Any Monkey Can Beat the Market! Really?

Any monkey can beat the market! That’s exactly how a headline of an article I recently came across reads.

This article was published in the Wall Street Journal in late 2012 (a tribesman recently shared it with me) and stated that if you give a monkey enough darts to throw at stock pages, they’ll beat the market. This was based on a research that simulated results of 100 monkeys throwing darts at the stock pages in a newspaper. The average monkey outperformed the US stock market index by an average of 1.7% per year since 1964.

Now, that would have bought them a lot of bananas!

In fact, as early as 1973, Burton Malkiel, a professor at Princeton University had claimed in his book, A Random Walk Down Wall Street, that “A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.”

Now, given that the monkeys have not just earned as much as the US stock market index, but have handsomely outperformed it, there’s something worth pondering about for those who are trying to work hard to pick their own stocks.

Why care to analyze businesses and estimate intrinsic values when you can hire a monkey (or I will send one to you for a fee 🙂 ) to pick your stocks?

You must care, dear tribesman!

Monkeys and Stock-Picking
While I don’t have data going back 20-30 years, I definitely wanted to test this “Monkey Hypothesis” in the Indian stock market.

Thus I did this small exercise of creating three Monkey Portfolios, one each from the BSE-Sensex, BSE-200, and BSE-500 indices.

I did not throw dart at these indices (have never been good at that, you see!). Instead…

1. I listed down all stocks from each of these indices in alphabetical order.
2. I generated a random number on the website – random.org. So this was my dummy monkey.
3. Example – If the number generated was 33, I picked the 33rd stock from top and added it to my “Monkey Portfolio”.
4. Using this method, I picked 10 stocks from each of these indices to create three different portfolios

Here are the three Monkey Portfolios I created this way…

(My monkey seems to have a special affinity towards Bajaj Auto, as the stock got chosen in two portfolios) 🙂

Anyways, here is the performance of the three portfolios against their respective indices over the past two years (since March 2012)…

Here is the performance of the three portfolios against their respective indices over the past three years (since March 2011)…

As you can see from the charts above, my monkey has really disappointed me. Its stock picking skill – or let me say, dart-throwing skill – has caused 5 out of my 6 Monkey Portfolios to underperform the broader indices. 🙁

The only Monkey Portfolio that has outperformed is the one picked from the BSE-200 index and analysed for return over the past three years.

Now, 2 or 3 years are small periods to back-test a hypothesis, but then this analysis proves that Indian monkeys may not have been as lucky as their American counterparts in beating the stock market through their dart throwing skills.

As far as the American monkeys are concerned, as per the above-mentioned research, they were asked to dart-pick 30 stocks from a 1,000 stock universe. Now, when a monkey (or anyone else) would throw darts at 1,000 stocks, there is a greater probability of hitting a “small and micro-cap stock” than a “large or mid-cap stock”, simply given the bigger universe of the former.

And as we know that small companies have generally outperformed big companies in the past, this is how the American monkeys have beaten the US market, represented by 30 large-cap stocks.

Here is one more difference between the Indian and US situations. When you look at the performance charts I have shown above, the biggest disappointment my monkey faced was while dealing with the BSE-500 index, which is made up of most number of small-cap stocks as compared to the other two indices – BSE-200 and BSE-Sensex.

So, over the past two and three years, small companies in Indian have fared worse than their larger peers. This is unlike the US situation, though over a longer term period.

As far as Indian monkeys and their dart throwing skill is concerned, I find one big reason they may not outperform the broader markets even in the future. That one reason is…

Corporate Mis-Governance
To say the least, corporate governance standards in India are worse than in the US. While a few American corporate scams have been much bigger than those that have been reported in India, the malaise is more widespread here than there. Plus, very few corporate crimes get reported in India, so we do not know how deep this malaise is.

And thus, there is a great probability that if you employ a monkey to throw darts at stock tables, there is a great probability that it may hit upon a few companies that are indulging in some or the other activities of corporate mis-governance.

That’s why, it’s very important to be very careful of the kind of companies you are buying in India, because there is a great probability of you stepping on a landmine if you don’t know what you are stepping onto.

Now you may wonder – “Is there no hope to find honest businesses in India?”

Yes, there is, I believe. There are companies that go about their businesses as usual – without bothering to play around with numbers and governance standards.

These are among the simple businesses, which need no or minimal debt to grow (when a company has too much debt, be doubtful), generate ample amount of cash, and have history of not cheating on their shareholders.

Only you, through a careful analysis, can identify such businesses. A monkey, even if it is the best dart-thrower in the world and may consider itself as a future fund manager, won’t be able to help you a bit in this regard.

Yes, you may want to play it ultra-safe by investing through index funds – that have beaten Indian monkeys in the past. But carefully selected business (and just a few) can still be your biggest winners 20 years down the line.

Investing is, after all, all about knowing your advantages and your disadvantages, and not playing a game you have no advantages in.

So, if you can build an advantage in stock picking, you don’t need a monkey to do it for you.

Still not convinced? Hire a monkey and try it for yourself! (But please don’t hurt the monkey, if it underperforms!)