How I’ve Beaten the S&P 500 the Last 9 out of 10 Years
Updated: Feb 27
We used to have a Christmas Eve tradition where everyone would get a $10 scratch ticket under their plate. One year, when I was 9 or so, I won $250. My older cousins who were in college and desperate for beer money asked with a tinge of jealousy what I planned to do with the money. "Invest it in my Aim Blue Chip fund" I said without hesitation. Everyone laughed hysterically. "What kid says that?"
Having a Dad who owns a financial services business has brainwashed me from a young age to invest, or 'pay yourself first' as he says. Starting at age 18, I allocated a good portion of my college job earnings to my maximum $5000/year Roth IRA contribution.
The traditional stock market investing advice these days is "invest in the S&P 500 index fund." When I was 18, I I chose to ignore that advice, and invest predominantly in individual stocks as well as a mutual fund through my Dad's company. Both have beaten the S&P 500 index the last 9 out of 10 years.
I haven't spend a ton of time on it -- maybe 10 hours per year. I don't check stock prices and make any trades more than once a quarter. In my opinion, stock investing is much more fun and rewarding than fantasy football or sports gambling.
How have I done it?
Academic Explanation: I invest in 8-10 diversified companies that have personally given me large amount of consumer surplus, have good unit economics, and have a large TAM.
That might sound complicated, but it's actually really simple.
English Translation: I invest in 8-10 different companies that I personally love buying from, who don’t lose money every time they sell a new product, and have a lot of people they can sell to.
What Does a Large Amount of Consumer Surplus Mean?
Academic Definition: Consumer surplus is defined as the difference between the total amount that consumers are willing and able to pay for a good or service and the total amount that they actually do pay (i.e. the market price).
English Translation: As a consumer you are getting more value than you are paying for. Otherwise you wouldn’t pay for the product. Consumer surplus is the extra value you are getting from the seller.
Companies like United Airlines, AT&T and Geico have very low consumer surplus. Their entire strategy is to maximize their profits by giving their customers as low of consumer surplus as possible, without pricing customers out. They have entire teams of people whose sole purpose in life is to f*** their customers out of money. Instead of focusing on innovating and creating value, companies caught in the low surplus trap focus on squeezing every possible penny out of their customers. As a result, there is typically much less room for their stocks to appreciate.
Companies like Airbnb, Twitter, Apple, Wix, Amazon, Google, Spotify, Slack, Netflix, Intuit, and Uber offer great consumer surplus (at least to me). They have unlocked a ton of value by innovating and focusing on their customers. They give more than they take. If these companies raised their prices tomorrow, I would still buy from them. At any time, these companies could play that card and outperform their quarterly targets. This gives them a lot more room to grow.
What Does 'Good Unit Economics' Mean?
Academic Definition: Unit economics are the direct revenues and costs associated with a particular business model expressed on a per unit basis
English Translation: Having good unit economics means that for each product the company sells they are making more than it costs them to produce.
For example, if I sell you a pair of jeans for $150, but it took me $200 to produce the jeans, those are BAD unit economics.
Perhaps you are getting $50 of consumer surplus from the transaction because you would pay up to $200 for the jeans. However, if I raised the price to over $200 you wouldn’t buy the jeans, and therefore there is no way for me to ever make a profit.
Positive unit economics are an indicator the company has healthy prices and has found what’s called product market fit. (See this Quora answer for a more technical definition of Unit Economics)
The good news is that if the company is publicly traded, there is a good chance they have positive unit economics. It's very difficult to IPO without having positive unit economics, but it does occasionally happen in bull markets. Therefore, it doesn’t hurt to look at a stock screener like Finviz to double check.
An example of a company with good consumer surplus but questionable unit economics in Tesla. Even though they provide consumer surplus to their customers, some analysts question their financials. They have cycled through CFO’s and their car prices are heavily subsidized from tax credits that are expiring this year. As oil prices go lower, more luxury electric cars come onto the market, and maintenance issues arise with current owners, their unit economics could quickly turn negative and bust the stock.
In addition to those reasons, I also don’t personally see enough consumer surplus to own a Tesla. Therefore, I don’t buy the stock.
This is in comparison to a company like Intuit who has an extremely high profit for every new user they bring on and have great retention rates. They offer a tremendous product I believe in and have a large market, so I invest in their stock.
Why Total Addressable Market (TAM) Matters
Can a publicly traded company give you great consumer surplus, have good positive economics, but not be a good investment at all? Trick question. The answer is not black and white. However, it's important to understand TAM for context when investing.
Total addressable market (TAM), is a term that is typically used to reference the revenue opportunity available for a product or service.
Companies that don’t have a lot of potential customers have a cap on how much they can be valued at.
This is not to say companies with a low TAM can’t be good investments. However, investing in these companies takes more detailed analysis and tracking of the markets. Therefore, as a part-time hobbyist investor, I stay away from non-international consumer facing companies when I invest.
Avoiding The Informational Disadvantage Trap
I believe the downfall of many hobbyist stock investors is they overanalyze financial ratios and try to look for “good deals.” A lot of times “good deals” look good because they are dying businesses, or the investor is at an informational disadvantages.
Companies’ financials are lagging indicators, so a company with a great P/E ratio may have just had one good quarter with a balance sheet windfall. Because of creative corporate accounting, numbers don’t always show the full picture. Often corporate leadership waits for the right time to “write-off” a bunch of assets on the balance sheet all at once.
Wall street and private equity are often incentivized to sacrifice long term value for quarterly profits. Companies that sacrifice long term value can have the bottom drop out at any time.
For example, Warren Buffett teamed with Brazilian private equity company 3G Capital in 2013 to acquire cash-flush, strong global brand Heinz and then merged with Kraft in 2015. For the past several years they had a strategy of acquiring brands and completely gutting them to maximize short term profits. This made the financials look great on paper. Then all of the sudden, the company recorded massive write downs and the stock plummeted.
A “great deal” stock might look great for a period of time, and then BOOM it goes down 30% in one day when it's revealed. Stocks that have raving fans and who are building long term value are less susceptible to this (although it came happen to them too).
Bonus Tip: Don't Invest in Stocks You've Never Personally Used, Penny Stocks, or Companies in Communist Countries like China
"Marijuana is being legalized, it's the future. I'm going to buy this weed dispensary penny stock."
"China has so many people it's the future. I'm going to invest in their tech stocks."
Don't be fooled. This is get rich quick thinking. Get rich quick schemes almost never pan out. Only suckers invest with rationale like this
Just because a stock is publicly traded on Wall Street doesn't mean it's not a scam. If you haven't personally used the company as a repeat customer, don't buy it.
One big investing mistake I made was investing in China, starting in 2013. Although I was right about the directional growth of China, I was at an immense informational disadvantage in a few ways. First off, the Chinese government controls everything. They can take control of a company whenever they please and collapse the company's value over night. Second off, China encourages ripping off foreign investors. In fact, it's completely legal to scam outside investors in China.Watch the China Hustle on Netflix to see all the Chinese stocks that Wall Street and China used to scam US investors
Investing is your opportunity to bet on where you think the world is going. Betting in companies you love with a viable business model is a win-win. Either those companies will eventually raise prices and the stock will go up OR they won’t and you’ll still be paying less than you should for the product.
I invest in 8-10 different companies that I personally love buying from, who don’t lose money every time they sell a new product, and have a lot of people they can sell to.
If you are new to investing, it might be a good idea to diversify with an index fund or mutual fund, while buying a few individual stocks that meet these criteria for you.
Disclaimer: This is in no way investing advice. This has been my strategy in my 20’s without needing to be risk averse at a young age. Growth investing is inherently more risking than other type of investing.