The Weird Portfolio

I wrote a book describing my passive approach to investing, the Weird Portfolio.

I was originally going to publish this on Amazon, but decided to give it away for free. I really want to get the message and ideas out there to a mass audience, so I thought this was the optimal approach.

I put the whole thing up on Medium for free. It’s a short book. It’s designed to be read in a couple hours on a Saturday afternoon. It’s an easy, breezy, read. It’s free so hopefully that’s a consolation for the typos that are probably in there.

You can read it here. I hope you enjoy it.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Is it crazy to own gold?

I hope you had a great July 4th!

Gold is a controversial asset.

Feelings about gold tend to be separated into two camps:

  1. Stock people who hate the asset. They don’t understand why anyone would invest in an asset that generates no income with no future prospects for growth. Stocks pay dividends and generate earnings. Bonds at least pay interest. For gold, there is no intrinsic value other than what other people are willing to pay for it. I was in this camp for a long time.
  2. Perma-bears who love the asset. The Fed is destroying the monetary system and blowing up bubbles. So, the only safe haven from a dollar that is being slowly decimated by the Fed is a hard asset, like gold.

My asset allocation has a 20% allocation to gold. I don’t go all-in the asset, but I think it serves an effective role in a portfolio. It tends to cushion drawdowns, although not as well as treasuries.

Long term treasuries remain the champion of performance during massive stock drawdowns:

With that said, I’m not comfortable putting 40% of my portfolio in treasuries. I don’t believe treasuries are truly “risk free.”

The greatest risk to treasuries is inflation. Inflation would prompt the Fed to increase interest rates, which would crush treasury prices. Inflation would also make the interest and principal payments more and more worthless.

I previously had TIPS in my asset allocation as my inflation protection, but this is flawed because TIPS rely on official government statistics on inflation.

If the US government wanted to hurt TIPS investors, it could simply manipulate the inflation statistics and change the inflation yardstick. I’m not going full “shadow stats” and don’t think the government is currently doing this, but I don’t think it it outside of the realm of possibility in the future.

Meanwhile, gold is a defensive asset. Like treasuries, gold can cushion drawdowns. Unlike treasuries, it has a track record of performing well during periods of dollar weakness and high inflation.

I don’t advocate a massive allocation to gold and I don’t think that the global economic system is about to unravel because of the Fed’s insanity, but I have 20% of my portfolio in gold because inflation (and a weaker dollar) is a real danger and gold is also an effective way to contain this risk.

I think a good way to demonstrate the usefulness of gold in a portfolio is to look at it through the perspective of a truly crazy portfolio: 50% US market cap weighted US stocks, 50% gold.

This portfolio is indeed crazy. I don’t actually advocate putting 50% of a portfolio in gold, but I think that this crazy portfolio helps demonstrate why gold is a useful asset in a portfolio.

Before I looked at the data, I assumed that a massive allocation to gold would weigh down on returns. Shockingly, it does not. In fact, the 50/50 portfolio slightly outperforms the returns of 100% stocks with less severe draw-downs and less volatility.

On its own, gold is an absolutely terrible investment. Massive volatility, an extremely long drawdown & recovery (gold entered a drawdown in 1980 and didn’t fully recover until 2007), and it has little promise to ever outperform US stocks.

But – in a portfolio – gold can do extraordinary things. It helps reduce drawdowns and it tends to do well in decades when stocks are not doing well.

Gold demonstrated extraordinary performance during the 1970’s, but it also did well during times like the early 1930’s. Gold prices tend to rise during periods of growing fear, as investors flock to “hard assets.” The flock to hard assets is what occurred during the Great Depression. As people gathered gold, the price rose, rising from $20.63 in 1929 to $26.33 in 1933, a 27% increase during a period when stocks were down nearly 80%.

When rebalanced with stocks, it helps deliver a great result: less volatility and cushioned drawdowns.

The interaction between stocks and gold in the 50/50 portfolio is something I’ve noticed with a lot of asset allocations: an investor gets a result that is greater than the sum of the parts.

One would assume – for instance – that the return would simply be an average of the return for the two asset classes. Gold has a CAGR of 7.8% since 1972. Stocks have a CAGR of 10.25%. Averaged together – it is 9.025%.

However, in a portfolio, the actual result is 10.29%. It’s greater than the expected average of 9.025%. It’s greater than the return of either asset. The result is greater than the sum of the parts.

As David Swensen points out, asset allocation is the only free lunch in investing.

This is because gold and stocks are truly uncorrelated. They are almost inversely correlated.

By regularly rebalancing, an investor is able to sell gold when it is up and then buy stocks when they are down. This regular process of rebalancing enhances returns by buying each asset class after poor performance and selling each asset class after strong performance. Meanwhile, thanks to the interaction of the asset classes with each other, drawdowns and volatility are reduced.

Just to reiterate: a 50% allocation is too much for my tastes, but I think this is a useful experiment to show how an allocation to gold isn’t completely crazy and it can serve as an effective defensive asset in a larger portfolio.

For my portfolio, my defensive allocation is split between long term treasuries and gold. Long term treasuries perform better during large drawdowns. However, long term treasuries will be decimated in a period of rising inflation and interest rates. For that reason, I split the “defensive” slice of my portfolio between both gold and long-term treasuries. You can read about my passive allocation here.


U2 at Live Aid in 1985.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Q2 2020 Update


Year to date, I am down 17.77% and the S&P 500 is down 3.9%.

This is actually pretty good in context of my deep value strategy. VBR, the Vanguard Small Value ETF, is currently down 22% YTD. QVAL, the deep value Alpha Architect ETF, is currently down 26% YTD.

The deep value universe of stocks with an EV/EBIT multiple under 5 is currently down 30% YTD.

17% isn’t all that bad in this context.

Due to my large cash position going into the crash, I was only down 26% at the lows, while most of this universe was in a nearly 50% drawdown.

With that said, I missed my chance to gobble up bargains at the lows because I thought the worst wasn’t over.

A Mixed Bag: Good Decisions & Bad Decisions

In the last year, I made some key decisions. Some of them turned out to be good moves and some look like mistakes.

I started accumulating cash last year when the yield curve first inverted. I thought we were going to have a run-of-the-mill recession and I thought due to the overvaluation of the market that this would be enough to cause at least a 50% crash.

I went into the March crash nearly 50% cash. This was a good decision. When I saw that the recession wasn’t going to be a run-of-the-mill affair and was turning into the worst recession since the Great Depression, I started selling my cyclical positions aggressively. By the bottom, I was nearly 80% cash.

I was also convinced that the selling wasn’t over. I saw an index at internet bubble valuations hitting the worst economic event since the Great Depression and assumed that the crash would continue. Value stocks aren’t a place to hide during a crash, so to stay market neutral, I bought a position in an S&P 500 inverse ETF to stay market neutral. This was not a good decision.

What I didn’t anticipate was the extent to which fiscal and monetary policy were going to go full-throttle in an all out effort to boost the stock market and the economy. As a result, the S&P 500 rocketed upward and my short position was beat up.

As a result, I lost about 15% on the short position. I finally got out of it when the S&P 500 went above the 200 day moving average. Fortunately, it wasn’t enough to hurt my overall YTD results.

At the lows, net-net’s started to re-appear and the number of stocks below an EV/EBIT multiple of 5 increased. I didn’t buy any of them, thinking that the economic downturn was going to continue melting down the market with no regard to valuation. I didn’t buy enough at the lows. This was not a good decision. There were many stocks I should have bought and I didn’t.

One position I bought near the lows has worked out marvelously – AOBC, which has turned into SWBI. This is a gun manufacturer. You can read my write up here. I noticed that AOBC was trading at a low multiple to book value while simultaneously background checks were surging due to COVID. Gun sales continue to be strong, and this continues to skyrocket due to the unrest currently gripping the country.

I’m currently up 189% on this position. Obviously, buying SWBI was a good decision. I sold a piece of this position when it grew to 10% of my account from 5%. I plan on doing the same thing once this happens again.

I recently purchased a net-net, Friedman Industries. You can read my write up here. It is yet to be seen if this was a good decision, but I think that the risk-reward makes sense.

Looking Ahead

Currently, the market continues to be strong and seems invincible.

I’m not short after getting my butt kicked in my short position, but I’m still not bullish. I’m currently 80% cash and still only have a handful of positions.

It’s still yet to be seen how COVID is going to shake out.

I am finding it hard to figure it out. On one hand, the lockdowns worked, we flattened the curve. On the other, now that the economy is being re-opened, cases are surging. Skeptics say that this is simply because of more testing. Those who sounded the alarm on the virus say this is concerning.

I don’t know how this shakes out. What I do know is that the the present state of the economy is not good. Unemployment looks poised to reach its highest levels since the Depression in the 1930’s. Many businesses have been completely destroyed, and the number of businesses that are being destroyed continue to mount.

On the other hand, unprecedented levels of fiscal & monetary stimulus might create a new economic boom as the economy re-opens.

I don’t know how the economy shakes out, either. My instincts tell me that the economy is screwed, but my instincts can be wrong. We went into this with unprecedented levels of leverage and the only way that a lot of businesses are surviving is by taking on even more debt, making them even more fragile. On the other hand, the fiscal & monetary stimulus might work.

I don’t know how the virus shakes out and I don’t know what’s going to happen to the economy. The way I see it, the current situation is replete with massive uncertainty.

Uncertainty is something that an investor should get paid for with a cheap valuation.

Investors aren’t getting paid for that uncertainty.

What I know for certain is that the market is not cheap by any stretch of the imagination. From a market cap to GDP perspective, the market trades at 147% of GDP. At the peak of the internet bubble, we were at 140%. That’s right – we are beyond the valuation of the most extreme bubble in American history and we’re in the midst of the worst economic calamity since the Great Depression.

If the market were to return to 100% of GDP – the S&P would crash to near 2,000. If we were to return to the lows of the last two nasty bear markets, we would fall to nearly 1,500 on the S&P.

The CAPE ratio is at 29 – higher than the peak of the real estate bubble although not as high as it was during the internet bubble.

Looking at the value universe I operate in, it is currently only an average opportunity set. There were many stocks in the EV/EBIT < 5 universe at the lows, which was a pretty decent opportunity but not as big as 2009. There are now 75, which is a pretty average opportunity set.

An average opportunity set and a market trading at internet bubble valuations is not compelling. It’s definitely not an opportunity when we face the wide range of possible outcomes that we face today.

As a result, I’ll continue to be cautious and hold a lot of cash. If I find more stocks like SWBI or FRD that look like big opportunities, I’ll buy. What I won’t do is fill up my portfolio with subpar opportunities.

The large cash balance definitely weighs on my mind. Cash is a terrible investment long term, but I want to have the dry powder if the market crashes again.

I’ve considered deploying it into my passive asset allocation that you can read about here, but haven’t made up my mind on that yet.

My goal when I started this blog was to focus on Ben Graham’s low P/E, low debt/equity strategy during the good times. When the bad times arrived, I was going to buy net-net’s. The net-net’s started appearing in March and I didn’t buy enough of them. I barely had time to research any of them before they disappeared.

My instincts tell me this isn’t over and I’ll get another chance to buy them. We’ll see.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Friedman Industries (FRD)


Key Statistics

Market Capitalization = $37.02 million

Current Assets = $69.29 million

Cash & Equivalents = $22.33 million

Total Liabilities = 12.68 million

Net Current Asset Value = $56.61 million

Operating Cash Flow = $3.47 million

Price/Tangible Book = 53%

Altman Z-Score = 4.66


Friedman is a steel company that has been around since 1965.

Their business is split up into two segments: coil products and tubular steel. Coil products account for 67% of revenue and tubular steel accounts for 33% of revenue.

Coiled steel is basically a form of sheet metal used in a wide variety of different industries. It can be used in the manufacture of automobiles, refrigerators, or roof gutters.

Tubular steel is used for a wide variety of applications. It can be used in the medical industry for stethoscopes or wheelchairs. Engines require tubular steel, which can be used in aircraft or automobiles. Steel tubing is also used in the manufacturing industry, to transport liquids throughout the process. It is also used heavily in the construction industry, for things like structural support or railings.

Friedman is a smaller player in an industry dominated by giants, but it has managed over the decades to continue to survive in a tough industry. Its plants are located throughout the Southern United States. The plants operate in Texas, Arkansas, and Alabama.

My Take

Friedman’s stock has been beaten up. It started to decline last year as a recession and reduced steel demand became more apparent. It hit a low of $3.72 during the depths of the COVID decline. I bought it yesterday at $4.9899. It has gone up significantly since the lows, but I still think it is relatively cheap. A return to the 52-week high would take the stock up to $7.01.

The stock trades below net current asset value, so I don’t expect it to be an outstanding business that is growing fast with high returns on invested capital.

With that said, in the universe of net-net’s (a world of reverse mergers and biotech science experiments), Friedman strikes me as a high quality net-net. In the last year, it has posted positive operating cash flow, so it is a viable business. The Altman Z-Score of 4.66 also shows a high degree of financial quality and limited bankruptcy risk. I’m confident based on the operating history and high level of financial quality that Friedman isn’t going to annihilate its current asset value, which can’t be said for many net-net’s.

The situation currently appears bleak for the steel industry. The customers for steel products are hitting hard times as a result of the recession. Construction and manufacturing activity are likely to slow down.

I think the hard times are already reflected in the stock price. At 53% of tangible book, this is near the lowest level that it has traded in the last 20 years. In the last five years, the stock usually trades in a range of 80%-100% of tangible book. When the steel industry was hot in the mid-2000s, Friedman traded at double tangible book value. I think it’s a reasonable assumption that this can return to 80%-100% range of tangible book, at which point I will sell.

If the economy returns to some semblance of normal, then construction and manufacturing activity will get back to normal. Coiled and tubular steel are essential for a number of uses that aren’t going away.

Meanwhile, steel plants are being shut down and steel production is down for the industry. This means that if demand returns back to normal, Friedman will be well positioned to take advantage of it.

If that doesn’t happen, then Friedman has the balance sheet and discipline to survive. It already trades at a price which indicates that there won’t be a recovery in the steel industry.

For those reasons, I think the risk/reward makes sense, so I purchased a position.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.


I sold 125 shares of Smith & Wesson (SWBI) @ $16.8803. I still own 145 shares. I was up 122% on the position and it had grown to 10% of my account. I took it back down to 5%. I still don’t think that the run for this stock is over, as gun sales are likely to be strong.

I bought 350 shares of Friedman Industries (FRD) @ $4.9899, which is below net current asset value and 50% of tangible book.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Portfolio Position in Troubling Times


Goodbye, shorts

I dumped my short position yesterday. It looks like I screwed up with this bet. Fortunately, it wasn’t a fatal bet.

I lost 15% on the position and I’m up slightly over the last few months overall, thanks to the performance of the stocks that I still own. I owned it mainly to stay market neutral and didn’t make a big bet on it, so it’s an outcome that isn’t the end of the world.

I’m still happy that I have been cautious this year. I’m down only 22% YTD, which is a lot better than the deep value universe that I operate in. The universe of stocks with an EV/EBIT multiple under 5 is down 40% YTD. It was previously down nearly 50% and I avoided nearly the entirety of this drawdown. I also outperformed this universe last year, when I was up 32%.

I still badly lag the S&P 500 since I started this blog in December 2016 – which is very disheartening – but I’ll take the good news where I can.

My passive approach (small value, long term treasuries, gold, international small caps, and real estate) has handled the crisis excellently, down only 5% YTD after being down only 20% in the worst of the crisis. I’m often tempted to put this brokerage account into that passive approach, but I still enjoy the hunt of picking stocks and trying to figure out the macro picture.


I bought only a couple stocks during the depths of the crisis – VLGEA (super markets) and AOBC (guns – now SWBI). VLGEA is flat, but AOBC has been an outstanding performer. I am up 80% on the position. It looks like my thesis – that COVID would drive higher gun sales – is proving to be correct. I couldn’t have anticipated nationwide riots, but that appears to be helping out the position, as well.

While I am no longer short, I still hold a lot of cash. 78% of my portfolio is still cash. Needless to say, I am still quite bearish on the market, even though I don’t want to be short it.

The Market

If I’m bearish, why aren’t I holding onto the short position?

I know that a trend following element is absolutely essential to shorting.

I walked into the short with an eye on the market’s 200-day moving average. Recently, the S&P 500 crept above the 200 day moving average.


As a value investor, I have always talked a lot of smack about trend following, but I have been changing my mind after examining the evidence.

A great resource on trend following is Meb Faber’s paper – A Quantitative Approach to Tactical Asset Allocation. The approach advocates owning asset classes only when they are above their 200 day moving average. The approach reduces drawdowns while still delivering the market’s rate of return.

A trend following strategy like that gets out of the market when it falls below the moving average and stays invested when it is above.

Looking at the S&P 500 over the last decade, an investor would have only been out of the market a few times. They mostly turned out to be false alarms that didn’t see the market make a massive move lower. This includes the 2011 debt ceiling showdown, the oil market chaos in 2015-16, and the December 2018 meltdown.

Where a trend following strategy helps is during the big, nasty draw-downs. An investor following a trend system would have sold in February, avoiding all of the mayhem that occured in March. It would have also kept an investor out of the market during most of the 2000-03 50% drawdown. It would have also kept an investor out of the market from 2007-09 during that 50% debacle. Trend following buys in late in the game – but who cares? They avoid the cops showing up to the party, and then arrive a little late to the next one.

When a market is solidly above the 200 day moving average, it usually continues rallying higher, even when the fundamentals don’t support it.

Paul Tudor Jones is probably the most vocal advocate of using the 200 day moving average as a trend indicator. He had this to say about the approach:

My metric for everything I look at is the 200-day moving average of closing prices. I’ve seen too many things go to zero, stocks and commodities. The whole trick in investing is: “How do I keep from losing everything?” If you use the 200-day moving average rule, then you get out. You play defense, and you get out.

Historically, it is a very bad idea to be short the market when it is above this level.

While it is often maddening to value investors like me, the fact of the matter is that there is nothing to prevent something absurd from getting a lot more absurd. This is a lesson that value investors who have been short stocks like Tesla have learned the hard way.

It’s something that people who were short the Nasdaq in the ’90s also learned the hard way. An investor could have looked at the market in early 1999 and concluded that it was absurdly overvalued. They would have been correct. Even though they would have been correct, it wouldn’t have stopped the market from wiping them out by doubling before melting down from 2000-03.

Unrelated: “The Hard Way” was a pretty funny early ’90s flick.


There is nothing to keep an absurd market from getting more absurd.

As a value investor, I have a visceral hatred of following the herd, but I think it’s important to keep tabs on the movements of the herd to prevent me from getting trampled by it.


Make no mistake: I think what’s going on is completely absurd, but I’m not going to fight it.

The real economy has been eviscerated. We have Depression level unemployment – approaching 20%. America’s corporations are surviving by leveraging up, making them even more fragile than they were before the crisis. Even the tech giants that have enjoyed the biggest gains of the rebound have seen their earnings dissipate.

The Fed is providing liquidity, but that’s all that the Fed can do. Jerome Powell isn’t a sorcerer who can create a 1999 economy out of 1930s unemployment. The Fed is preventing the system from collapsing, but that’s not the same thing as fixing the damage that has been done to the actual economy. The Federal government is providing fiscal stimulus, but that isn’t enough to replace a job or re-create the actual productive economic activity that has been eliminated.

Wall Street doesn’t care. It has doubled down on its commitment to the Fed put – the idea that the Fed will have the power to prevent any further meltdown in the market. The actual earnings capacity of the market has been decimated, but the markets are completely ignoring this.

The bear thesis of the last decade – that the markets are fraudulent and being manipulated by the Fed – has now turned into the bull thesis. Buy stocks because the Fed will make it go higher. Earnings and the economy don’t matter. This is dangerous and absurd thinking.

One take is that the market believes we will swiftly return back to normal with the economy re-opening. Maybe, but I think this is a dubious bet. I’m sure activity will resume and life will go back to normal, but it’s not going to be 100% of where we were before. There will be a number of businesses (like bars & restaurants) that will not re-open, because they couldn’t survive a 100% drop in revenues. Meanwhile, furloughed employees won’t be immediately re-hired, as businesses take a wait-and-see approach to bringing them back on board.

Nor will everyone in the economy immediately leap back to normal. Everyone isn’t going to re-book their vacations, even if 70% of them do. Businesses aren’t going to resume all of their business trips and conferences. Older people will likely wait until it’s clear that the virus has either been overblown or that we have a vaccine. They also command most of the disposable income, so that’s a major hit to the economy.

There also isn’t a guarantee that there won’t be a resurgence of the virus once the lockdowns end. We flattened the curve, but who is to say this won’t start spreading all over again? This virus started with a handful of people in China and spread all over the world. Once we resume normal activities, won’t it start spreading all over again?

Most of the damage from the Spanish Flu occurred during the second wave of the virus. Will we have a second wave of this virus? Will that trigger another round of economically destructive lockdowns? I don’t know, but the probability of that happening is not zero.

Call me a pessimist, but I don’t see a lot to be optimistic about these days. The market is partying like it is 1999 while the economy is in 1932.

I’m still holding a lot of cash even though I am no longer short, simply because I think that the risks are massive and the market is behaving like they don’t exist.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.


With the market now above the 200 day moving average combined with the fact that it is seemingly immune to bad economic news and nationwide riots, it’s apparent to me that fighting the Fed and buying this ETF was a mistake.

I still think the market is overvalued and hold a lot of cash, but I’m not going to be short this market anymore.

Sold 290 shares @ $23.025.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Horse Racing & Value Investing


Teenage Fun at the Track

I grew up near a horse racing track.

As a teenager, my friends and I didn’t partake in normal teenager activities. As a bunch of geeks, we didn’t go to many school dances or parties.

Instead, we hung out in a smoke filled race track with a bunch of old men.

I instantly fell in love with the track. The atmosphere was something that I gravitated towards.

There was something fun about 20 screens with odds and potential bet combinations flowing at me.

There was the smell of smoke everywhere, along with constant yelling and cursing.

I loved it.

My friends and I would always laugh at the old men who could string together the most colorful combinations of profanity.

They would invent combinations of curse words that I couldn’t imagine. These men were the William Shakespeares of profanity. Maestros of expletives.

We were never carded, despite the fact that we were under 18. It was strange because we were clearly a bunch of 16 year olds. We would place our bets electronically and only go up to the tellers to cash out.

I’m sure that the tellers knew what was going on and just didn’t care. They probably weren’t being paid enough to make a big deal about it. After all, our age was even more apparent when compared to the group of 70 year old men that we were hanging out with.

We would usually go to the track with $5 in our pockets and spend an afternoon at the track, pooling our funds together to share in the losses and occasional winnings.

The amount of effort and brain power that we put into losing money was truly astounding, but we had a lot of fun doing it.

I learned a few early lessons at the track:

1) Horse betting is a game where the house takes 20% of the pool and is a sure fire way to lose money.

2) The worst way to gamble is to bet on the horse with the best odds.

3) Horse racing is a fun way to spend $20 on an afternoon of exhilarating fun.

Point #2 is the most relevant when it comes to investing.

When we first starting gambling, we would bet on the favorites and thought that made the most sense.

As we lost money betting on favorites, we realized that the favorite was nearly always over-valued.

It dawned on me that horse racing wasn’t about predicting the horse most likely to win. It was about finding a horse that was undervalued. It was about finding where the payoff would exceed the true odds of the horse.

It didn’t take sophisticated analysis to realize that the favorite was overvalued. This was obvious when analyzing the data.

To find data, we needed an important source: The Daily Racing Form.

Unfortunately, the Racing Form was an expensive document and we didn’t want to dip into our gambling pool to pay for it. We had to get creative.

Usually, to conserve our betting pool, we would sit patiently and listen for a particularly foul mouthed gambler. Usually, the tempo of the profanity was tied closely to the amount of money that they were losing. Eventually, this gambler would throw their racing program on the floor in disgust and vow never to return to the track. They would scream that the place should be burned to the ground, as if it were the city of Carthage and they were the Roman Empire. (Narrator: They would usually return on the following weekend.)

I would then take the mangled program off of the floor and use it to make betting decisions for the rest of the afternoon.

In the program, the best horse was usually given something like 2-1 odds by a professional handicapper. As the bets poured in, the horse was usually assigned odds of something like 1-1 because everyone wants to bet on the winner. In other words, the favorite typically became overvalued.

The favorites were guaranteed to pay out less than they were “worth,” a phenomenon made particularly punishing by the house’s takeout.

In other words, everyone knows that the favorite is the likely winner and the favorite typically became over-valued. Betting on favorites is a way to win more often, but it’s also the way to lose the most money at the track.


I think of the best stocks in the stock market as favorites at the track.

Charlie Munger explains this better than I can:

The model I like—to sort of simplify the notion of what goes on in a market for common stocks—is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.

Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system.

Everyone knows who the winners are in the market. Facebook, Amazon, Google, Netflix, Visa, Mastercard, Costco, Domino’s, etc.

Everyone wants to bet on the winner.

As a result, the favorites are bid up to extraordinary valuations. Valuations that don’t always make sense.

It happens again and again in every market cycle. The Nifty 50. The late ’90s Nasdaq.

Everyone wants to bet on the winner. It’s satisfying because the winners win the most often. There is also comfort in going with the crowd.

However, betting on the favorites is a way to lose money at the track. Similarly, betting on expensive stocks is a way to lose money in the markets, even though it hasn’t seemed that way for the last decade.

Like the track, the trick in investing is to identify under-valued bets. You want to find a bet where the odds don’t make sense. You want to identify situations where the quoted odds are worse than the true odds. In other words, you want to identify mis-priced securities.

With that said, reflexively betting on horses with bad odds is also a way to lose money, as my friends and I learned. They often deserve those bad odds. This is likely why buying all of the stocks at 52-week lows is also a terrible way to invest.

Anyway, like favorites, expensive stocks under-perform over the long run as a group, which is what all of the data screams in every backtest over every long period of time.

Of course, it’s hard to rely on that data when looking at a market. It feels good to bet on the winners.

The trouble is: everyone else knows who the likely winner is. That’s why they command a high price.

The OG Of Quant: Andrew Beyer

In my quest to find a better way to handicap horse races, I looked for a book that would teach me how to handicap.

I discovered the work of the greatest handicapper of all time: Andrew Beyer.

Andrew Beyer was doing quantitative analysis before Moneyball. He was doing it before James O’Shaughnessy wrote What Works on Wall Street or Jim Simons launched Renaissance Technologies.

When Andrew Beyer started betting, most horse handicappers were obsessed with class. Class was based on the breeding history of the horse. Horses of a better lineage were assigned better odds. Handicappers would often assign nonsensical stories to horses in their efforts to attempt to predict horse races.

Andrew Beyer thought that all of this was unreliable sorcery and sought to create a more rigorous way of determining the true odds of the horse.

He developed what became known as the Beyer Speed Figure: a quantitative way to determine how fast a horse ran a race and to do it in a way that captured different conditions and lengths of track. A single number that would assess a horse’s performance in a race.

When Beyer was gambling with his own funds in the 1960’s and early 1970’s, he had to manually calculate speed figures. He would spend his time manually going through old racing forms and figuring out the speed figures of different horses.

At the time, he had a critical piece of information that no other horse player had. He was like the Jim Simons of the racetrack.

Beyer was able to use this information to figure out that the true favorite in the race was a long shot with 30-1 odds that no one was paying attention to.

He had the holy grail of horse racing: a quantitative system that would allow him to collect money from other gamblers at the track.

In 1975, Andrew Beyer wrote a book about his discovery, Picking Winners. This began the gradual unraveling of speed figures as a tool to make money.

Andrew Beyer could have silently continued cashing in wining tickets, but he was a journalist and a young man who wanted to make his mark on the world, so he published his book about it.

The book outlined how to manually calculate speed figures, which many horse players started doing. Unfortunately, because more people knew about the signal, horses with the best speed figures started to command better odds.

In the 1980’s, paid services began providing the speed figures for a fee. This further diminished the labor of horse geeks who were manually calculating speed figures on their own.

Beyer responded to this by publishing The Winning Horseplayer in 1983, which advocated using complex bets (such as Exactas, Trifectas, and Daily Doubles) and combining with speed figure analysis to identify under-valued situations at the track that were not simple win bets.

Of course, the knowledge and availability of speed figures continued to chip away at the potential profits that could be made from this signal. Even the complex bets advocated in The Winning Horseplayer lost their effectiveness.

The final nail in the coffin was applied when The Daily Racing Form began publishing speed figures in 1992. Once that happened, the horse with the best speed figure started to command the best odds. Speed figures were no longer a tool that could be used to regularly generate profits.

With that said, speed figures were still the best tool available to predict the outcome of a horse race but they were no longer a way to consistently cash winning tickets.

Andrew Beyer became a legend and I’m sure he made a significant amount of money from the publication of his books and the incorporation of his method in the Daily Racing Form.

Unfortunately, Beyer speed figures no longer offered an edge to the horse player who could use them to find under-valued bets at the track.

Once everyone knew about them and the information was widely available, the party was over.

Value Investing

I sometimes worry that simple metrics of value are suffering the same fate as the Beyer Speed Figure.

Beyer himself discusses his speed figure in comparison to the stock market and the use of the P/E ratio:

It was a tremendous edge to have the figures at a time when most people didn’t use them or even believe in them. I can only draw an analogy to the stock market if the concept of the P/E ratio were unknown to, or its importance was disbelieved by the majority of people buying stocks, and you were about the only guy who knew what the P/E of different stocks was, it would be a tremendous advantage and I had that advantage for many years.

When everyone realizes that simple measures of cheapness work, doesn’t that crowd out the trade and reduce the effectiveness?

One can imagine that men like Benjamin Graham and Walter Schloss were like Andrew Beyer at the track in the 1960’s. They had a statistical method that no one else used and were able to use the information to make tremendous amounts of money in the stock market.

The disappearance of net-net’s in the US stock market lends credence to this view. Net-net’s disappeared because everyone knew about them. It’s obvious that a company selling below liquidation value is a tremendous bargain, which is why there aren’t a lot of companies that trade below liquidation value today.

Meanwhile, value as a statistical factor has become very popular since Fama and French made it respectable in the early 1990’s.

If everyone knows that simple statistical measures of value work, will it stop working?


Perhaps the “cheap” buckets of the market were filled with mis-priced securities in the past, but now this cheap universe generates more scrutiny among investors, thus eliminating the mis-pricings.

As the mis-pricings are eliminated and quantitative investors elevate the valuations of the cheapest stocks, will this have the same effect of everyone betting on speed figures and making the signal worthless?

I don’t think so.

If this were happening, I would expect to see the cheap buckets of the market become expensive relative to their long term mean.

This doesn’t seem to be happening. In fact, the cheapest chunk of the market is not expensive relative to its long-term mean.


If value were becoming a crowded trade, wouldn’t this segment of the market become more expensive? Just like horses with high speed figures started to command better odds as the figures became more popular?

I actually think this case could have been made in the mid-2000’s, but no one was making it back then.

By the mid-2000’s, value was triumphant. The unwinding of the tech bubble wrecked the investment world, and the only people with respectable track records were those who embraced cheap stocks.

Quantitative value investing became popular and investors piled into it. This made value stocks more expensive relative to their long-term mean.

We’re now at the opposite end of the spectrum. After a poor decade for value investing, most people hate it. Even value investors are capitulating and buying into the compounders.

I think the absolute cheapness of value is an indication that the party is not over for quantitative value investors. It’s as if the high Beyer speed figure horses are commanding worse odds than they were before the signal was discovered. It’s not a crowded trade right now.

It was a crowded circa 2007.

It should have been obvious in the mid-2000’s that this was becoming a crowded trade when value stocks started to become much more expensive relative to their long term mean.

For this reason, I think it is important for quantitative investors to play close attention to the absolute valuation of the value segment of the market. There are times when the bet on value makes sense and times when it does not.

It’s completely possible that simple metrics of cheap will no longer be useful in the future. Monitoring the absolute cheapness of the factor is a way to monitor whether or not this is happening, just like better odds on fast Beyer horses was a sign that the party was over.

The Equity Risk Premium

Everyone likes to pick on value investors, but I find it amusing that no one ever asks if something like the equity risk premium can be arbitraged away.

In my view, the equity risk premium is not different than the value factor.

If everyone knows that equities command higher returns than other asset classes, why doesn’t that become a crowded trade that reduces long-term returns?

So far, the 21st century hasn’t offered much of an equity risk premium. Since 2000, the US stock market has delivered a 5.62% CAGR, while the US bond market has delivered a 4.98% rate of return. That’s not much of a premium, especially compared to the pain that equity investors had to endure, such as multiple 20-30% meltdowns and two nasty 50% drawdowns. International stocks have actually under-performed bonds entirely, delivering a pathetic 2.58% CAGR.

This all stands in sharp contrast to what happened last century, before everyone knew about the equity risk premium.

In the 20th century, stocks returned 10.16% and bonds returned 4.82%. Now that’s a premium!

Could the poor performance of equities have occurred because everyone realized that equities perform better over the long run in comparison to bonds? As a result, were equities bid up to a level in the late ’90s that guaranteed poor performance going forward?

In fact, right now, equities are so expensive that they are likely to deliver another lost decade like the 2000’s. It’s possible that they may even under-perform the low yields offered by US treasuries. In fact, I think that’s probable.

At the moment, I think that the prospects for the value factor are better than those for the equity risk premium itself. This is high level heresy, but the evidence backs it up. After all, in the 21st century, there hasn’t been an equity risk premium. Small value is one of the only investing styles that has offered a decent return over the last twenty years, a 7.9% CAGR.


Two TV themes that struck terror in my heart as kid in the 1980s:

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

I am a value investor. My outlook is inspired by the ideas of Benjamin Graham. This site is a real time chronicle of my portfolio and an outlet to share my ideas. I hope you enjoy.