How to beat the market analysts

Market analystBig caps and small caps are very different.

In short, you cannot possibly know more than the analysts when analysing big caps -- so you really have to make far-reaching big calls when judging their value. The same isn't true of small caps, where your individual in-depth analysis and research can really give you the edge.

The big calls on big caps can be made in a number of different ways. The method perfected by Foolish writer Stephen Bland over many years is one such way. Stephen calls this "strategic ignorance". This is a 'let the numbers do the talking' type of approach, using Stephen's 'PYAD' formula. It holds that companies with a price-to-earnings (P/E) ratio of a maximum of two-thirds that of the market, a yield 50% above the market, assets in excess of the company's valuation (price-to-book value under one) and zero debt if possible, with net cash, tend to outperform the market.

This is an excellent method and one certainly worth trying to emulate.

Big calls over a long time
Another way of making the really big calls is to zoom out and not get caught up in the detail. This is similar to the PYAD approach, but isn't always about fundamental value. For example, if you took the view that the 'drowning in oil' type analysis back in 1999 was wrong, and that 'Peak Oil' theory had more validity, then you may well have hunted for oil companies with exciting prospects, etc, which didn't necessarily display fundamentally good value characteristics. And you'd generally have been right to do so.

Similarly, if you think the banks and some other financials are at or near the bottom on a cyclical basis now, as I do, then the fact that they aren't making as much profit over the foreseeable future as you may like to see is of little consequence for a longer-term view.

Interestingly, though, during severe bear market downturns, the analysts are very much worth their salt even with big caps for us private investors.

As an example, the forward P/Es on many large caps reached comically low proportions back in early 2009 when the FTSE dipped below 3,500. It seemed the investing world simply didn't believe them.

Making a big call that the world wasn't retreating into bunkers with baked beans and shotguns would have been a good one at or around the low point in March that year. However, this would have been a big best-guess macro call, so a tracker would have done just as good a job as roughly half the individual big caps. But there are times like these when you're in accord with the analysts.

Always good reasons to worry
Of course, there are usually good reasons why companies hit unfeasibly low valuations on the most basic of value measures. But it's also surprising how often such basic value measures come out in a good capital gain. As a specific example, Man Group looked unfeasibly cheap at 112.7p back in January -- and so it proved to be, so far anyway.

Making big judgment calls to beat the market and the analysts, though, requires much longer timescales. And therein lies the opportunity. The market usually has too short a timescale, but you don't need to.

If you really believe you can view the long-term investing landscape well, then back your own judgment on a long-term view, beyond the analysts' horizons.

If you can't do so, or aren't confident enough to, then the "strategic ignorance" follow-the-numbers strategy may be the best way forward.

More stories

What is risk?
10 steps to making a million from shares
Why are the banks doing so well?

Read Full Story