Why most investors underperform | Pareto's law, deal flow and finding the 4%

Most investors don’t underperform because they’re bad at research or don’t work hard enough, it’s because they’re looking in the wrong places. Or, they simply don't have the time to turn over as many stones as possible.

The truth is, just 4% of stocks drive nearly all market returns. If you’re not finding those winners, you’re missing out.  

In this episode, we break it down:  
✅ Why 80% of your results come from just 20% of your effort
✅ Why deal flow matters more than you think
✅ How to spot potential compounders

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Disclaimer:
Nothing in this podcast can be considered financial advice. This is for educational purposes only. We may hold positions in the businesses discussed. Do your own research.

Transcript

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Welcome back to the Dutch Investors Podcast. Today we're diving into something that's absolutely important for long-term investing which is deal flow. In today's episode we're going to break down this step by step. We'll talk about why deal flow matters, how to balance quality and quantity in your research and how to spot a potential good company. Stick with us and by the end of this episode you'll have a better perspective on how to improve your investing game. Let's get started! We are not venture capitalists. We don't just throw money at risky startups and hope one of them becomes the next unicorn. We don't prioritize short-term gains over long-term sustainability. And we certainly don't invest in companies with no solid culture or leadership. But there is one thing venture capitalists understand better than most of us. Let's start with a simple analogy. Imagine you're searching for diamonds in a vast, endless field filled with rocks. If you only pick up three rocks per year, the odds of you finding a genuine diamond is very slim. You might stumble upon one by sheer luck, but you're mostly left hoping rather than strategically improving your chances. Now consider a different approach. What if you examined hundreds or even thousands of rocks? By increasing the volume of stones you inspect, you dramatically raise the probability of finding that elusive gem. This is also how investing works. The more companies you research, the more opportunities you have to identify potential long term winners. This is exactly how investing works. The more companies you research, the more opportunities you have to find that potential diamond. it's not about mindlessly scanning stocks but about systematically filtering through a high volume of great opportunities to uncover that true diamond or in the investing world I like to call it the true compounders just like a diamond hunter learns to recognize the signs of a valuable stone clarity, cut and quality an investor must develop a keen eye for businesses with strong fundamentals a durable competitive advantage and consistent returns on capital the secret isn't luck even a broken clock is right twice a day it's effort it's knowledge and persistence in turning over more stones than the average investor does if you're only looking at three to five companies per year You're not giving yourself a fair shot of finding a real business that will compound your wealth for decades. This is what we do at the Dutch investors. By working together, we analyze 52 companies in depth every year for our members, using a time-tested philosophy and a strategy that maximizes our chances of uncovering the best opportunities in the market. Sometimes we're amazed at how little this topic gets discussed in the investing world. Yet it is one of the most important insights every investor needs to print into their mind. Especially those who are, just like us, stubborn enough to think they can beat the index. Perhaps you've probably heard of the 80-20 rule. Or perhaps Pareto's law. It applies to almost everything. for personal development 80% of your progress comes from 20% of your habits but also in music 80% of all streams come from 20% of all artists business performance this is also true 80% of revenue often comes from 20% of the customers but does this also apply to the stock market? actually it doesn't It is far worse. Only 4% of all stocks account for all wealth creation in the market. Professor Hendrik Bessenbinder studied over 25,000 stocks from 1926 to 2016 and his findings were staggering. Just 4% of companies account for all the market's wealth creation. and an even smaller 0.3% of companies account for over 50% of total wealth creation take a moment to let that sink in meanwhile the median company actually destroys value losing about 54% over its lifetime On the other hand, the exceptional companies, the 4% of companies that actually account for all the wealth creation holds the key to outperformance. So remember, only a handful of stocks drive the market forward while most destroy value. If you are an index investor, you have this problem in a lesser sense. The stock market index has a built-in advantage. It always includes the losers, but it also always includes the extreme winners. And these rare companies propel the index upward, even though most stocks underperform or decline. This makes beating the index incredibly tough. And the challenge gets even harder over time. If you underperform the index one year, you're facing the same uphill battle the next year. due to the majority of stocks underperforming. This is why most individuals and professional investors fail to outperform the index. But here's the challenge. Thorough research takes time. If you go too broad, you risk skimming the surface and making poor investment decisions. But if you go too deep, you might spend an entire year researching just two companies, which severely limits your deal flow. So how do we solve this problem? Well, this was the exact problem we faced as passionate investors by the Dutch investors. Each of us felt we were missing out on opportunities because we weren't analyzing enough companies alone. So we made a pact. Each of us would analyze one company per month. That gives us four weeks to analyze a company just enough to know all the ins and outs and to basically assess whether it's worth diving deeper. This allowed us to cover 52 companies per year as a team. But it's not just about quantity. We also give each other critical feedback. We challenge our assumptions and trust in each other's research. And this way, we maintain depth and breadth in our research. So, how do you go from limited deal flow to a constant pipeline of high-quality opportunities? Well, here's a quick framework. First, cast a wide net. Expand your universe, we like to call it. Look at international stocks, microcaps, spin-offs, founder-led businesses, and under-followed industries. Use screeners, SEC filings, earnings calls, and niche forums. Ideas can come from anywhere. Two, build a systematic process. Something that works for you. It's like a filtering system. Maybe it's first checking revenue growth, then profitability, then insider ownership. Maybe you start with a simple checklist, but whatever it is, have a process. That is very important. Three, track and maintain a watch list. Most great companies don't look cheap when you first look at them. But over time, valuations change, markets overreact and opportunities emerge. Stay ready! We have a watchlist filled with our favorite companies over on the dutchinvestors.com and it's free for you to request. 4. Network and learn from others Find like-minded investors. Some of the best ideas come from discussions with people who think differently. Stay open to those ideas and don't get stuck in the mud. Be selective about what you read. The investing world is filled with garbage and distractions. Mainstream financial media will waste your time with sensational headlines and social media is often filled with noise. be extremely picky about who and what you follow quality over quantity your time is limited so be selective you don't need a massive investing community just a few friends or join the Dutch investors that is all you need most investors hear about a company do some quick research perhaps a day or two and pull the trigger but the best investors they look at hundreds of companies before making a decision they turn over every single rock possible. Warren Buffett reads 500 pages a day and I know it's not possible for me or for you, but it just says something about his work ethic. Peter Lynch visited thousands of companies. Great deal flow isn't just about volume, it's about being in the right position to find asymmetric opportunities. The more deals you evaluate, the more patterns you recognize and the better you become at identifying outliers. The reality is the best investors are relentless learners. You start seeing what others don't. Once you've built a strong deal flow, something that works for you, how do you separate the winners from the noise? Here are some essential ingredients, say, of a very good or great company. The first one is great management. We like to look for owner operators with a proven track record of smart capital allocation. Are they transparent? Do they execute well? Are they compounding value over time? Another ingredient is increasing profitability. Revenue growth is good, but profitable growth is better. Expanding margins and strong free cash flow tell you that the business is scaling efficiently. three a long runway for growth the best companies can reinvest capital at high rates exceeding the weighted average cost of capital for years look for industries with tailwinds and businesses with pricing power of course a growing durable mode because competition is brutal does the company have a sustainable advantage Network effects, branding power, switching costs, scale efficiencies, ecosystems. Modes are the difference between a flash in the pan and a compounding machine. But also, skin in the game and the right incentives. You want CEOs and insiders who own significant equity. Their interests should be aligned with shareholders, not driven by short-term bonuses. and of course a fair valuation. Even the best businesses can be a bad investment at the wrong price. The key is finding great companies at reasonable valuations, ideally with a margin of safety. Luckily, if you don't want to do this all by yourself, we at the Dutch investors help you. We give you 52 reports each year, every single Friday. When you put all these pieces together, you find the investments that truly matter. The ones that can 10, 15 or even 100x over decades. Investing isn't about making one big lucky bet. It's about positioning yourself to recognize greatness when it appears. And that only happens when you put in the reps. when you build your deal flow and hone your ability to filter out the noise. So if you're serious about investing, here's the challenge. Double your deal flow. Look at more companies. Read more filings. Talk to more investors. Expand your circle of competence. Because at the end of the day, the best opportunities don't come to you. You have to go out and find them. That's it for today. If you found this valuable, make sure to leave a review. And remember, keep turning over those rocks. And as always, stay curious, keep learning, and happy investing.