Achieving Alpha

One of the most unwise takes I heard recently is from one of my favorite podcasters, Sam Parr. He said that if you know there is a tool that can return you 7% compound, why would you want to put your money elsewhere?

Well, what Sam is hinting at here is: why would someone ever put their money anywhere else rather than the S&P 500? Historically, it returned a 7% compound annual growth rate; why wouldn't it keep doing this in the future? Sam isn't the only person with this view; this view is the standard advice for anyone trying to figure out what to do with their savings.

Life isn't gentle and soft-it's tough and competitive. It is foolish to assume that it would give you a tool that will guarantee positive returns, let alone good returns till the end of time without doing any work. Also, this tool is available to anyone, all what you need is a broker account. Intuitively, this should tell you that this tool is not the best tool to get rich. But even if this tool exists, it will probably only protect your money from inflation and won't be enough to make you wealthy. Let me be clear here: nobody is getting wealthy investing in the S&P 500. If it keeps performing as it was historically—and I really doubt it—you would still get a mediocre return that, in best case scenario, should be a bit above inflation.

You've probably read somewhere that the average money manager can't beat the index, so how would you, the average Joe, beat it? This is the most uninformed and probably gate keeping advice in the investing world. What people always miss is that the average money manager is playing a different game than the retail investor. The money manager's game is way harder; we retail investors have some advantages that we can play with. In this quick post, we will explore what guru investors tell us are our advantages as retail investors.

Warren Buffett

He needs no introduction: 20% returns for half a century. These returns are unreal; these returns solve world hunger; these returns cure cancer; when this guy talks, everyone listens.

In an interview, Buffett said he can get a 50% annual return if he is investing a small sum of money. It is important to understand why this is the case. Buffett currently can't invest in the majority of companies; his current cash position is a staggering $280 billion. He can basically go acquire Uber and Airbnb combined and still have some cash left. This is true for most of the successful investors: the better the return, the more money they manage, the harder it gets for them.

Imagine the sea of opportunities in the small-cap market. These companies don't have tons of analysts spending their full-time jobs understanding their business models and providing forecasts for their futures. These companies can have price inefficiencies that we, the retail investors, can take advantage of. Actually, if I were to think of a dream company—the best company I would invest in—it would be a company with little coverage. This is when we can exploit the inefficiencies in the market and get an insane return.

Lesson 1: Small investments are easier to manage and get higher returns.

Peter Lynch

Peter Lynch is my favorite investor; he achieved a staggering 29.2% return for 11 years straight. Peter is a promoter of the idea that regular retail investors can outperform traditional institutional money managers by utilizing their circle of competence.

If you go through Reddit posts in different investment subreddits, you will notice a lot of questions that follow this format: 'Hey guys, what do you think of {name your most niche stock here}? Should I buy it or not? I read in a post that it is an interesting buy.' Usually buried within the 'buy it/don't touch it' comments is the correct answer: 'Don't buy what you don't know.' It might seem intuitive, but most people ignore it. They buy the stock and then study it without really understanding the essence of what the company does and what the opportunities are. How can you make a solid investing thesis if you don't understand the company? Are you really going to put your hard-earned money into something you don't understand?

Lesson 2: Invest in what you know

Martin Shkreli

Controversial Martin Shkreli has had an undeniable impact on the retail investing community. Both before and after his time in jail, he has provided extensive investment knowledge to the public through his YouTube channel. I personally believe he is one of the top three most influential people in the retail investing community. Shkreli has been providing the retail investment community with a ton of advice to help them achieve alpha. My personal favorite is when he analyzes a stock. You can see a step-by-step process of how he uses his models to value a company.

When Shkreli was in prison, a friend asked him whether he should invest in AMC during its hype. Shkreli's first response was, 'How many stocks have you looked at before deciding that AMC is the best one?' The friend replied, 'Uh, just a couple of stocks.' Shkreli then asked, 'How many have you really studied?' Skeptical of his friend's research, Shkreli advised, 'Look, you can definitely find a better stock.' Ironically, the friend ignored his advice and invested in AMC, which has since plummeted by 95%. This friend could have invested in any other company in the stock market. He could have randomly picked another stock and would have achieved a better return than AMC.

Lesson 3: Study a lot of stocks before you invest in one; the more you look, the better the chance you will find a better stock.

Takeaway

There are three strategies that we can utilize to outperform the market. Sticking to these methods will play into our advantages as retail investors. Throughout the writings of Pillow Payday, our strategy will be to focus on these three lessons.

We will focus on smaller companies, the ones that are not covered by a lot of analysis.
We will focus on the companies that we understand; I like to focus on B2B SaaS companies and fashion companies.
We will study a lot of companies before we invest in one; we will be releasing two stock analyses per week.

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