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62  5 Years  10 Years  75 Years  20 Years  25 Years  Low P/E  $22,849  $51,461  $114,893  $257,591  $581,787  Low P/CF  $21,914  $47,799  $103,880  $223,978  $488,126  Low P/BV  $21,818  $47,681  $103,488  $223,620  $490,046  Low P/D  $20,276  $40,913  $81,877  $163,517  $327,157  Market  $19,122  $36,220  $68,709  $128,321  $241,350 
*ThE median COMPOUNDED RETURN IN A MONTE CaRLO SIMULATION OF 10,000 TRIALS. "No question contrarian strategies look impressive, if not overwhelming in studies," some readers would ask, "but what are my chances of beating the market in practice? After all, weve all heard the story of the average depth of a river being 4 feetbut the poor hiker with a 50 pound backpack finds its 2 feet in some places and 8 feet in others." Again, lets look at our chances of outdistancing the market over time in terms of the odds at a casino. Using our 27year study, we know that the odds are 6040 in our favor in any single play. But what are they over a large number of hands? In market terms that would mean playing these strategies over some years. To determine the answer, we use a statistical calculation, not by coincidence called the Monte Carlo simulation. We treat each quarter as a single card. Since we have a 27year study, we have 108 quarters. Using low P/E as our strategy, we randomly pick a quarter from the 108 quarters in the 27 years, calculate the retum against the market, whether it is positive or negative. The card is then put back into the 108quarter deck. We then randomly select another card in the same manner, calculate the retum, and again put it back into the deck. This allows any quarter to be drawn more than once, or other quarters to be missed entirely in a random selection. In effect we are taking any possible combination of market returns over the 108 quarters of the study to determine just what are tiie probabilities of beating the market. A game would consist of 100 draws for each hand, which would total 25 years. This gives us an almost infinite number of combinations of cards, which provides very accurate odds of how well a strategy will work over time. The Monte Carlo simulation allows us to get bilHons of possible combinations (actually 3x10", or Table 82 The Payoff Using Contrarian Strategies Retum on $10,000 Initial Investment 19701996 with Annual Rebalancing*
  5 Years  10 Years  75 Years  20 Years  25 Years  $1,000  Low P/E  $8,538  $27,950  $71,218  $169,145  $392,459   Market  $7,728  $22,724  $51,504  $107,362  $215,519  $5,000  Low P/E  $42,688  $139,749  $356,092  $845,725  $1,962,296   Market  $38,639  $113,618  $257,520  $536,812  $1,077,594  $10,000  Low P/E  $85,375  $279,498  $712,183  $1,691,450  $3,924,592   Market  $77,278  $227,236  $515,040  $1,073,624  $2,155,188  $20,000  Low P/E  $170,751  $558,996  $1,424,367  $3,382,901  $7,849,183   Market  $154,556  $454,472  $1,030,079  $2,147,248  $4,310,377 
*The median compounded return in a Monte Carlo simulation of 10,000 trials. more than the number of inches from here to the Andromeda Galaxy, which is two miUion hghtyears away). But most investors dont malce a onetime investment in the market. They put away a few thousand dollars or more each year. Not wanting to bore the computer, we asked it to calculate the odds of beating the market for 10,000 plays of each strategy, investing sums from $1,000 to $20,000 annually. The computer did this for the four value strategies, with only a minor whine at the monotony. Table 83 shows the result of investing these amounts using the lowP/E strategy against the market over time. As you can see, the dollars you accumulate using a contrarian strategy are almost mindboggling. Investing only $1,000 a year over 25 years in a taxfree account would become $392,459 dollars. Investing $20,000 a year in the same way $7,849,183. If you used the low P/E strategy and repositioned your portfolio quarterly into the lowest P/E group, what are your odds of beating the market over 25 years? High enough to make the owner of the plushest casino drool. If you play a 100card series 10,000 times, your probabihties of winning are 9,999 out of 10,000! Thats right, you would unde erform the market only once in ten thousand 100card plays. Remember, this casino is different; even unde erforming the market doesnt send you away with empty pockets, but with a large stack of chips if you get even a reasonable percentage of the markets retum. But say that 25 years was much too long for you to investwhat would happen if you moved to a 10year span? Using this strategy for 10 years reduced your chances of beating the market, but not by much. Table 83 Building a Nest Egg the Easy Way Adding to the Investment Each Year 19701996*
Walking Away from the Chips Its important to realize that investing using contrarian strategies is a longterm game. One roll of the dice or a single hand at blackjack is meaningless to the casino owner. He knows there will be hot streaks that will cost him a nights, a weeks, or sometimes even a months revenues. He may gmmble when he loses, but he doesnt shut down the casino. He knows hell get it back. As an investor, you should follow the same principles. You wont win every hand. Youll have periods of spectacular retums and others you might diplomatically describe as lousy. But its important to remember that contrarian strategies, hke the odds for the casino owner, put you in the catbird seat. Professional investors, along with everyday folks, normally forget this important principle and demand superior retums from every hand. You would still come out a winner 9,917 times out of every 10,000 hands you played, not bad in casinos or markets. If you invested for five years in this manner, your odds of beating the market are still 95.3 out of every hundred hands. The probabilities of winning with this strategy are a gamblers or an investors fantasy. But lets stop for a moment. Maybe you dont like to tum over a part of your portfolio each and every quarter. Such a strategy might be too anxietyproducing; it might drive you, along with the toy poodle, to Prozac. How do we do if we opt for a longer holding period, say a year, without changing any part of the portfolio? Once again, this casino pays off like a dream. If you played this strategy for oneyear periods, for the full length of the study, thus making modest changes to the portfolio annually, your odds go down. But, Im sure youll take themtry winning 9,923 of 10,000 hands. If you wanted to go for shorter periods, your odds of beating the market decrease some, but are still high94% for ten years and 87% for five years. The probabilities are nearly identical for pricetocash flow and pricetobook value. A casino owner would die for these odds rather than the roughly 555 the house gets. In fact, some casino owners, including Bugsy Segal, pushed daisies for the lesser odds. These odds are by far the highest consistently available of any investment strategy of which I am aware. There is nothing closer to a sure thing for milUons of investors, yet strangely enough, few play this game. The green wing has always been sparsely populated, and, despite all the statistics, its likely to remain so.
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