How would you like to know an investing strategy that outperforms 95% of Wall Street’s highly paid fund managers in the long term?
You might think such a strategy to be arcane knowledge locked away in a bank vault somewhere, but in fact, some such strategies are quite well known.
One of those strategies is indexing. Studies have shown that index funds outperform 95% of similar active funds over a 20-year time frame. The degree of index outperformance over active funds varies from market to market — it’s weaker among small caps and bonds than large-cap stocks. However, for the S&P 500 and related large indexes, the 95% statistic usually holds true.
But what if there was an investment strategy that performed even better than indexing? A relatively simple strategy involves a diversified portfolio somewhat similar to that of an index fund but with a little more selectivity about the timing of stock purchases.
According to the late investing legend Charlie Munger, such a strategy exists. Shortly before his death, Munger was quoted as saying, “If you only buy quality stocks on the 200-week moving average, you’ll outperform the S&P 500 by a wide margin.” That’s a pretty bold claim, given how hard the S&P 500 is to beat. However, assuming that Munger’s “quality stocks” could be identified, the strategy would probably work, as the investor would be buying good assets when they’re down.
Quality stocks
The hardest part of Charlie Munger’s “quality stocks on the 200-week moving average” strategy is identifying quality stocks. What Munger means here is companies with durable competitive advantages that are highly profitable.
A classic example of a Canadian stock that scores high on the quality factor is Canadian National Railway (TSX:CNR). It has a strong competitive position, having only one major competitor. It is highly profitable, with a 32% net income margin, a 15% free cash flow margin and a 27.55% return on equity. Finally, it has an irreplaceable role in North America’s economy, shipping $250 billion worth of goods per year and rising. This combination of qualities argues that CN Railway is a high-quality business.
The above paragraph isn’t meant to be a recommendation of CN Railway’s stock. Although the business is great, the stock is a little pricier than I’d like, given its merely so-so growth. However, CN Railway acquired cheaply enough, and it is definitely an asset worth owning.
The 200-week moving average
Once you’ve identified some quality stocks, your next step is to buy them on the 200-week moving average. The 200-week moving average is basically the average price over a 200-week period or a little less than four years. Buying on the 200-week moving average means you’re not buying at an extremely high level for the stock. Assuming you’ve identified your “quality stocks” correctly, then buying them at that level should work out, as it means you’re buying something with a future brighter than its past at a price lower than at its peak.
I’ve never backtested Munger’s strategy, but I wouldn’t be surprised to learn that it works. It makes intuitive sense. At any rate, it’s something to think about.
