I haven’t written on this subject recently, but I wanted to dust if off today and get back to the basics of my message a little bit. So, let’s talk about investing strategy for the beginning investor. I say for beginning investors, but honestly this can be applicable to all levels of experience. From my own experience, talking to other experienced investors and listening to many many people smarter than me, one of the most consistent reason beginning investors stop investing or consider it as too hard is losing money in the market.
These investors are excited to get into the market, choose a stock or several stocks, lose much of their investment in a drawback, panic and take their money out of the market and never go back. This is a real and valid fear. We all get in the market to make money, not lose it and DANG IT we worked HARD for the money we put in. It’s easy to tell yourself that you are putting money in the market you can afford to lose, but it’s harder when you see it going down. This leads to lesson one…you haven’t actually lost the money until you take it out of the market.
Lesson one seems both intuitive and non-sensical all at once. It’s true however, your initial money is there in the market until you take it out and realize either a gain or a loss. So, if I put $5,000 in and buy a stock and it falls to $4500, I haven’t lost $500, my position has just experienced a drawdown. If we are investing with a real proven strategy however, we should have every belief and expectation that that stock will rise again, and we will get back that $500 in movement. On the flipside, $5000 becomes $6000 in a day, you don’t have $1000 gain, you have an unrealized gain until you pull it out. Please see, I am not saying take your money out of a position every time you make a small gain to realize it, that will cost you money in fees and incurs tax liabilities and a whole host of other complications. This leads us to lesson two, we invest for the long term.
Lesson two can be hard for some and easy for others. I will admit to being one of the former, it’s fun to me to keep analyzing the market and finding opportunities for profit. However, most of those positions are more akin to trading than investing. Let’s go over the difference as I see it, and I will keep it simple we Trade in the short term and Invest in the long term. I won’t say one is better than the other, but the difference is usually in the amount of research we put into our move. If you take the time properly research a company, their fundamentals, the market for their product and their future outlook you will likely have missed the opportunity you were looking at for a quick profit. I will go over momentum trading and hyper growth shortly, but this is more fundamental. Long term investing you are looking to find a company to invest in that will provide returns over time for a minimum of five years, but hopefully forever!
If I am researching a company that I find to be a wonderful company I am looking to buy it at what I determine to be a huge discount to it’s fundamental value. This may mean missing some short-term gains or even seeing it drawback after I buy it. This leads to a funny story a very famous and respected investor tells about his experience in the market. He said that every time he buys a position it drops; he is fully convinced that it’s because he bought it that the drop happens, and this is not abnormal among investors who are looking for the long term. The biggest difference between investors and traders is this, investors buy into a company, see a drop in price and instead of fear they rejoice! Why?! It’s because they KNOW they picked a wonderful company, and this drop likely means they can buy even MORE knowing it will go up. This is a mindset that can make your investing experience much more fun.
There is also a possibility that you may research a wonderful company and by the time you decide to buy it is above your “On sale” price and you can’t buy it then. Well, you might think, “that’s dumb, you There will also be times where after you do all of this research and find a wonderful company where the price has moved above your “On sale” price and you can’t buy. This is just part of the life of a long-term investor. Now you might say, “that’s dumb you missed your opportunity at profit” or “just buy it if you think it’s going to return over the years”. These make sense on the face of it, if you are a trader, but if you are an investor it is just part of the process. I have already done the research and unless something fundamental changes about the company I can wait for the price to drop due to a short-term event or a market retracement to buy in. The second thought of just buy it has problems, no matter how good my research is I will eventually be wrong. If I was right on every pick, I wouldn’t be sharing with you here, I’d be on CNBC with the big kids!
That’s why we have the “On Sale” price, which Warren Buffett and Charlie Munger call a “Margin of Safety”. This is a hedge at its core, we are buying a company on sale in case we are wrong, because we believe even if we are wrong, we won’t lose money on the investment because of this Margin. We may even make small gains, but if we are not making a compounded annual return rate less than 15%, we consider that we may have made a mistake. Sounds crazy? It’s not, learn and do the research and you will see that this is possible. It is not likely to happen though unless you have done your homework.
Why do we pick “safe”,” wonderful”, ”long-term” companies over the huge gains from hyper-growth stocks we see on all the TV shows? Here is my answer, “because I am not smart enough”. I have no preconceived belief in my own infallibility, I believe in the people who are smarter than I am who I have learned from, history is on my side, and I am just not THAT lucky. What does all that mean? Let’s unpack it.
Are there people who go from hot pick to hot pick and make a ton of money? Yes. However, the ability to consistently pick a company on the assent and “time the market” has been shown to be nearly impossible to maintain over any longer time period. Most make and lose fortunes in short periods of time. I wish I could remember where the figures came from, but I remember listening to a speaker who noted that professional traders do not beat the market average for more than 2-4 years.
Let’s think about that, the market average is around 9% CARR (Compounded Annual Rate of Return), therefore these people are picking all their stocks (likely to include hyper growth) which can make massive initial returns so let’s be conservative and say it’s around 20% CAGR (Compounded Annual Growth Rate). This means then that they will make these gains and then lose enough to drop their Rate of Return by 11% from their initial growth figure in four years. That is a fortune made and lost.
This is what I mean by trying to time the market, when someone tries to time the market, they somehow believe they are uniquely capable of identifying the moment that bullish investors take control of a position and drive it upward. Then, they believe they are uniquely capable of identifying when the position has achieved apogee and is about to turn bearish. This is the oldest and quite frankly dumbest belief of some trading speculators. If there were people capable of routinely doing this, then we would have more multi-billionaires than broke folks.
The markets are a living breathing organism and are not rational. These people believe that somehow, they see through the matrix to the turning points of individual positions. What gives them special insight? The truth…absolutely nothing other than their own self-confidence. The only ways to time markets that perfectly is to either be investing in a company that you run or have intimate knowledge of or be privy to insider information, or you could Bernie Madoff it. If that last reference doesn’t make sense to you, then look him up, you’ll understand then. It is all about luck for these people, but the danger is that it is luck masked as natural talent. When we start believing in our invulnerability then we are primed for a massive fall. I should know, I have lived it.
I have learned through some extremely heavy losses that I am not as smart as I thought I was, not infallible like I thought I was, and I got to watch luck walk up and slap me upside the head and saunter off. It was an extremely humbling experience that has brought me back to my natural belief system in the value of Value Investing. While the above-mentioned gambling is shown over time to not work better than average, long term Value Investing has been shown to bring in consistently great returns.
Warren Buffett has consistently brought in an unheard of 26% including recessions, down turns, plain bad luck and horrible company decisions. Is Warren Buffett smarter than the rest of us? The answer is yes, but it doesn’t change that much in the argument. The most exciting stock Warren Buffett has bought I think might be Apple and he waited into his 80s to do that, and let’s not forget he and Bill Gates have been Bridge partners for decades already. Sound like hyper-growth market timing to you? Not a bit. He let Microsoft in its infancy, Apple, Amazon, Netflix, Shopify, Facebook and dozens of other hyper-growths go by and still returns a 26% CAGR…I’m just saying…boring works.
So how do we get to be that good? I encourage you to read about Buffett and read his letters to investors. They can be found for free and give a unique insight into the mind of a master of the long-term investing model. If I were to ask you whether you wanted to double your money once in twenty years or four times. I don’t believe most of us have the ability to knock 100% gains out of the park or even 50% gains with regularity while venturing enough money to allow us to retire the way that we want. It would take that rare all in bet on a 100% winner you were completely sure of, or finding a few wonderful companies that you know will return 15% CAGR over the life of your investing that will give you multiple doubles and likely set you up for a pleasant retirement.
It’s easy to go out and buy and sell positions every day, the discipline required to stick with your companies and watch their growth moving seemingly fractionally compared to other hot stocks is what is difficult. I would wager though deep down most of us would sleep better if we could put our money into a vehicle sure to not lose us money and likely to bring in that large growth rate over time than frantically jumping from one trending stock to another and watching the downturns with trepidation instead of joy. Let’s remember we can always buy more of a security when it drops and is cheaper than we can buy more of stock that is skyrocketing already.
Lastly, I say you need to apply the test of common sense. What is a company worth? If Shopify closed their business today would they really be worth their $159 billion valuation? Their EPS (Earnings per Share) only turned positive last year, and they are trading at a P/E (Price to Earnings) multiple of 524. Their price to sales is a 49 times multiple, and their price to book is a 26 times multiple. If they stopped selling today and we were to only be able to recover our funds from their earnings we would get back less than a penny on the dollar. If they sold intellectual rights, goodwill, property you might get near a nickel. Now, I ask does a price of $1300 a share make sense? I would say no, but over the past year you could have made 250% on it…so how long do you hold on and did you bet your entire stake on it? Hard questions to answer.
Why would I not look for a company that is valued below market standard but with a solid busines model and protective Moat? Why would I not want a company with room to grow before becoming an overinflated giant with nothing backing their valuation? I would much rather value a company based on their free cash flow (FCF) or earnings potential and room for growth knowing I was buying it for pennies on the dollar and having to wait 8-10 years (that is our average target hold time) to cash in on my prize which is statistically more likely to occur than to pick a handful of hyper growths win one and lose the others coming out not too much better than someone tracking an index.
I can’t tell you how to invest your money and quite frankly don’t want to try. This is another reminder I am not Certified Financial Advisor nor even a Financial Advisor at all, though honestly, I’m not always sure how much more they know than the rest of us. When the rote answer is “Invest in Mutual Funds” how much work are you really doing? I could pick a basket of 200 stocks (yes that is essentially what investing in multiple mutual funds gets you) and pick enough right to return a market average. However, that is not my point and I am flat out not smart enough, qualified enough, or in a legal standing to give anyone financial advice. I only advocate that you use a little reason and common sense when approaching the market and realize that the market itself does not work by common sense.
The market is highly emotional and irrational, do not be fooled into thinking it is a rational and correctly priced being. That is pure lunacy. Do your homework and find what works best for you. I am happy to share my sources and inspirational figures any time and often do mention them in these posts. Go find yours and I wish you the best. Till next time.
Please remember I am not a financial advisor and nothing I say in this article should be taken as financial advice because I am not your financial advisor and I have looked at your personal financial situation as your fiduciary. This should be read for education and entertainment value only. I we are not responsible for any financial choices that you may make or take after reading this article and you agree to not hold us legally responsible for any outcomes or choices you make. If you are taking anything I say as financial advice you are crazy and should go get that checked out. I only present information that I have sifted through from multiple sources over a lifetime of learning and that make sense to me. This is only my opinion and should be taken as such.