut through the waves of the market, put themselves in a unique position, eventually emerged as success stories. These people made huge fortunes by concentrating their investments in the right companies.
When an investor is able to buy a company’s strong cash flow at a discount to current market valuations, it’s effectively buying free earnings. This happens when a company delivers earnings and provides cash flow, rather than just promising to be profitable sometime in the future. At this point, the company is growing faster than the current market can assess the company’s ability to do so. Through the free income generated, the company positions itself to make a substantial contribution to its employees and the community, in addition to the profits delivered to shareholders. It’s a great time for the company, and an opportune time for investors to get involved in its stock.
Companies typically show rapid growth in both revenue and profit margins only when they introduce new products. Companies in new industries represent where some of the best investments have gone. Tremendous advances are currently taking place in certain fields, such as technology and medical science, which may result in excess investment returns. Sophisticated investors who have a good sense of where technology or healthcare is going in the future can reap huge gains.
Kimmel’s first book was published before 1999, and since then various new industries have emerged and are entering their heyday. Fuel cells, nanotechnology, alternative energy, cybersecurity, and solar power—companies that were unheard of at the time—are now creating huge profit opportunities for savvy investors.
A great investment is a combination of a great company and the investor figuring it out at the right time. But real wealth can only be generated over a long-term time frame, and with considerable effort. Success in the stock market depends on a combination of things—a strategy that works, good timing, and time. Kimmel reminds us not to expect positive guidance from economists. Most economists are not great investors. By focusing on the current industry leaders, investors can cut out the market noise and focus on a few top companies.