One rea­son peo­ple reject index invest­ing is that we all know of great com­pa­nies that have expe­ri­enced sig­nif­i­cant growth: FedEx, Cisco, Wal-Mart, and oth­ers. But a great com­pany does not nec­es­sar­ily make a great stock. To be great, a stock must be under­priced. When every­body believes that the com­pany is well run and its bal­ance sheet is solid, more investors pur­chase their stock. This dri­ves the stock price up, mak­ing it appro­pri­ately priced, or per­haps even over­priced. It is rel­a­tively easy to find a good com­pany, but only if the company’s stock is under­priced is it a good investment.

Sev­eral stud­ies by Michelle Clay­man, a well-known insti­tu­tional investor, drive home this point. She ana­lyzed two port­fo­lios, one based on the top, best man­aged com­pa­nies from Tom Peters’ clas­sic “In Search of Excel­lence”. The other port­fo­lio con­sisted of “un-excellent com­pa­nies,” firms with bad bal­ance sheets, man­age­ment prob­lems, and poor prospects. The result was aston­ish­ing: the “un-excellent” port­fo­lio beat the “excel­lent” port­fo­lio. You won’t beat the mar­ket by buy­ing stocks in good cor­po­ra­tions; you need to find under-priced stocks. And while these mis-pricings are very, very hard to find, they show up more often in trou­bled com­pa­nies than good ones. Mil­lions of investors are con­stantly search­ing for them. Many believe they have found them, but few turn out to be con­sis­tently correct.

For many aca­d­e­mics and investors, the jury has been in for quite some time: index­ing is the smartest way to invest. Click here to see what the giants of invest­ing say.