A balanced view from Dimensional (DFA) perspective. The disciplined approach.

1. Outside the Flags
June 2011
Stock Tipping Secrets
Jim Parker, Vice President, DFA Australia Limited
Every few months at a financial newspaper, particularly
when there’s no news around, the order goes out to
ring a few brokers for a story about “stocks to watch”.
It’s usually better to watch these stocks than to buy
them, though.
The assumption behind all these stories is that you can put together a perfect
portfolio on your own with a handful of stocks that deliver year after year, beating the
index and saving you a bundle in managed fund fees.
It’s a nice idea. But the truth is, as we shall see, you would be better off flinging darts
at a board, blindfolded, than you would by listening to brokers and media pundits
about which stocks to buy. And even if you “just buy the blue chips”, chances are you
would be better off in a diversified fund.
Currently on this writer’s list of stock watching articles is a piece that appeared in
The Sydney Morning Herald in late January this year – ‘The Stocks to Watch in 2011’.
Notice the word ‘The’, denoting this was a definitive list.
We were told that “caution was the word” for investors after a so-so year on the
equity market in 2010. Similar mediocre returns were expected in 2011, which meant,
surprise surprise, that “careful stock picking” was crucial. This is rather like the real
estate agent who tells you about how this is the “last chance” to pick up a “once in a
lifetime opportunity”.
So the reporter dutifully sought out the key stock picks by ringing a “selection of
market experts”. Note the implication that these people are “experts” because they
know what is going to happen next – which prompts the question as to why such
prophets would be slaving away in low-margin brokerages in the first place.
Anyway, the reporter returned with a list of nine stocks, which we were told were
primed to do well in 2011. (Remember, you were a mug if you just sought out the
market return. You needed to select the best stocks carefully chosen for you by a
broker with expertise).
Now, while the year is not even half over and we must consider the possibility these
top stocks will do better in the second half, let’s look at how the “experts” panel is
faring against the broad market so far this year. (See Table 1)

2. TABLE 1
‘TOP STOCKS’ (31 DEC 2010 TO 31 MAY 2011) RETURN
ANZ Banking Group -2.5%
BHP Billiton -1.0%
Austin Engineering 13.9%
Billabong International -20.3%
Coca-Cola Amatil 11.0%
Cochlear 0.6%
Flight Centre -9.5%
Newcrest Mining -1.6%
Telstra 13.7%
Portfolio (Market Cap Weighted) 0.6%
S&P/ASX 300 ACCUMULATION RETURN 0.9%
Stock data source: Bloomberg.
Now, you can see there are a few stars in this bunch – Austin Engineering, Telstra and
Coca-Cola Amatil. But there are also a few under-performers year-to-date – notably
Billabong International, Flight Centre and ANZ.
The important point to note is that merely by investing in the broad index, your return
year-to-date would have been broadly similar, indeed slightly higher, than a market-cap
weighted portfolio based on these nine elite stocks chosen by the “experts”.
Of course, this is a very short timeframe. So let’s look back 10 years (See Table 2)
and the biggest blue-chips on the Australian market at that time – the four major
banks and AMP, resource leaders BHP, Rio Tinto and Woodside Petroleum, plus Telstra,
News Corp, Woolworths, Foster’s, Westfield and Wesfarmers.
We have left out of this exercise those stocks that were in the top 20 a decade ago
but which no longer exist in the form they were then as listed entities. These include
Cable & Wireless Optus, St George Bank, Coles Myer, WMC, Brambles and Westfield
Holdings.
TABLE 2
‘TOP STOCKS’ OF 2001 ANNUALISED
(PERFORMANCE: 31 MAY 2001 TO 31 MAY 2011) RETURN
National Australia Bank 3.3%
Telstra -0.4%
BHP 18.6%
Commonwealth Bank of Australia 10.8%
News Corporation -6.1%
Westpac Banking Corp 10.5%
Australia and NZ Banking Group 9.8%
AMP -5.4%
Rio Tinto 13.6%
Foster’s Brewing Group 4.3%
Woolworths 14.8%
Woodside Petroleum 16.0%
Wesfarmers 11.3%
Portfolio (Market Cap Weighted) 8.0%
S&P/ASX 300 ACCUMULATION RETURN 7.8%
Dimensional Australian Large Company Trust* 7.7%
Dimensional Australian Value Trust* 11.3%
Dimensional Australia Small Company Trust* 12.0%
Stock data source: Bloomberg.
*Dimensional returns source: Returns program all net of fees.

3. There were some good performers in this group over the past decade – notably BHP,
Rio and Woolworths. But there were also some real disappointments – particularly
AMP, Telstra and News Corp.
The broad market over the 10 years between 2001 and 2011 delivered an annualised
return of 7.8 per cent. While that’s less than those top performing stocks in this list,
it’s considerably more than the underperformers. So to show you would have “beaten
the market” with a direct stock portfolio, you have to prove that you would have only
bought the winners and not the losers. That’s a stretch.
Keep in mind, also, that these numbers do not include the cost of brokerage in owning
a direct stock portfolio or the multiple decision you would have had to have made
about corporate actions such as rights issues, buybacks and restructurings. You have
to get a lot of decisions right and you have to ensure your small portfolio doesn’t start
to suffer from over-weights to any one sector.
The lesson from this is that when you “invest” in a small number of stocks, you are
taking on diversifiable risk. In other words, your portfolio is much more subject to
stock-specific and industry-specific factors. It’s like betting on a horse. He may be
quick, but what happens if the rider falls off half way?
In contrast, if you invest across the whole market, those individual influences are
washed away. And you can broaden your palette further by tilting your portfolio to
small cap and value (or low-priced) stocks that research shows behave differently to
large cap and growth (or high-priced) stocks.
Using Dimensional’s Australian equity trusts as a comparison over the same period,
the broad market, as defined by the S&P/ASX-300, and the Australian Large Company
Trust delivered similar returns. The Australian Value Trust and the Australian Small
Company Trust delivered annualised returns, net of fees, of 11.3 per cent and 12.0
per cent respectively.
No stock picking is required this way and no worrying about making the right decision
with individual stocks. Plus, you are basing your portfolio around broad market forces
that drive risk and return, not factors dependent on chance.
This process is called diversification. It means not taking risks you don’t need to take.
And it is the difference between speculation and true investment.
It’s not rocket science. It’s common sense. But, amazingly, much of the population
still believes in stock picking and market timing and all the other investment myths
promulgated by a media that has a vested interest in keeping them alive.
This material may refer to resident trusts offered by DFA Australia Limited. These resident
trusts are only available in Australia. Nothing in this material is an offer or solicitation to
invest in these resident trusts or any other financial products or securities. All figures in this
material are in Australian dollars unless otherwise stated.
Dimensional Fund Advisors LP (“Dimensional”) is an investment adviser registered with the
Securities and Exchange Commission.
All expressions of opinion are subject to change without notice in reaction to shifting market
conditions. This article is provided for informational purposes, and it is not to be construed as
an offer, solicitation, recommendation or endorsement of any particular security, products,
or services.
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