There is an old saying about coaching football, “It ain’t so much about the X’s and O’s. It’s about the Jimmy’s and the Joe’s.” Coaches at all levels measure player attributes such as size, speed, agility, and strength, because they know that the bigger, faster, quicker, and stronger their teams are, the more games they are likely to win.
Almost everyone that has ever played a sport has experienced a moment when they realized that another player was just too big, fast, quick, or strong to compete with. College coaches work year round to identify players with those traits and then try to convince them to come to their school.
The National Football League has even made the process of collecting the evidence of those characteristics part of their entertainment package by televising their combine each spring. That’s right, you can watch players run 40 yard dashes, bench press, jump, and get weighed for fun.
To show how important it is to fill a team with the biggest, fastest, quickest, and strongest, a recent review of national championship teams done by Clay Travis of Outkick The Coverage showed that, “Since 1998 every team that has won a national title except for Oklahoma in 2000 has had at least two top ten national signing classes in the four years before a title.”
Clay points out that top recruiting classes don’t guarantee a title, but they are necessary to put a team in position to win it all. What does all of this tell us about in investing?
Over the past fifty years or so, we’ve learned that investing is more about looking for the right attributes, too. It started in the 1960’s when University of Chicago economist, Eugene Fama, showed that trying to outguess the market’s “Random Walk” was pointless. He demonstrated that while stocks have outperformed bonds and cash as an asset class, trying to choose which stocks will perform best within the asset class is too random to predict and not worth the effort or expense. This work led to the creation of index investing.
Then in the 1990’s, Fama and Dartmouth finance professor, Ken French, proposed that two types of stocks tend to do better than the overall market. They showed in their 3 Factor Model that smaller company stocks and stocks priced lower relative to their book value, or value stocks, have “excess returns” over larger companies and growth stocks.
Most recently, another economist, Robert Nory-Marx, has shown that companies that have higher return on equity also outperform. In other words, he demonstrated that profitability should be associated with higher returns.
With the knowledge that attributes such as indexing, company size, relative value, and profitability should lead to better returns, investors can build their portfolios using those approaches if they want to increase their odds of success. It won’t insure success every year, just as the most talented teams don’t win every game. But over time, the evidence suggests that indexed portfolios tilted to value, small companies, and profitability will outperform.
Here at ATX Portfolio Advisors, we believe that having a good grasp of the X’s and O’s is important, which is why we create a financial plan for each of our clients. But ultimately, the Jimmy’s and Joe’s are those evidence based factors that give you the edge in the long run.
If you would like to learn more, let’s get acquainted.