EC HH It’s True. Quality Leads Market Returns In Narrow Breadth Markets

It takes time to find great investment ideas.

I know I have to pass on at least eight ideas before two become research worthy, but it still doesn’t guarantee that those two ideas are investment worthy.

Unless you are a full-time investor, it’s difficult to dedicate the hours you need into searching, analyzing and learning at the speed that you’d like.

The whole investing process is a funnel. You start with the search, casting a net wide and far. Then let it trickle down the spout.

The Traditional Investment Funnel

Here’s an example of an investing and search funnel that I found a while back.

This funnel is pretty detailed and will take you a while to go through it.

Graham and Walter Schloss did something similar back in the day by hand so it’s a tried and tested method.

He [Graham] and Walter collected numbers from the Moody’s Manuals and filled out hundreds of the simple forms that Graham-Newman used to make decisions – pg 185 Snowball

A Narrow Market Could Reduce Your Returns

But here’s something to think about trying to everything by hand.

There are thousands of stocks. Include OTC companies and there are over 10,000 public companies.

In Nov 2015, Goldman Sachs released their Breadth Index (GSBI) which shows how only a handful of stocks really contributed to the market returns.

Top 25 Contributing Stocks to S&P500 Returns

Out of 500 stocks in the S&P, 25 made up most of the performance. They call this a narrow breadth  market.

In other words, 475 or 95% of the stocks in the S&P500 were either market performers or duds.

When the market breadth is narrow like this, it’s more important to focus on quality as this image shows.

Valuation is at the bottom on the left chart, but that’s misleading because the study was done by analyzing 6 month returns. Might as well have left out valuation.