I remember learning about “The Normal Distribution Curve” in secondary school – a diagram that still reminds me of the “Kilroy was here” graffiti that shows a man with a long nose peeking over the top of a wall.

At first it sounded really complicated, but what it really boiled down to was just a pictorial image of how people or things grouped around averages…or something like that.

Many years later in the real world of investment a clever fund manager used a similar “Kilroy” drawing on a piece of A4 paper to explain the way people can invest more wisely, posing his idea against the more common approach of just settling for the type of average performance you might get from an Index, like the FTSE 100, or as in his example, the S&P 500.

He used his Kilroy image, or Normal Distribution Curve to show that, in any one year, perhaps 20 to 25% of shares in any Index represent those shares that traded below their proper value, for some reason or other; like a crisis that downgraded a sector below its real value as airline shares did after 9/11, or oil shares following a glut of supply, like 2020.

Simultaneously, at the other end of the curve, about 20 to 25% of shares traded well above their true intrinsic value because everybody wanted to own them; just as Technology shares do now.

And the remaining 50%? Well, in that dome making up the middle of “Kilrory’s” head, share prices reflected their fair value based on their assets; like property value and Price to Earnings (P/E).

Now, please do stay with me, because that clever fund manager then asked: “If you were like a fisherman fishing for shares that offered the best value for money, in which pool would you concentrate your efforts?

We all guessed right, saying that we would probably fish in the pool on the left where shares are cheap for some temporary reason.

“Correct,” he said.

“And then,” he continued, “You will now keep hold of those ‘fish’ throughout the time it takes until their share price equals their real value as they swim over the pool on the far right, when they become overvalued. Then you’ll sell them, making a large profit.”

“And who then,” he asked, “Is daft enough to buy them off you at that time?”

We agreed that it would be investors who are attracted to those ‘fish’ because of their more recent success.

“True,” he said, “But they’re also bought by Index trackers, who have to buy them simply because they have to, whether It makes sense or not.”

The lesson? Fish where you can enjoy the value instead of the popularity.

Right now, amidst the COVID-19 panic, there’s been the biggest dislocation between perceived value and future prospects for shares that find themselves unwanted or desired, and usually for what is likely to be the wrong short-term reasons.

In fact, one of our favourite US active funds has just taken the opportunity to hook in a world class business battered by sentiment and dumped by Index Trackers, at a share price down by over 75% from its intrinsic value.

And in a few years after holding onto that undervalued fish – as it swims towards the overvalued pond – he will sell it on at a huge profit to those investors (and trackers) attracted to what will, at that time in the future, be considered its recent success.

They say patience is an attribute of the best fishermen.

That, and knowing where to cast their rod.

Don’t be attracted to what’s average, or what everybody else is chasing.

If you found this note interesting and you want to chat about it, do get in touch.