The Mind-Blowing Chart That Forever Changed How I Invest in Stocks

 

I’ll never forget when I stumbled across the chart below.

After reading it, I said out loud:

“Why am I not profiting from this??”

This chart contains two mind-blowing insights that forever changed the way I invest in stocks.

Let me break down exactly what I see and why it had such a big impact on me.

First, I'll explain what we’re looking at here:

This chart is from an article by O’Shaughnessy Asset Management where they’re testing:

  • ...how well different investment strategies (such as “value”, “momentum”, “financial strength” and “earnings quality”)
  • ...would have worked to produce market-beating profits (what they call “factor alpha”)
  • ...amongst different stock sizes (what they call, “universes”)
  • ...over the past 45 years (from 1970 - 2015)

OK, that's a lot of financial jargon, so let me simplify a bit:

The chart is examining this question: “From 1970 - 2015, if you were to apply these four investment strategies to large stocks, small stocks, and micro cap stocks, how would each strategy have performed on each stock size?”

What they found blew me away.

Here are the two big insights that I’ve carried with me ever since:

1) There are several proven investment strategies that consistently earn market-crushing profits.

When you look across this chart, the first thing that jumps out is that all four of the investment strategies (value, momentum, financial strength and earnings quality) are able to predict which will be the best returning stocks and which will be the worst returning stocks.

Where it says “highest decile” or “cheapest decline,” that simply means the best 10% of stocks according to each strategy.

Similarly, where it says “lowest decline” or “most expensive decline,” that simply means those are the worst 10% of stocks according to each strategy.

Here I’ve added notation in red so you can see which are the “best” and “worst” stocks.

What’s remarkable is that regardless of whether they’re large, small, or micro cap stocks, the best stocks are beating their benchmarks by a wide margin and the worst stocks are losing to their benchmarks by a wide margin.

To put it simply:

There are several proven investment strategies that consistently earn market-crushing profits over time.

Most investors have heard of the first one on the left - value investing. This involves buying stocks that are trading below what they’re truly worth (i.e., undervalued) and avoiding stocks trading far above what they’re truly worth (i.e., overvalued).

But it turns out there are many other strategies, in addition to value investing, which can successfully predict which stocks will earn market-beating profits.

Since coming across this chart, I’ve dedicated literally thousands of hours to discovering and refining such proven strategies. And they've become the foundation for how we invest here at Uncharted Investing.

So, the first takeaway is that there are strategies that can work to earn market-beating profits over time.

This leads us right into the second big insight, which you might be able to guess by now…

2) These proven investment strategies perform FAR better on small undiscovered stocks than on large stocks.

Now, before coming across this chart, I already knew that small stocks outperformed large stocks over time.

As you can see by this chart from Morningstar, from 1926 - 2018, small stocks beat large stocks by nearly 2% per year which grew a $1 investment into $36,929 (small stocks) instead of just $7,353 (large stocks). 

That means small stocks beat large stocks by more than 5x!

So, I already knew that small stocks offered huge opportunities that couldn’t be found anywhere else.

But until I saw this chart, I didn’t realize that applying proven investment strategies (such as value investing) to small stocks offered SO MUCH more upside than large stocks.

Looking at our chart again, we see that in every case, the value, momentum, financial strength, and earnings quality strategies performed dramatically better among small stocks and micro stocks than among large stocks.

For example, over the last 45 years buying the most undervalued micro stocks offered nearly DOUBLE the excess annual return as buying the most undervalued large stocks.

This means that for regular individual investors, carefully selected small stocks can offer a huge upside that's often overlooked by big Wall Street investors. 

And to be clear, "small stocks" certainly does NOT have to mean speculative penny stocks or OTC / pink sheet stocks or anything like that. 

Instead, it means lesser-known or undiscovered companies that are both high quality AND overlooked by most investors. 

Pulling it all together, here are the two big takeaways that forever changed how I invest in stocks:

  1. There are several proven investment strategies that consistently earn market-crushing profits.
  2. These proven investment strategies perform FAR better on small undiscovered stocks than on large stocks.

So, naturally I began working around the clock to discover and refine as many of these strategies as I could.

Through extensive research and testing, I've been able to uncover dozens of investment strategies that can provide market-beating returns over time.

I also focused on separating the strategies which worked best on small stocks from those which worked best on larger stocks. That way I could use the best possible stock-picking strategy depending what size company I was looking at.

These strategies are now the foundation of my Profitable Stocks & Strategies newsletter, which offers three stock portfolios based on proven investment strategies:

  1. Fast Profit Portfolio (Aggressive Growth) aims for fast profits by holding 12 small, high-potential, fast-growth, hidden-gem stocks.
  2. Steady Growth Portfolio (Moderate Growth) aims for steady, long-term profits across all market environments by holding 12 large, stable, high-quality, growth stocks.
  3. Wealth Protector Portfolio (Defensive Dividends) aims for wealth protection and steady dividend income by holding 12 low-risk, recession-resistant, dividend stocks.

You can learn more about the Profitable Stocks & Strategies newsletter and its advanced recession warning service on the Subscription Information page.

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