• Bill Smead's value fund is up 141% since March 20, 2020.
• The S&P 500 is up 114% over that same period.
• In a note, Smead shared his tips for beating the market and picking stocks.

Bill Smead has gone on an impressive run over the last few years.

Since the market's March 2020 lows, his Smead Value Fund (SMVLX) is up 141%. Compare that to the S&P 500's 114% returns over the same period. Making that performance even more eye-opening is the fact that Smead does not invest in any of the mega-cap Magnificent Seven stocks that have been mostly responsible for lifting the S&P 500 to its 19% gains over the last year.

But the founder of Smead Capital Management has delivered admirable performance over the long run, too. His fund, which he co-manages with his son Cole, is up 494% over the last 15 years, which has been good enough to beat 97% of similar funds, according to Morningstar data. He's also beaten 97% of peers over the last 10 years and 98% over the last five years.

How does he do it? In a note on Tuesday, Smead shared the secrets to his success via four guiding principles for outperforming the market.

4 ways to beat the market

Smead said generating alpha comes down to four things: paying attention to valuation; holding on to names for a while; selecting the right stocks; and having the courage to go against market consensus.

Starting valuation matters greatly in stock market investing over the long term. Here's a chart from Bank of America showing the impact that starting valuation has on subsequent returns — over 10 years, 80% of a stock's return can be explained by starting valuation.

This goes hand in hand with having low turnover, or holding on to stocks for an extended period. But Smead said this is also an important trait to have as an investor because it allows you to ride through a stock's rough periods.

"Low turnover requires patience and carries a big reward. The biggest part of alpha comes from long-term winners that you sat with through numerous corrections in the process," he said. "We will give you a simple example: if you buy a stock at $30 per share and pay cash, you are limited to losing $30 per share. If you buy a stock at $30 per share that goes to $90 and sell it, you will leave $120 on the table if it goes to $210. What is worse, losing $30 per share or the sin of omission by missing the next $120 gain per share?"

In the example above, one has to own the right stock to begin with. Smead said he has a list of eight criteria for stock selection, five of which are mandatory: the company meets an economic need; the company has a formidable competitive advantage; it has a track record of profitability; its free cash flow levels are high; and its valuation is low. The three remaining preferred attributes include: its management has been good to shareholders in the past; its balance sheet is in good shape; and a large part of the company is owned by the company itself.

Finally, Smead said you can't be scared to bet against consensus.

"Our optimism for companies goes up as the price goes down when it fits our eight criteria for stock selection," Smead said. "Most of the time our rewards take 12-18 months to show up and, in some cases, have taken longer. Therefore, courage combined with patience at the point of purchase and ownership combined with patience on winners has been a source of alpha for us."

7 stocks Smead is betting on now

In the note, Smead listed seven companies he owns that fit these criteria: oil firms Occidental Petroleum (OXY) and ConocoPhillips (COP); homebuilders D.R. Horton (DHI) and Lennar (LEN); pharmaceutical company Merck (MRK); biotech firm Amgen (AMGN); and one of the biggest banks in the US, Bank of America (BAC).

"In studies, 90% of drivers think they are above average. We believe that 100% of the people who pick stocks for a living think they will be above average," Smead said. "As opposed to drivers who overestimate themselves, we seek to be above-average stock pickers by doing the things that most professional investors struggle with, like being courageous and patient."

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