The Little Book: That Still Beats the Market

Chapter 7. Chapter Seven

IT AIN'T THE THINGS WE DON'T KNOW that get us in trouble," said Artemus Ward, a nineteenth-century newspaper col um nist. "It's the things we know that ain't so." And that, in a nutshell, is our problem. The magic formula looks like it works. In fact, the results are so good there can hardly be any argument. And of course, we want it to work. Who wouldn't want to make lots of money without trying all that hard? But does the magic formula really work? Sure, all the numbers look good, but do we know where they came from (or who they've been with, for that matter)? More important, do we know where they're going? Even if the formula worked in the past, are we merely learning how to "fight the last war"? Will the formula continue to work in the future? Good questions, certainly. Before what we learned from chapter 6 gets us into too much trouble, let's see if we can find some good answers.

First up, where did all those numbers come from? There's often a problem when looking back and making assumptions about what could have been accomplished in the past. While a computer stock-picking formula may appear to have generated spectacular theoretical returns, duplicating those results in the real world may be quite difficult. For instance, the magic formula may be picking companies that are so small that few people can really buy them. Often, small companies have very few shares available for purchase, and even a small amount of demand for those shares can push share ...