Market Overview

4 Proven Methods For Building Wealth In The Stock Market

4 Proven Methods For Building Wealth In The Stock Market

This piece contains the opinions of deep value investor Tim Melvin that do not reflect the opinions of

I have always been a student of the markets. Since my first disastrous experience as a broker with a Dean Witter 'stock of the day,' I figured out pretty quick that I better spend time researching stock picks as the firms didn't seem to have a particular grasp on stock picking.

The stock in question was a chain of day care centers (La Petite Academy) back in the 1980s, just as the dual household income theme was starting to accelerate. It had a great story and cold calling for new accounts with it was a breeze.

Unfortunately, the firm in question disclosed some uninsured liability issues and the stock tanked by almost 50 percent and set my new career back a few steps. Since then, I have made it a point to read and test all the different theories about making money in the markets.

As computer technology has progressed, it has gotten a little easier. I know long have to write off to various universities and government agencies to find material and wait a month to get in the mail I can access it right on lap top and read at the blink of an eye. Unfortunately technology has just now caught up to my lack of programming and data base skills.

The New Face Of Technology

In recent years, watching me wrestle with Excel spreadsheets and data was a source of amusement to more technologically-advanced members of society, like my children. As it has gotten easier to gather and crunch numbers, I have spent an enormous amount of time looking for what really works in the stock market.

I have found four methods that stand the test of time and will allow you to get rich slowly in the stock market. There is no way to get rich fast in the stock market other than pure dumb luck for most of us. There are some math prodigies that can develop models that work and can be highly leveraged to get there a little quicker, but unless you 12 hours a day, advanced degrees in statistic and physics as well a couple of Cray supercomputers at your disposal, you will have to settle for getting wealthy over time.

Those who are running a business, professional practice or building a career do not have the time, skill-set or technology to master that kind of approach should use a mix of the four time tested approaches to build wealth over time.

Methods Of Madness

The first method will surprise those of you who know me as an avowed deep value investor but the simple fact is that momentum works very well. Stocks that have positive price momentum tend to keep climbing for a period of time. If you combine momentum with fundamental factors like earnings and sales growth in a fashion similar to Louis Navellier or Charles Driehaus should experience market beating returns over time.

Nothing in finance is linear in nature and at bull market tops, you will occasionally take a pretty good short-term beating, but the fact remains that momentum works. I am not a momentum guy and it is not really in my wheelhouse, but there are some pretty good tools available around the web that could help you devote part of your portfolio to momentum strategies. I will be talking about those in the near future. We will also have to redefine momentum but it is not what most investors think when they first hear the word momentum stocks.

The second method is, of course deep value investing. Academic practice and real-life experience have proven over and over again that buying unloved companies that trade for less than asset value but are strong enough to survive until they thrive is a path to market beating returns. It is an easy principle that is very hard to put into practice as you have to fight the herd mentality and your own lizard brain that urges fight or flight.

When stock prices are falling and a company appears to be struggling, the flight instinct kicks in and urges you to sell when you should be buying. Buying and holding undervalued assets requites a long-term private equity mindset and set aside short term instincts to earn long term gains.

The third method is not really value investing, but it is contrarian investing at its finest. This method consist of simply stockpiling cash until the market enters a full on crash zone and buying stocks when panic has set in and there is truly blood in the streets. Again, this is simple but not easy to practice. As Charlie Munger once remarked "It takes character to sit there with all that cash and do nothing. I didn't get to where I am by going after mediocre opportunities."

Munger put this into practice in 2009 when he invested the cash reserves of Daily Journal (NASDAQ: DJCO) into stocks near the bottom and has grown book value by an average rate of 30 percent annually since. Andy Beal has become a billionaire by using such this approach and only buying asset classes that were crashing. Crash buying once made Hetty Green the richest woman in the world.

At the last Berkshire Hathaway (NYSE: BRK-A) meeting, Warren Buffett talked about the power of having cash when there was economic turning. He practices what he preaches and since Berkshire became too big to invest in cigar butts he has very much been a buy in a crash investor.

The last approach involves buying community bank stock below book value. It is an offshoot of classic value investing that has racked up some pretty impressive returns over the years. A recent study by Matthew Kelly when he was an analyst at Sterne Agee CRT showed that buying community banks when a activist investor filed a 13D provided investors massive outperformance over the last decade.

Finding A Specialty

When I was a broker, my specialty was selling shares of small banks to local businessmen. Every rich lawyer, doctor, business owner and professional I ran across back then knew the value of a well-run local bank. In solid economic times, they are cash machines with steady growth in earnings, dividends, book value and stock prices. In the aftermath of a crisis like the savings and loan (S&L) crisis, the internet collapse and the recent crisis the sector usually sees a wave of consolidation that drives price much higher over the next seven to 10 years.

These four approaches have stood the test of time and can be used by individuals to build enormous wealth over their investing lifetime. IN the weeks and months ahead we will take a deeper dive and look at each method and explore methodologies and resources we can use to put them to work for us in our wealth building efforts.

Tags: momentum stock regional banks undervalued stocks

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