The Fast and the Strong

“Don’t fight the tape.”
“Make the trend your friend.”
“Cut your loss­es and let your win­ners run.”

All these Wall Street max­ims mean the same thing — bet on price momen­tum. Of all the beliefs on Wall Street, price momen­tum makes effi­cient mar­ket the­o­rists howl the loud­est. The defin­ing prin­ci­ple of their the­o­ry is that you can­not use past prices to pre­dict future prices. A stock may triple in a year, but accord­ing to effi­cient mar­ket the­o­ry, that will not affect next year.… Con­verse­ly, anoth­er school of thought says you should buy stocks that have been most bat­tered by the mar­ket. This is the argu­ment of Wall Street’s bot­tom fish­ers, who use absolute price change as their guide, buy­ing issues after they’ve done poor­ly. Let’s see who is right.

I’m quot­ing from Chap­ter 15 of “WHAT WORKS ON WALL STREET” by James O’Shaugh­nessy.

He did some analy­sis on the 50 stocks with the best and the worst 1‑year price changes from both the All Stocks and the Large Stocks uni­vers­es to see which cohort per­formed the best in the fol­low­ing year, using Decem­ber 31, 1951 as the start­ing date — and hold­ing them until the end of 1994. That’s a very long, 43-year game of “buy and hold”.

So what hap­pened?

The stocks from the “best” list per­formed pret­ty well — a com­pound return of 14.45 per­cent a year. They were, how­ev­er, high­ly volatile, and he warns that not many investors would have the stom­ach for that kind of wild ride.

How about the stocks from the “worst” list? Well they had a com­pound return of… 2.54 per­cent a year.

His con­clu­sion?

“Run­y­on’s quote is apt. Win­ners con­tin­ue to win and losers con­tin­ue to lose.”

The same $10,000, over the same 43 years, became $3,310,255 in the win­ners and $29,351 in the losers.

And while, yes, this ver­sion of this book uses 1951–1994 US data, lat­er edi­tions and mod­ern momen­tum research con­firm the pat­tern still holds.

Runyon Who?

If you aren’t too sure who “Run­y­on” was — Damon Run­y­on was the Amer­i­can short-sto­ry writer best known for the Broad­way tales that became the musi­cal Guys and Dolls. He wrote sto­ries cel­e­brat­ing the world of Broad­way in New York City that grew out of the Pro­hi­bi­tion era — gam­blers, hus­tlers and show­girls, who spoke dis­tinc­tive wise­crack­ing slang where gang­sters had colour­ful names like “Nathan Detroit”, “Har­ry the Horse”, “Good Time Charley”.

The line O’Shaugh­nessy uses is Run­y­on’s most quot­ed: “It may be that the race is not always to the swift, nor the bat­tle to the strong, but that’s the way to bet.”
It’s itself a riff on Eccle­si­astes (“the race is not to the swift, nor the bat­tle to the strong…”). Run­y­on’s twist is the punch­line: sure, upsets hap­pen, but if you’re bet­ting, he would back the fast and the strong. So do we. We just refuse to pay full price for them.

Isn’t this like the DOGS of the DOW?

Long-time lis­ten­ers might recall us dis­cussing the “Dogs of the Dow” con­cept over the years. It’s the same same but dif­fer­ent. The Dogs of the Dow is an invest­ment strat­e­gy pop­u­larised by Michael B. O’Hig­gins in a 1991 book which pro­pos­es that an investor annu­al­ly select for invest­ment the ten stocks list­ed on the Dow Jones Indus­tri­al Aver­age whose div­i­dend is the high­est frac­tion of their price, i.e. stocks with the high­est div­i­dend yield. So they tend to be high-yield­ing stocks whose share price has been bat­tered over the last twelve months. This is the big dis­tinc­tion with the O’Shaugh­nessy exper­i­ment, which did­n’t take into account div­i­dend yield (he looks at that in a dif­fer­ent chap­ter).

Sim­i­lar Dogs exper­i­ments have been done annu­al­ly in Aus­tralia. The strat­e­gy tends to per­form okay — over­all it beats the index, which is bet­ter than most active fund man­agers — but it does­n’t per­form as well as QAV over the long-term.

From the results pro­vid­ed by the annu­al updates from Hugh Dive (Atlas Funds Man­age­ment) over the 11 years 2014–2024:

The ASX200 returned 7.5% p.a. and the Dogs returned 10.3% Com­pound (CAGR). So it out­per­formed but nowhere near the dou­ble mar­ket out­per­for­mance we strive for.

As a bet­ter direct com­par­i­son to QAV:
For the cal­en­dar years 2020 — 2025, the Dogs returned 10.5% ver­sus the ASX200 8.2% CAGR.

The QAV Dum­my Port­fo­lio returned 16.8%.

How does this apply to the QAV strategy?

We like invest­ing in win­ners of a par­tic­u­lar vari­ety — cheap win­ners. We try to invest in com­pa­nies that have a his­to­ry of gen­er­at­ing cold, hard cash, which we take as a sig­nal of a healthy busi­ness and strong man­age­ment. But, of course, we only invest in those com­pa­nies when we can buy the stock at a dis­count to their intrin­sic val­u­a­tion. Why? Because valu­ing a stock is a bit of a dark art. There are lots of vari­ables that we can’t be com­plete­ly aware of, mar­ket nuances that aren’t obvi­ous, indus­try trends that we don’t appre­ci­ate, things like that. So we try to build in a moat around our invest­ments, which means that even if we get things a bit wrong, we should still come out on top — most of the time. It’s a secu­ri­ty mea­sure.

So the Dogs aren’t “buy losers.” They’re “buy qual­i­ty at a tem­po­rary dis­count.” That’s a val­ue strat­e­gy wear­ing a con­trar­i­an cos­tume — and it’s exact­ly why O’Shaugh­nessy’s own work shows high div­i­dend yield works among large stocks while worst price per­form­ers fail across all stocks. No con­tra­dic­tion. The two find­ings are best friends.

We don’t buy losers hop­ing they bounce, and don’t chase win­ners blind­ly off a cliff. Buy qual­i­ty busi­ness­es that are win­ning and still cheap.

Here’s the twist. O’Shaugh­nessy is watch­ing share prices. We’re watch­ing busi­ness­es. We don’t buy a stock because its price is climb­ing — we buy a cheap, qual­i­ty com­pa­ny and then let our rules do the sort­ing. The sell dis­ci­pline cuts the losers before they become falling knives, and lets the win­ners run until the trend breaks. We end up hold­ing win­ners and dump­ing losers — the exact pat­tern O’Shaugh­nessy rewards — but we get there through rules, not by chas­ing a chart. No tree grows to the sky, as Tony says. We just let our sys­tem tell us when it’s stopped grow­ing.

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QAV Myth Killers is a week­ly col­umn in the QAV newslet­ter, tak­ing apart a piece of
invest­ing con­ven­tion­al wis­dom. Read the series, or
get it by email every Fri­day.

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