One of my favourite investing articles is an old piece, written in February 2008, by The Motley Fool’s co-founder, David Gardner. It had the provocative title, The Greatest Secret of All, and an equally provocative lede (emphasis is his):
“Welcome to my article. I’m glad you found it, because it is your lucky day, dear Fool: The greatest secret to easy riches in the stock market is contained right here, below.”
The article does contain the greatest secret in investing, and I implore all of you to read it. I’ll come back to his piece and provide a link to it later. For now, let’s turn to my girlfriend’s investment portfolio.
The portfolio
In early 2019, my girlfriend wanted to build a portfolio of stocks for herself. We started having long conversations about what she can do and how she should be building the portfolio. Eventually, she settled on a list of stocks in the US that she was really keen on, and she made the purchases on the night of 8 March 2019.
The list of stocks are shown in the table below, along with their initial weightings. I merely acted as a sounding board – the stocks were bought by her. She made the final call and the “Buy” mouse clicks.
From the get-go, the portfolio did really well, producing a gain of 20% in just a few short months. There was a brief swoon from mid-July to early-October, but then things picked up again. Her stocks ended up charging to an overall gain of 36% in mid-February 2020. That was when all-hell broke loose.
The fall, and the aftermath
The S&P 500 in the US – the country’s major stock market index – hit a peak on 19 February 2020, before fears over COVID-19 started ripping across the market. By 23 March 2020, the S&P 500 had declined by 34% from peak-to-trough.
My girlfriend’s portfolio was not spared – it tumbled by 29% over the same period. All her previous gains were wiped out in the fall. The portfolio even dipped into the red.
Here’s a chart of the performance of my girlfriend’s portfolio (the blue line; without dividends) and the S&P 500 (the red line; with dividends) from 8 March 2019 to 8 June 2020:
Source: Google Finance and Yahoo Finance
As of 8 June 2020, my girlfriend’s portfolio has a 50% gain from its initial value on 8 March 2019, and has comfortably surged past the previous peak seen in February 2020. Meanwhile, the S&P 500 has rebounded strongly from its 23 March 2020 low, but it’s still a little off its high.
The greatest secret, revealed
Some of you may be thinking that my girlfriend had made significant changes to her portfolio in March 2020 that resulted in the strong gains seen in the right-hand part of the chart above. Not at all. Her portfolio had zero changes during the COVID-19 panic. In fact, she has made no changes to her portfolio since she first purchased her stocks on 8 March 2019.
This brings me back to David Gardner’s article, The Greatest Secret of All. The secret that David is referring to is this:
“Find good companies and hold those positions tenaciously over time to yield multiples upon multiples of your original investment.”
The word “tenaciously” needs highlighting. There was a painful period earlier this year when my girlfriend’s portfolio was in the red. She needed tenacity to hold on. To her credit (and it’s all her credit!), she held on. She was forward-looking and never gave in to the prevailing pessimism about COVID-19.
Yes, COVID-19 – and the economic slowdown that has happened globally as a result – was and still is painful for all of us. But she was confident that “this too, shall pass.” Tomorrow will be a brighter day.
She was also confident in the long-term futures of her companies. If you look at the names, these are companies that are building the world of tomorrow. There’s robotic surgery (Intuitive Surgical); DNA analysis and precision medicine (Illumina); e-commerce (Amazon, Shopify, MercadoLibre); digital payments (Mastercard, PayPal, Visa); streaming (Netflix, Spotify); and cloud computing (DocuSign, Paycom Software, Veeva Systems, Twilio etc). There’s more, but I think you get the drift.
What’s next?
The story of her portfolio is not over yet. Only 1 year and 3 months have passed – that’s way too short a time to come up with any high-probability insights. A new bear market may be just around the corner. It’s not our intention to take a victory lap.
But what has happened to my girlfriend’s portfolio throughout the COVID-19 situation – because of her tenacity in being actively patient – is worth bringing up. Because, 10 years from now, her portfolio could very well be another real-life example of David Gardner’sgreatest secret in investing.
Disclaimer:The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.I, the author, own all the shares mentioned here (except for Spotify). I will be making sell-trades on most of the stocks mentioned here for reasons that are explained in this article.
With the S&P 500 now up year-to-date, is it a good time to short the market?
On 8 June 2020, the US stock market’s NASDAQ index closed at an all-time high, while the S&P 500 showed a profit for the year. There’s a big mismatch between what is going on in the American stock market and economy, so some investors may be asking if now’s a good time to short stocks.
(To short a stock means to invest with the view that its price will fall.)
These are unprecedented times. But before you start shorting stocks, here is a reminder of the risks of shorting.
“The market can remain irrational longer than you can remain solvent”-John Maynard Keynes
I think its important to remind ourselves that shorting a stock can provide an upside gain of 100%, but it has unlimited downside risk.
If you short a stock and it climbs by more than 100%, you would have lost more than 100% of your starting capital. And that may happen more often than you imagine. Hertz, the car rental company that filed for bankruptcy protection last month, has seen its share price climb by more than 600% from its 26 May 2020 low.
Let’s also not forget that even if your short position ultimately ends up correct, you will need to endure stomach-churning volatility. This could cause you to have to put up much more capital – to maintain the short position – in order to earn a small return. In addition, if the stock climbs and you run out of cash to back your position, your broker could force-close your position, leaving you with a loss.
It may also take years for a short position to eventually pay off, giving investors a very small annualised return if the stock does fall.
Professional investors are not immune to huge losses
Bill Ackman’s Herbalife bet comes to mind.
Herbalife is a company that sells nutritional products through a multi-level marketing scheme. In this marketing model, consumers can earn a commission by referring friends to purchase the company’s products.
Ackman believed that Herbalife was so aggressive in recruiting sellers that most of its sales came from people who wanted to earn from the commissions, and not because they wanted to use the products they bought. These “customers” simply bought the products so that they could try to sell them and earn commissions.
Ackman started his short on Herbalife in 2012 and gave a now-infamous 3-hour long presentation in 2014 on why he believes the company is a pyramid scheme. A pyramid scheme is effectively a scheme where only the top of the pyramid gets rich at the expense of those at the bottom of the pyramid.
Although I personally believe that Herbalife’s marketing methods were aggressive and could be labelled as unethical, it wasn’t illegal. Ackman’s Herbalife bet was also made more complicated when billionaire investor Carl Ichan took a long position and snapped up over a quarter of the company’s shares.
First of all, it is extremely difficult for Ackman or the authorities to prove that Herbalife was operating a pyramid scheme as long as there was a product at the end of it all. In this case, even though many Herbalife distributors ended up buying nutritional products that they did nor consume, the company can say it was legitimately selling the products to them.
It may not be an ethical business (in my eyes) but the authorities did not think it was a fraudulent one either. Ackman’s fund, Pershing Square, ended up losing US$1 billion on its short bet on Herbalife.
Short (but painful) squeeze
Short positions may also face sudden spikes in a stock’s price arising from a short squeeze. A short squeeze happens when a stock rises in price, forcing short sellers to close their positions. This, in turn, causes the stock price to rise further, leading to more short sellers being forced to close their positions.
The spike in price can be sudden and swift, and many short sellers will have no choice but to close their positions with a hefty loss.
An example that comes to mind is Tesla’s stock.
Tesla has been one of the most shorted stocks in recent years. However, there have been numerous days when Tesla’s stock has seen a sharp and swift rise in price.
Some of these sharp rises were due to good news coming from the company. But it’s likely that the increases also had contributions from short sellers being forced to close their positions.
Final words
We are living in strange times. The S&P 500 is now showing a positive return so far in 2020, while the NASDAQ is above its pre-COVID-19-crisis level. With many economies still in partial lockdown, investors are wondering why stock prices are not reflecting the current economic contraction.
However, if you are tempted to short the market, it is important to know the risks involved.
Shorting can be a profitable activity, but is also filled with risks. Personally, as a long-term investor, instead of trying to make a little money shorting stocks, I prefer buying quality stocks for the long term where the odds of success are much more heavily stacked in my favour.
Disclaimer:The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
Companies that have a great view on how we live, work, spend, and play have recently shared important clues on how a post COVID-19 world could look like.
The title of this article is a topic that I think many investors badly want to know.
I don’t think anyone has a firm answer. But we can get important clues from the comments that some companies have shared in recent times. I’m referring to companies that have a great view on how we live, work, spend, and play.
“As COVID-19 impacts every aspect of our work and life, we have seen two years’ worth of digital transformation in two months. From remote teamwork and learning, to sales and customer service, to critical cloud infrastructure and security, we are working alongside customers every day to help them stay open for business in a world of remote everything. There is both immediate surge demand, and systemic, structural changes across all of our solution areas that will define the way we live and work going forward.”
“Throughout the quarter, we saw consumption continue to increase across the platform and growth of the number of hosts, containers metrics traces and logs, for example, have remained consistent with historical trends.
We started to see some negative effects in impacted industries such as travel, hospitality and airlines. But we’ve also seen substantially increased usage from other categories such as streaming media, gaming, food delivery and collaboration, as these customers scaled up their operations in this environment.
We also saw a surge of usage and surge in accounts in March in response to COVID that we expect could be more transitory in nature and may normalize over time.”
“In the past month, there has been unprecedented demand for our products and services. Our transactions are up 20% year-over-year, with branded transactions up over 43% more than double pre-COVID levels in January and February. On May 1st, we had our largest single day of transactions in our history, larger than last year’s transactions on Black Friday or Cyber Monday.
Our net new actives hit record highs in April, surging over a 140% from January and February levels, averaging approximately 250,000 net new active accounts per day. For the month of April, we added an all-time record of 7.4 million net new customers. I don’t want to lose sight of the fact that we also had a record Q1 adding 10 million net new accounts, but that will pale in comparison to the 15 million to 20 million net new active accounts we anticipate adding in Q2…
… We had a very strong January and February, with FX-neutral revenues growing by an average of 18% and TPV growing at 26%. We began to see some COVID-19 impacts in late February, but the strength of our overall business outweighed cross border weakness coming out of China. However, all that changed as we exited the first week of March.
Shelter-in-place and social distancing became the norm across the globe, and as one economy after another effectively shut down, we saw a substantial revenue decline, predominantly in our travel and ticketing verticals. Some of our important customers, including Uber, Airbnb and Live Nation saw rapid decreases in transaction volumes…
… As I mentioned earlier, we began to see a very noticeable shift in our results toward the end of March and throughout April. We saw dramatic increases in our daily net new actives and overall engagement levels. Our daily number of transactions accelerated throughout the month growing from the beginning of April until month end by 25% with 7.4 million net new actives, record engagement and transaction volumes and 20% revenue growth. I would characterize April is perhaps our strongest month since our IPO.”
“We’ve seen our customers rise to the occasion too. While shelter in place orders have slowed foot traffic to our sellers, they found new ways to keep their doors open, retain staff and serve customers. Retailers, wine shops and QSRs launched online ordering by building websites in less than a day for delivery and curbside pickup. Larger full service restaurants opened community markets to sell raw ingredients, produce and food staples through online stores, even Michelin Star restaurants like Chez Panisse in Berkeley.
Distilleries and taylors shifted to selling personal protective equipment like hand sanitizer and masks. Hairdressers and beauticians moved to video appointments to advise on self-styling. Over the past six weeks we’ve also seen Cash App customers come together like never before. Folks are donating the strangers in need through social media, fundraising for charities, small businesses and churches and tipping artists during online performances…
“While GMV through the point-of-sale (POS) channel declined by 71% between March 13, 2020 and April 24, 2020 relative to the comparable six-week period immediately prior to March 13, as most of Shopify’s Retail merchants suspended their in-store operations, Retail merchants managed to replace 94% of lost POS GMV with online sales over the same period. Retail merchants are adapting quickly to social-distance selling, as 26% of our brick-and-mortar merchants in our English-speaking geographies are now using some form of local in-store/curbside pickup and delivery solution, compared to 2% at the end of February.”
“A great example of this is what we did with the state of Illinois, which was a notable win in the quarter for both workforce and customer identity. With the onset of the pandemic, Illinois needed to ensure it could securely manage its remote workers and secure the identity and access of several state agencies. The state had numerous disparate legacy identity systems across its agencies, which caused friction for its employees, contractors and citizens. Illinois selected Okta to be their identity standard, which will streamline their operations with a single unified identity platform.
With Okta’s customer identity solutions, Illinois’ citizens will have a secure, seamless experience when accessing their government resources. And with Okta’s workforce identity, the state’s employees and contractors will be able to more efficiently do their jobs…
… In just 36 hours, we helped FedEx deploy the Okta Identity Cloud to enable more than 85,000 remote and essential employees to connect to critical applications amid increased demand during the crisis…
… We were one of the first companies to host a large and virtual event, two events if you include our Investor Day. It was an unexpected and challenging task, but both events were incredibly successful, and our customer and investor feedback was amazing. We had nearly 20,000 registrations for Oktane20 Live, which is over 3 times what we had been expecting for the in-person event…
… As we look forward to the rest of this year and beyond, when this crisis is over, we don’t expect organizations to revert to their prior ways of working. We have no doubt that a much higher percentage of workforces will be connecting remotely, and we see that as an inevitable long-term trend.”
“I think if you look at some of the metrics around commerce in North America, I know that e-commerce has been, kind of, trending up from 10%, 11%, 12% over the last few years of total commerce. I think it just jumped to something like 25%, 27% of all commerce. That trend is not going away.”
“Looking at things, a different way, our newly booked room nights, which exclude the impact of cancellations, were down over 60% year-over-year in March and down over 85% in April. This gives you a clear indication of how much our business is currently impacted by this crisis.
That being said, while the virus’ impact on travel is unprecedented, I am confident that this crisis will eventually end and people will travel again. Travel is fundamental to who we are and while it may take some time to return to pre-COVID-19 levels, we will get there eventually. And then we’d expect travel to continue to grow thereafter…
“New bookings revenue for full second quarter may vary from April’s results depending upon the level of travel demand and accommodation availability we experience in May and June. As Glenn noted, we’re seeing some stability on newly booked room night growth trends with the year-on-year decline rate being quite consistent for our April after reducing rapidly through the first quarter. We believe that domestic travel will rebound sooner than international travel as we expect travelers to look to their home country or region first for safe travel option.”
“The effects of the pandemic have been far-reaching and the world is looking to life sciences companies for solution. The industry is less affected financially than many others and remains relatively strong overall, but it is certainly a time of significant change as many of the industry processes become more virtual. Healthcare providers and patients are delaying many non-essential visits and elective procedures. When comparing February to April in the US using Crossix data, doctor visits were down by more than 50%. This is impacting some life sciences companies more than others depending on their product portfolio.
Many clinical trials have been delayed to avoid nonessential patient visits to doctors, in-person visits by sales reps or clinical research associates to doctors have also largely stopped. These changes are causing patients, doctors and the industry to rapidly adopt digital strategy. Necessity is creating innovation. Using Crossix data, we see that telemedicine increased rapidly in the US from less than 1% of doctor visits in February to more than 30% of visits in April. Doctors and patients are getting used to a mix of in-person and digital interactions and are finding it productive.
Using Veeva Pulse data from Veeva CRM, we see that in the US remote meetings between pharma and doctors with CRM Engage are up more than 30 times, and Approved Email communications are up more than 2 times from February to April. Doctors are telling us they find digital meetings effective and they look forward to a mix of in-person and digital interactions once things get back to normal. It’s good to see the healthcare systems and the life sciences industry evolving so rapidly. It was a very busy quarter for Veeva.”
““People, after having been stuck in their homes for a few months, do want to get out of their houses; that’s really, really clear,” Airbnb Inc. Chief Executive Officer Brian Chesky said in an interview. “But they don’t necessarily want to get on an airplane and are not yet comfortable leaving their countries.”
Airbnb saw more nights booked for U.S. listings between May 17 and June 3 than the same period in 2019, and a similar boost in domestic travel globally. The San Francisco-based home-share company is seeing an increase in demand for domestic bookings in countries from Germany to Portugal, South Korea, New Zealand and more. Other companies, including Expedia Group Inc.’s Vrbo and Booking Holdings Inc. are also seeing a jump in domestic vacation-rental reservations…
… International sojourns usually planned months in advance are being replaced with impulsive road trips booked a day before and weekend getaways are turning into weeks-long respites, Chesky said. Previously, a New Yorker might have headed to Paris for a week in June. Now they are going to the Catskills for a month. “Work from home is becoming working from any home,” he said.”
“Especially, from January 20, 2020 until February 20, 2020, local governments issued strict control measures… Shortly after February 20, 2020, when orderly resumption of work took place across the country, an increasing number of restaurants started to resume their operations while demand from consumers also gradually recovered. However, as some of consumer demand continued to be negatively impacted by hygiene concerns and quarantine measures, the ongoing closure of universities, and work-from-home policies that applied to many of our high frequency consumers, the order volume still had not fully recovered to its normal levels by the end of March 2020…
… In spite of the short-term negative impacts, we strongly believe that the COVID-19 pandemic will play a positive role in the industry’s long-term development. On the consumer side, the pandemic has further accelerated the cultivation of consumption behavior, helping to further educate some of our targeted potential consumers in a positive way… Notably, we have seen increasing consumer preference for high ticket size categories during the pandemic due to the increasing adoption of food delivery for formal meals, further diversification of high-quality supplies on our platform and growing preference for branded restaurants…
… On the merchant side, the overall catering industry was severely disrupted in the first quarter of 2020… More notably, the pandemic has further accelerated the digitization process, especially for many branded restaurants with high quality supply, which have traditionally focused on in-store dining instead of delivery services. In the first quarter of 2020, a large number of premium restaurants, highly-rated restaurants, chain restaurants, Black Pearl restaurants and five-star hotel restaurants, which did not have or had very limited food delivery services, initiated food delivery operations as their primary vehicle for business operations due to the pandemic. Participation by these restaurants increased high-quality supply on our platform in the long term, while we reinforced our importance to small- and medium-sized independent restaurants as food delivery almost became their sole source of income during the pandemic.
On the delivery front, although delivery capacity was not the bottleneck for our food delivery business during the pandemic, delivery cost per order increased both on a quarter-over-quarter basis and a year-over-year basis as a result of the increased incentives paid to delivery riders working during Chinese New Year and pandemic situations, additional costs associated with anti-epidemic measures, and the decline in order density. However, the pandemic has accelerated the adoption of new delivery models and stimulated technological innovation. As a leader and promoter of on-demand delivery, we pioneered the launch of contactless delivery services, which received widespread acceptance and recognition from consumers, merchants and local governments. In addition to helping to mitigate the hygiene risks for both consumers and delivery riders, the contactless delivery model improves delivery efficiency and creates more opportunities for the exploration of diversified delivery models and new technology for autonomous delivery…
… During the pandemic, our in-store business was more severely challenged in comparison to the food delivery segment, and its recovery was noticeably lagging behind that of the food delivery segment. As the majority of the in-store service categories are classified as discretionary or entertainment-related services, which usually involve close contact with others and/or large crowds, both supply and demand remained low in the first quarter of 2020 due to consumers’ hygiene concerns and local governments’ restrictions…
… As the leading platform in local services, we began to work with local governments in March 2020 to launch the Safe-Consumption Festival and issued vouchers to consumers to use in local services, especially in restaurant dining, which sustained the most impact during the pandemic. We believe that consumer vouchers could not only stimulate one-off consumptions, but also have strong leverage effects that stimulate the recovery of the overall consumption demand in relevant regions and industries….
… While local accommodation and business travel activities, especially in lower-tier cities, have started to gradually rebound at a faster pace along with the general recovery process, consumers were still taking conservative measures and postponing travel-related activities and expenditures even after the peak of the pandemic. To further support industry recovery, we leveraged our platform capabilities and launched the Safe-Stay Program. Under the Safe-Stay Program, we established precautionary measures and increased service capabilities for our partner hotels, such as the adoption of strict health precautions for all employees and consumers, close tracking of consumer information, free booking cancelations, and discounts for additional nights.”
“We engaged a new public sector customer, the Department of Labor in one of the largest U.S. states to help transform its previously complex and lengthy process for handling emergency unemployment benefit. Supported by DocuSign eSignature, the department distributed over $500 million in benefits to more than 500,000 residents in less than one week. We enabled hundreds of U.S. national and regional financial institutions to accept applications for Small Business Administration loans more efficiently. In one of those large banks, we were involved with over 0.5 million loan applications, 75% of which were signed in less than 24 hours.
We worked with a regional telecom provider using DocuSign Intelligent Insights, which is our contract analytics tool to analyze potential pandemic-related risks in thousands of their supplier contracts. Finally we helped a European telemedicine provider issue e-prescriptions and online sick leave certificates by using our video identification capability to confirm the patients’ identities…
… Some of the healthcare opportunities were big. If you think about the situation where you’re trying to — you’re now trying to do COVID-19 testing and you’ve never been an organization that did that kind of testing before, and now you say, “I got to figure out a way to get people’s information and get them to fill out forms, Oh! but I don’t want to touch them, I don’t want to touch anything they’ve touched, I also need a digital solution for doing that.” And we had sales cycles that happened in that in a matter of days, where people came to us, explained that business need that they had, or that healthcare need that they had and we were able to get up and running that use case.”
“As you can imagine, customers in the hospitality and travel have exhibited very unusual patterns during this period. First, there were spikes in volume as airlines and hotels dealt with rebookings and canceled flights during the transition from pre-COVID-19 into travel restrictions and shelter-in-place protocols. Then, there was a sharp decline as business slowed. Another example is that ridesharing saw a large decline during this time, with offsets in many cases by sharp increases in demand for food delivery, curbside pickup and retail logistics. In addition, telehealth and work-from-home contact centers saw a pickup of adoption during this time.
While we are cautiously optimistic, no one can predict what exactly will transpire in the back half of the year given the uncertainty of the macroeconomic environment…
… We’ve seen companies across multiple industries adapt in real time due to COVID-19. Digital transformation projects that could have taken years such as transitioning from an on-trend contact center to the cloud instead took a weekend. Developers and companies big and small got to work, reconfiguring the world for a work-from-home and nearly 100% e-commerce reality.
Let me give you just a few use cases across various industries that we’ve helped our customers win over the last couple of months. With shelter-in-place and social distancing going into effect, demand for telehealth solutions has soared. Virtual care became a new reality for doctors, nurses, clinicians and millions of patients around the world. And Epic, the company that supports the comprehensive health records of 250 million people, mobilized to build its own telehealth platform powered by Twilio’s programmable video. The solution allows providers to launch a video visit with a patient, review relevant patient history and update clinical documentation directly within Epic.”
Disclaimer:The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
What we can learn from an investor who produced an annual return of 23% for 47 years.
I first learnt about Shelby Cullom Davis sometime in 2012 or 2013. Since then, I’ve realised that he’s seldom mentioned when people talk about the greatest investors. This is a pity, because I think he deserves a spot on the podium alongside the often-mentioned giants such as Warren Buffett, Benjamin Graham, Charlie Munger, and Peter Lynch.
Davis’s story is well-chronicled by John Rothchild in the book, The Davis Dynasty. Davis started his investing career in the US with US$50,000 in 1947. When he passed away in 1994, this sum had ballooned to US$900 million. In a span of 47 years, Davis managed to grow his wealth at a stunning rate of 23% annually by investing in stocks.
There are wonderful investing lessons found in The Davis Dynasty and there are three that I want to share in this article.
Lesson 1: It’s never too late to start investing if you do it correctly
Warren Buffett was a whiz kid. He started his own investment partnership at the ripe “old” age of 26 in 1956. But not everyone starts young like Buffett. If you think you’re too old to start investing because you need to draw upon your savings as you approach retirement, take heed. Davis only started his investing career at 39 – without prior experience – and went on to build an immense fortune.
The secret of Davis’s success is that he started investing with a sound process. He was an admirer of Benjamin Graham, Buffett’s revered investing mentor. Just like Graham, Davis subscribed to the discipline of “value investing”, where investors look at stocks as part-ownership of businesses, and sought to invest in stocks that are selling for less than their true economic worth. Davis’s preference was to invest in growing and profitable companies that carried low price-to-earnings (P/E) ratios. He called his approach the ‘Davis Double Play’ – by investing in growing companies with low P/E ratios, he could benefit from both the growth in the company’s business as well as the expansion of the company’s P/E ratio in the future.
Davis also recognised the importance of having the right behaviour. He ignored market volatility and never gave in to excessive fear or euphoria. He took the long-term approach and stayed invested in his companies for years – even decades, as you’ll see later –through bull and bear markets. Davis’s experience shows that it is a person’s behaviour and investing process that matters in investing, not their age.
Singapore’s statutory retirement age is currently 62. For those who are 65 at the moment, the average life expectancy is 21.1 years. So, most people approaching retirement, or even those who are already retirees, will likely still have decades to invest. If they can use a portion of their retirement savings (and only just a portion!) to invest in stocks with the right behaviour and process, the investments could provide an additional income stream through dividends and/or a better tomorrow through capital appreciation. The stock market will almost surely decline steeply from time to time (volatility is normal!). But investors with a sound process, regardless of age, should still stand a great chance of coming out ahead.
Lesson 2: Buying and holding works
In The Davis Dynasty, John Rothchild wrote that the foundation for Davis’s wealth was built on a few stocks that he had bought in the 1960s and held till 1992. Notable examples included: (1) A US$641,000 purchase of Japanese insurer Tokio Marine & Fire in 1962 that grew to US$33 million; and (2) shares of American insurer American International Group that he began buying in 1969 that grew to US$72 million.
The journey was rough for Davis. His portfolio shrunk from US$50 million to US$20 million during the vicious bear market that US stocks experienced in the early 1970s. But he watched unmoved. Instead of selling, Davis bought shares of undervalued companies very aggressively during the bear market, while holding on to the stalwarts he had purchased in the 1960s.
Davis knew that the companies he had invested in were still solidly profitable with bright growth prospects. He saw no reason to sell their shares during the bear market. He was confident that their value would be far greater in the future, because his investment focus was on companies with excellent management, good returns on capital, and a strong balance sheet. These are attractive company-traits for long-term investors.
His experience during the 1970s bear market, and the eventual wealth he built, is a great reminder that a long-term buy-and-hold approach to investing will work if your investing process is sound.
Lesson 3: The world is your oyster
In 1962, Davis travelled to Japan and learnt about Japanese insurance companies that had solid operations because of governmental support. He used the knowledge gained from his investing experience in the US to analyse the Japanese insurance companies.
At the time, American investors only had eyes for American companies. Their thinking was that investing in foreign stocks was too risky. But Davis thought differently. He saw value in the Japanese insurance companies. He ended up investing in four insurers for around US$2 million in total. They are: Tokio Marine & Fire; Sumitomo Marine & Fire; Taisho Marine and Fire; and Yasuda Fire & Marine. Davis held them for more than three decades. By 1992, they were worth a combined US$75 million.
Davis was not the only American investor, decades ago, who dared to venture abroad. Sir John Templeton, an investing legend who achieved a 15.4% annualised return from 1955 to 1992, was also a renowned global stock picker.
“The concept of geographical diversification is particularly important for Singapore investors. Look at the stocks in our local stock market benchmark, the Straits Times Index. There’s no good exposure to some of the important growth industries of tomorrow, such as cloud computing, DNA analysis, precision medicine, e-commerce, digital advertising, and more.”
There are risks associated with international investing and we should not be blind to them. Understanding an overseas-based company may be tougher. Currency fluctuations can also hurt our returns. But these risks can be mitigated by finding great companies to invest in. We shouldn’t constrain our investing activities by geography.
Final word
I highly recommend John Rothchild’s book, The Davis Dynasty. There’s so much more about investing that we can learn from Shelby Cullom Davis’s life experiences than what I’ve covered here. But if I were to summarise what I’ve shared in one short sentence, it will be this: Invest for the long run with the right process, and never let age or geography dictate your investing opportunities.
Disclaimer:The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
My takeaways from “The Big Short”, a great movie on how a few real-life investors foresaw the 2008-09 financial crisis and profited wildly from it.
My girlfriend is currently taking online courses on financial analysis for her own personal development. The content can be really dry for her at times. To spice up her learning, I recently suggested that she watch the movie, The Big Short.
The film came out in 2015 and is based on the 2010 book by renowned author Michael Lewis, The Big Short: Inside the Doomsday Machine. Both the movie and book depict the real-life experience of a few groups of investors who foresaw the 2008-09 US housing and financial crisis and profited from it.
When the movie first came out, I was so excitedthat I helped organise an outing to watch it with a group of friends who are also keen investors. I remember being captivated by the film.
After recommending The Big Short to my girlfriend (she loves the movie too – yay!), I decided to rewatch it last weekend. It was the first time I did so, five years after I initially saw the film. In my second run, I experienced the same captivation I did as on my first. But this time, I also came away with investing lessons that I want to share – perhaps a by-product of me having this investment blog that I love writing for.
Lesson 1: The market can remain irrational longer than you can remain solvent
The characters in The Big Short mostly used leveraged instruments – credit default swaps (CDSs) – to make their bets that the housing market and the financial instruments tied to the housing market would fall. This is a simplified explanation, but the financial instruments that were tied to the housing market were essentially bonds that were each made up of thousands of mortgage loans from across the US.
The CDSs are like insurance contracts on the bonds. If you own a CDS, its value will rise significantly, or you will receive a big payoff, if the value of the bonds fall or go to zero. But before the decline happens, you have to pay regular premiums on the swaps as long as you own it. Moreover, you have to meet margin calls on the CDS if the value of the bonds increase.
The investors depicted in The Big Short suffered temporary but painful losses to their portfolios because of the premiums and margin calls they had to pay prior to the flare up of the housing and financial crisis. Their experience reminded me of a great quote that is commonly attributed to the legendary economist John Maynard Keynes, but that is more likely to have originated from financial analyst Gary Shilling:
“The market can remain irrational longer than you can remain solvent.”
If the housing and financial crisis did not erupt when they did, the investors in The Big Short may have suffered debilitating losses if they held onto their CDSs long enough. This is a key reason why I do not short financial assets nor use leverage. Some investors can do it very successfully – the ones in The Big Short certainly did – but it’s not my game.
Lesson 2: Investing can be a lonely affair
One of the real-life investors profiled in the movie and book is Dr Michael Burry. The movie did not explore much of Burry’s earlier life before he invested in the CDSs, but his real backstory is amazing.
Growing up, Burry was somewhat of a loner. But he managed to excel academically and eventually graduated with a medical degree. He worked in a hospital for some time, but found that his real interest was in stock market investing. When he was a doctor, he spent his free hours researching stocks and writing about them on the internet. His sharing was excellent and attracted the attention of the well-known investor Joel Greenblatt (the character Lawrence Fields in the movie is based on him). Burry eventually left medicine to establish his investment firm, Scion Capital, with Greenblatt’s seed capital.
Burry’s reputation was built on his uncanny ability to pick stocks mostly through bottoms-up, fundamental analysis. In Scion’s early days, he posted tremendous returns for a few years by shorting overvalued stocks and investing in undervalued ones. But in 2005, after he discovered the house of cards that the US housing market was built on and decided to invest in CDSs, his investors started turning on him. They had no faith in his ability to find investment opportunities outside of the stock market. They wanted him to stick to his knitting.
The Big Short depicted the intense emotional loneliness that Burry felt when his investors turned their backs on him. Some even threatened to sue. Burry was vindicated in the end. In 2007, the US housing market started to collapse and the bonds that were built with the mortgage loans failed. Burry’s CDSs soared as a result. But he was so burnt out by the experience that he decided to close Scion Capital after cashing in the profits.
What was even sadder is that even though Burry made a lot of money for his investors in Scion Capital – the fund gained 489% in total, or 27% annualised, from its inception in November 2000 to June 2008 – the relationships he had with his investors, including his mentor Greenblatt, had mostly soured beyond repair.
At times in investing, we may be the only ones who hold a certain view. This could be a lonely and draining experience (although it’s probably unlikely that we will face the same level of isolation that Burry did) so we have to be mentally prepared for it.
Lesson 3: Famous investors can be very wrong at times too
This is related to Lesson 2. Joel Greenblatt produced a 40% annualised return for 20 years with his investment fund, Gotham Capital, that he co-founded in 1985. That’s an amazing track record. But Greenblatt got it wrong when he butted heads with Dr Michael Burry’s decision to invest in CDSs.
It’s very important for us as investors to know what we don’t know. As I mentioned earlier, Burry started his investing career by being a very successful stock picker who did bottoms-up fundamental analysis. Being a good stock picker does not mean that you will automatically be good at other types of investments. I believe this was Greenblatt’s concern and I sympathise with him. This is because it was a legitimate worry that Burry may have ventured into an area where he had zero expertise when he shorted the US housing market through CDSs.
This is not meant to be a criticism of Greenblatt in any way. His results are one of the best in the investing business. I would have been worried about Burry’s investment actions too if I were in Greenblatt’s shoes. What I’m trying to show is just how difficult investing in the financial markets can be at times, and that even the best of the best can get it wrong too.
Lesson 4: Luck can play a huge role in our returns
One of the central characters in the movie and the book is hedge fund manager Steve Eisman (named Mark Baum in the film) who first heard of the CDSs trade from a bond trader at Deutsche Bank, Greg Lippmann (named Jared Vennett in the film). What is amazing is that Eisman only knew about the idea because of a mistake that Lippmann made.
Lippmann wanted to introduce his idea of shorting the housing market with CDSs to hedge funds that had a certain characteristic. One hedge fund Lippmann discovered that fit his bill was Frontpoint. Eisman’s hedge fund was named Frontpoint – but the problem was Eisman’s Frontpoint was not the Frontpoint Lippmann was looking for. Lippmann only realised his mistake when he met Eisman in person. Nonetheless, Eisman saw the logic in Lippmann’s idea. He made the trade for his Frontpoint, and the rest as they say, is history.
This goes to show how important luck can be to our investment returns. Eisman only knew about the idea because Lippmann suffered a case of mistaken identity. Sure, Eisman may have eventually discovered the same idea independently. But this is a counterfactual that is impossible for us to ever know. What we do know is that Lady Luck had smiled on Eisman, and to his credit, he acted on it.
Disclaimer:The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
9 years 7 months and 6 days. This is how much time has passed since I started managing my family’s investment portfolio of US stocks on 26 October 2010. 19.5% versus 12.7%. These are the respective annual returns of my family’s portfolio (without dividends) and the S&P 500 (with dividends) in that period.
As of 31 May 2020
I will soon have to say goodbye to the portfolio. Jeremy Chia (my blogging partner) and myself have co-founded a global equities investment fund. As a result, the lion’s share of my family’s investment portfolio will soon be liquidated so that the cash can be invested in the fund.
The global equities investment fund will be investing with the same investment philosophy that underpins my family’s portfolio, so the journey continues. But my heart’s still heavy at having to let the family portfolio go. It has been a huge part of my life for the past 9 years 7 months and 6 days, and I’m proud of what I’ve achieved (I hope my parents are too!).
In the nearly-10 years managing the portfolio, I’ve learnt plenty of investing lessons. I want to share them here, to benefit those of you who are reading, and to mark the end of my personal journey and the beginning of a new adventure. I did not specifically pick any number of lessons to share. I’m documenting everything that’s in my head after a long period of reflection.
Do note that my lessons may not be timeless, because things change in the markets. But for now, they are the key lessons I’ve picked up.
Lesson 1: Focus on businessfundamentals, notmacroeconomic or geopolitical developments – there are always things to worry about
My family’s portfolio has many stocks that have gone up multiple times in value. A sample is given below:
Some of them are among the very first few stocks I bought; some were bought in more recent years. But what’s interesting is that these stocks produced their gains while the world experienced one crisis after another.
You see, there were alwaysthings to worry about in the geopolitical and macroeconomic landscape since I started investing. Here’s a short and incomplete list (you may realise how inconsequential most of these events are today, even though they seemed to be huge when they occurred):
2010 – European debt crisis; BP oil spill; May 2010 Flash Crash
2011 – Japan earthquake; Middle East uprising
2012 – Potential Greek exit from Eurozone; Hurricane Sandy
2013 – Cyprus bank bailouts; US government shutdown; Thailand uprising
2014 – Oil price collapse
2015 – Crash in Euro dollar against the Swiss Franc; Greece debt crisis
2016 – Brexit; Italy banking crisis
2017 – Bank of England hikes interest rates for first time in 10 years
2018 – US-China trade war
2019 – Australia bushfires; US President impeachment; appearance of COVID-19 in China
2020 (thus far) – COVID-19 becomes global pandemic
The stocks mentioned in the table above produced strong business growth over the years I’ve owned them. This business growth has been a big factor in the returns they have delivered for my family’s portfolio. When I was studying them, my focus was on their business fundamentals – and this focus has served me well.
In a 1998 lecture for MBA students, Warren Buffett was asked about his views on the then “tenuous economic situation and interest rates.“ He responded:
“I don’t think about the macro stuff. What you really want to do in investments is figure out what is important and knowable. If it is unimportant and unknowable, you forget about it. What you talk about is important but, in my view, it is not knowable.
Understanding Coca-Cola is knowable or Wrigley’s or Eastman Kodak. You can understand those businesses that are knowable. Whether it turns out to be important depends where your valuation leads you and the firm’s price and all that. But we have never not bought or bought a business because of any macro feeling of any kind because it doesn’t make any difference.
Let’s say in 1972 when we bought See’s Candy, I think Nixon [referring to former US President, Richard Nixon] put on the price controls a little bit later, but so what! We would have missed a chance to buy something for [US]$25 million that is producing [US]$60 million pre-tax now. We don’t want to pass up the chance to do something intelligent because of some prediction about something we are no good on anyway.”
Lesson 2: Adding to winners work
I’ve never shied away from adding to the winners in my portfolio, and this has worked out well. Here’s a sample, using some of the same stocks shown in the table in Lesson 1.
Adding to winners is hard to achieve, psychologically. As humans, we tend to anchor to the price we first paid for a stock. After a stock has risen significantly, it’s hard to still see it as a bargain. But I’ll argue that it is stocks that have risen significantly over a long period of time that are the good bargains. It’s counterintuitive, but hear me out.
The logic here rests on the idea that stocks do well over time if their underlying businesses do well. So, the stocks in my portfolio that have risen significantly over a number of years are likely – though not always – the ones with businesses that are firing on all cylinders. And stocks with businesses that are firing on all cylinders are exactly the ones I want to invest in.
Lesson 3: The next Amazon, is Amazon
When I first bought shares of Amazon in April 2014 at US$313, its share price was already more than 200 times higher than its IPO share price of US$1.50 in May 1997. That was an amazing annual return of around 37%.
But from the time I first invested in Amazon in April 2014 to today, its share price has increased by an even more impressive annual rate of 40%. Of course, it is unrealistic to expect Amazon to grow by a further 200 times in value from its April 2014 level over a reasonable multi-year time frame. But a stock that has done very well for a long period of time can continue delivering a great return. Winners often keep on winning.
Lesson 4: Focus on business quality and don’t obsess over valuation
It is possible to overpay for a company’s shares. This is why we need to think about the valuation of a business. But I think it is far more important to focus on the quality of a business – such as its growth prospects and the capability of the management team – than on its valuation.
If I use Amazon as an example, its shares carried a high price-to-free cash flow (P/FCF) ratio of 72 when I first invested in the company in April 2014. But Amazon’s free cash flow per share has increased by 1,000% in total (or 48% annually) from US$4.37 back then to US$48.10 now, resulting in the overall gain of 681% in its share price.
Great companies could grow into their high valuations. Amazon’s P/FCF ratio, using my April 2014 purchase price and the company’s current free cash flow per share, is just 6.5 (now that’s a value stock!). But there’s no fixed formula that can tell you what valuation is too high for a stock. It boils down to subjective judgement that is sometimes even as squishy as an intuitive feeling. This is one of the unfortunate realities of investing. Not everything can be quantified.
Lesson 5: The big can become bigger – don’t obsess over a company’s market capitalisation
I’ve yet to mention Mastercard, but I first invested in shares of the credit card company on 3 December 2014 at US$89 apiece. Back then, it already had a huge market capitalisation of around US$100 billion, according to data from Ycharts. Today, Mastercard’s share price is US$301, up more than 200% from my initial investment.
A company’s market capitalisation alone does not tell us much. It is the company’s (1) valuation, (2) size of the business, and (3) addressable market, that can give us clues on whether it could be a good investment opportunity. In December 2014, Mastercard’s price-to-earnings (P/E) ratio and revenue were both reasonable at around 35 and US$9.2 billion, respectively. Meanwhile, the company’s market opportunity still looked significant, since cashless transactions represented just 15% of total transactions in the world back then.
Lesson 6: Don’t ignore “obvious” companies just because they’re well known
Sticking with Mastercard, it was an obvious company that was already well-known when I first invested in its shares. In the first nine months of 2014, Mastercard had more than 2 billion credit cards in circulation and had processed more than 31.4 billion transactions. Everyone could see Mastercard and know that it was a great business. It was growing rapidly and consistently, and its profit and free cash flow margins were off the charts (nearly 40% for both).
The company’s high quality was recognised by the market – its P/E ratio was high in late 2014 as I mentioned earlier. But Mastercard still delivered a fantastic annual return of around 25% from my December 2014 investment.
I recently discovered a poetic quote by philosopher Arthur Schopenhauer: “The task is… not so much to see what no one has yet seen, but to think what nobody has yet thought, about that which everyone sees.” This is so applicable to investing.
Profitable investment opportunities can still be found by thinking differently about the data that everyone else has. It was obvious to the market back in December 2014 that Mastercard was a great business and its shares were valued highly because of this. But by thinking differently – with a longer-term point of view – I saw that Mastercard could grow at high rates for a very long period of time, making its shares a worthy long-term investment. From December 2014 to today, Mastercard’s free cash flow per share has increased by 158% in total, or 19% per year. Not too shabby.
Lesson 7: Be willing to lose sometimes
We need to take risks when investing. When I first invested in Shopify in September 2016, it had a price-to-sales (P/S) ratio of around 12, which is really high for a company with a long history of making losses and producing meagre cash flow. But Shopify also had a visionary leader who dared to think and act long-term. Tobi Lütke, Shopify’s CEO and co-founder, penned the following in his letter to investors in the company’s 2015 IPO prospectus (emphases are mine):
“Over the years we’ve also helped foster a large ecosystem that has grown up around Shopify. App developers, design agencies, and theme designers have built businesses of their own by creating value for merchants on the Shopify platform. Instead of stifling this enthusiastic pool of talent and carving out the profits for ourselves, we’ve made a point of supporting our partners and aligning their interests with our own. In order to build long-term value, we decided to forgo short-term revenue opportunities and nurture the people who were putting their trust in Shopify. As a result, today there are thousands of partners that have built businesses around Shopify by creating custom apps, custom themes, or any number of other services for Shopify merchants.
This is a prime example of how we approach value and something that potential investors must understand: we do not chase revenue as the primary driver of our business. Shopify has been about empowering merchants since it was founded, and we have always prioritized long term value over short-term revenue opportunities. We don’t see this changing…
… I want Shopify to be a company that sees the next century. To get us there we not only have to correctly predict future commerce trends and technology, but be the ones that push the entire industry forward. Shopify was initially built in a world where merchants were simply looking for a homepage for their business. By accurately predicting how the commerce world would be changing, and building what our merchants would need next, we taught them to expect so much more from their software.
These underlying aspirations and values drive our mission: make commerce better for everyone. I hope you’ll join us.”
Shopify was a risky proposition. But it paid off handsomely. In investing, I think we have to be willing to take risks and accept that we can lose at times. But failing at risk-taking from time to time does not mean our portfolios have to be ruined. We can take intelligent risks by sizing our positions appropriately. Tom Engle is part of The Motley Fool’s investing team in the US. He’s one of the best investors the world has never heard of. When it comes to investing in risky stocks that have the potential for huge returns, Tom has a phrase I love: “If it works out, a little is all you need; if it doesn’t, a little is all you want.”
I also want to share a story I once heard from The Motley Fool’s co-founder Tom Gardner. Once, a top-tier venture capital firm in the US wanted to improve the hit-rate of the investments it was making. So the VC firm’s leaders came up with a process for the analysts that could reduce investing errors. The firm succeeded in improving its hit-rate (the percentage of investments that make money). But interestingly, its overallrate of return became lower. That’s because the VC firm, in its quest to lower mistakes, also passed on investing in highly risky potential moonshots that could generate tremendous returns.
The success of one Shopify can make up for the mistakes of many other risky bets that flame out. To hit a home run, we must be willing to miss at times.
Lesson 8: The money is made on the holding, not the buying and selling
My family’s investment portfolio has over 50 stocks. It’s a collection that was built steadily over time, starting with the purchase of just six stocks on 26 October 2010. In the 9 years, 7 months and 6 days since, I’ve only ever sold two stocks voluntarily: (1) Atwood Oceanics, an owner of oil rigs; and (2) National Oilwell Varco, a supplier of parts and equipment that keep oil rigs running. Both stocks were bought on 26 October 2010.
David Gardner is also one of the co-founders of The Motley Fool (Tom Gardner is his brother). There’s something profound David once said about portfolio management that resonates with me:
“Make your portfolio reflect your best vision for our future.”
The sales of Atwood Oceanics and National Oilwell Varco happened because of David’s words. Part of the vision I have for the future is a world where our energy-needs are met entirely by renewable sources that do not harm the precious environment we live in. For this reason, I made the rare decision to voluntarily part ways with Atwood Oceanics and National Oilwell Varco in September 2016 and June 2017, respectively.
My aversion to selling is by design – because I believe it strengthens my discipline in holding onto the winners in my family’s portfolio. Many investors tend to cut their winners and hold onto their losers. Even in my earliest days as an investor, I recognised the importance of holding onto the winners in driving my family portfolio’s return. Being very slow to sell stocks has helped me hone the discipline of holding onto the winners. And this discipline has been a very important contributor to the long run performance of my family’s portfolio.
The great Charlie Munger has a saying that one of the keys to investing success is “sitting on your ass.” I agree. Patience is a virtue. And talking about patience…
Lesson 9: Be patient – some great things take time
Some of my big winners needed only a short while before they took off. But there are some that needed significantly more time. Activision Blizzard is one such example. As I mentioned earlier, I invested in its shares in October 2010. Then, Activision Blizzard’s share price went nowhere for more than two years before it started rocketing higher.
Peter Lynch once said: “In my investing career, the best gains usually have come in the third or fourth year, not in the third or fourth week or the third or fourth month.” The stock market does not move according to our own clock. So patience is often needed.
Lesson 10: Management is the ultimate source of a company’s economic moat
In my early days as an investor, I looked for quantifiable economic moats. These are traits in a company such as (1) having a network effect, (2) being a low-cost producer, (3) delivering a product or service that carries a high switching cost for customers, (4) possessing intangible assets such as intellectual property, and (5) having efficient scale in production.
But the more I thought about it, the more I realised that a company’s management team is the true source of its economic moat, or lack thereof.
Today, Netflix has the largest global streaming audience with a pool of 183 million subscribers around the world. Having this huge base of subscribers means that Netflix has an efficient scale in producing content, because the costs can be spread over many subscribers. Its streaming competitors do not have this luxury. But this scale did not appear from thin air. It arose because of Netflix’s CEO and co-founder, Reed Hastings, and his leadership team.
The company was an early pioneer in the streaming business when it launched its streaming service in 2007. In fact, Netflix probably wanted to introduce streaming even from its earliest days. Hastings said the following in a 2007 interview with Fortune magazine:
“We named the company Netflix for a reason; we didn’t name it DVDs-by-mail. The opportunity for Netflix online arrives when we can deliver content to the TV without any intermediary device.”
When Netflix first started streaming, the content came from third-party producers. In 2013, the company launched its first slate of original programming. Since then, Netflix has ramped up its original content budget significantly. The spending has been done smartly, as Netflix has found plenty of success with its original programming. For instance, in 2013, the company became the first streaming provider to be nominated for a primetime Emmy. And in 2018 and 2019, the company snagged 23 and 27 Emmy wins, respectively.
A company’s current moat is the result of management’s past actions; a company’s future moat is the result of management’s current actions. Management is what createsthe economic moat.
Lesson 11: Volatility in stocks is a feature, not a bug
Looking at the table in Lesson 1, you may think that my investment in Netflix was smooth-sailing. It’s actually the opposite.
I first invested in Netflix shares on 15 September 2011 at US$26 after the stock price had fallen by nearly 40% from US$41 in July 2011. But the stock price kept declining afterward, and I bought more shares at US$16 on 20 March 2012. More pain was to come. In August 2012, Netflix’s share price bottomed at less than US$8, resulting in declines of more than 70% from my first purchase, and 50% from my second.
My Netflix investment was a trial by fire for a then-young investor – I had started investing barely a year ago before I bought my first Netflix shares. But I did not panic and I was not emotionally affected. I already knew that stocks – even the best performing ones – are volatile over the short run. But my experience with Netflix drove the point even deeper into my brain.
Lesson 12: Be humble – there’s so much we don’t know
My investment philosophy is built on the premise that a stock will do well over time if its business does well too. But howdoes this happen?
In the 1950s, lawmakers in the US commissioned an investigation to determine if the stock market back then was too richly priced. The Dow (a major US stock market benchmark) had exceeded its peak seen in 1929 before the Great Depression tore up the US market and economy. Ben Graham, the legendary father of value investing, was asked to participate as an expert on the stock market. Here’s an exchange during the investigation that’s relevant to my discussion:
“Question to Graham: When you find a special situation and you decide, just for illustration, that you can buy for 10 and it is worth 30, and you take a position, and then you cannot realize it until a lot of other people decide it is worth 30, how is that process brought about – by advertising, or what happens?
Graham’s response:That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realizes it in one way or another.”
More than 60 years ago, one of the most esteemed figures in the investment business had no idea how stock prices seemed to eventually reflect their underlying economic values. Today, I’m still unable to find any answer. If you’ve seen any clues, please let me know! This goes to show that there’s so much I don’t know about the stock market. It’s also a fantastic reminder for me to always remain humble and be constantly learning. Ego is the enemy.
Lesson 13: Knowledge compounds, and read outside of finance
Warren Buffett once told a bunch of students to “read 500 pages… every day.” He added, “That’s how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.”
I definitely have not done it. I read every day, but I’m nowhere close to the 500 pages that Buffett mentioned. Nonetheless, I have experienced first hand how knowledge compounds. Over time, I’ve been able to connect the dots faster when I analyse a company. And for companies that I’ve owned shares of for years, I don’t need to spend much time to keep up with their developments because of the knowledge I’ve acquired over the years.
Reading outside of finance has also been really useful for me. I have a firm belief that investing is only 5% finance and 95% everything else. Reading about psychology, society, history, science etc. can make us even better investors than someone who’s buried neck-deep in only finance books. Having a broad knowledge base helps us think about issues from multiple angles. This brings me to Arthur Schopenhauer’s quote I mentioned earlier in Lesson 6: “The task is… not so much to see what no one has yet seen, but to think what nobody has yet thought, about that which everyone sees.”
Lesson 14: The squishy things matter
Investing is part art and part science. But is it more art than science? I think so. The squishy, unquantifiable things matter. That’s because investing is about businesses, and building businesses involves squishy things.
Jeff Bezos said it best in his 2005 Amazon shareholders’ letter (emphases are mine):
“As our shareholders know, we have made a decision to continuously and significantly lower prices for customers year after year as our efficiency and scale make it possible. This is an example of a very important decision that cannot be made in a math-based way.
In fact, when we lower prices, we go against the math that we can do, which always says that the smart move is to raise prices. We have significant data related to price elasticity. With fair accuracy, we can predict that a price reduction of a certain percentage will result in an increase in units sold of a certain percentage. With rare exceptions, the volume increase in the short term is never enough to pay for the price decrease.
However, our quantitative understanding of elasticity is short-term. We can estimate what a price reduction will do this week and this quarter. But we cannot numerically estimate the effect that consistently lowering prices will have on our business over five years or ten years or more.
Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon.com. We’ve made similar judgments around Free Super Saver Shipping and Amazon Prime, both of which are expensive in the short term and—we believe—important and valuable in the long term.”
On a related note, I was also attracted to Shopify when I came across Tobi Lütke’s letter to investors that I referenced in Lesson 7. I saw in Lütke the same ability to stomach short-term pain, and the drive toward producing long-term value, that I noticed in Bezos. This is also a great example of how knowledge compounds.
Lesson 15: I can never do it alone
Aaron Bush is one of the best investors I know of at The Motley Fool, and he recently created one of the best investing-related tweet-storms I have seen. In one of his tweets, he said: “Collaboration can go too far. Surrounding yourself with a great team or community is critical, but the moment decision-making authority veers democratic your returns will begin to mean-revert.”
I agree with everything Aaron said. Investment decision-making should never involve large teams. But at the same time, having a community or team around us is incredibly important for our development; their presence enables us to view a problem from many angles, and it helps with information gathering and curation.
I joined one of The Motley Fool’s investment newsletter services in 2010 as a customer. The service had wonderful online forums and this dramatically accelerated my learning curve. In 2013, I had the fortune to join an informal investment club in Singapore named Kairos Research. It was founded by Stanley Lim, Cheong Mun Hong, and Willie Keng. They are also the founders of the excellent Asia-focused investment education website, Value Invest Asia. I’ve been a part of Kairos since and have benefited greatly. I’ve made life-long friends and met countless thoughtful, kind, humble, and whip-smart people who have a deep passion for investing and knowledge. The Motley Fool’s online forums and the people in Kairos have helped me become a better human being and investor over the years.
I’ve also noticed – in these group interactions – that the more I’m willing to give, the more I receive. Giving unconditionally and sincerely without expecting anything in return, paradoxically, results in us having more. Giving is a superpower.
Lesson 16: Be honest with myself about what I don’t know
When we taste success in the markets, it’s easy for ego to enter the picture. We may look into the mirror and proclaim: “I’m a special investor! I’ve been great at picking growth stocks – this knowledge must definitely translate to trading options, shorting commodities, and underwriting exotic derivatives. They, just like growth stocks, are all a part of finance, isn’t it?”
This is where trouble comes. The entrance of ego is the seed of future failure. In the biography of Warren Buffett, The Snowball: Warren Buffett and the Business of Life, author Alice Schroeder shared this passage about Charlie Munger:
“[Munger] dread falling prey to what a Harvard Law School classmate of his had called “the Shoe Button Complex.”
“His father commuted daily with the same group of men,” Munger said. “One of them had managed to corner the market in shoe buttons – a really small market, but he had it all. He pontificated on every subject, all subjects imaginable. Cornering the market on shoe buttons made him an expert on everything. Warren and I have always sensed it would be a big mistake to behave that way.”
The Shoe Button Complex can be applied in a narrower sense to investing too. Just because I know something about the market does not mean I know everything. For example, a few years after I invested in Atwood Oceanics and National Oilwell Varco, I realised I was in over my head. I have no ability to predict commodity prices, but the business-health of the two companies dependson the price of oil. Since I came to the realisation, I have stayed away from additional commodity-related companies. In another instance, I know I can’t predict the movement of interest rates, so I’ve never made any investment decision that depended on interest rates as the main driver.
Lesson 17: Be rationally optimistic
In Lesson 1, I showed that the world had lurched from one crisis to another over the past decade. And of course, we’re currently battling COVID-19 now. But I’m still optimistic about tomorrow. This is because one key thing I’ve learnt about humanity is that our progress has never happened smoothly. It took us only 66 years to go from the first demonstration of manned flight by the Wright brothers at Kitty Hawk to putting a man on the moon. But in between was World War II, a brutal battle across the globe from 1939 to 1945 that killed an estimated 66 million, according to National Geographic.
This is how progress is made, through the broken pieces of the mess that Mother Nature and our own mistakes create. Morgan Housel has the best description of this form of rational optimism that I’ve come across:
“A real optimist wakes up every morning knowing lots of stuff is broken, and more stuff is about to break.
Big stuff. Important stuff. Stuff that will make his life miserable. He’s 100% sure of it.
He starts his day knowing a chain of disappointments awaits him at work. Doomed projects. Products that will lose money. Coworkers quitting. He knows that he lives in an economy due for a recession, unemployment surely to rise. He invests his money in a stock market that will crash. Maybe soon. Maybe by a lot. This is his base case.
He reads the news with angst. It’s a fragile world. Every generation has been hit with a defining shock. Wars, recessions, political crises. He knows his generation is no different.
This is a real optimist. He’s an optimist because he knows all this stuff does not preclude eventual growth and improvement. The bad stuff is a necessary and normal path that things getting better over time rides on. Progress happens when people learn something new. And they learn the most, as a group, when stuff breaks. It’s essential.
So he expects the world around him to break all the time. But he knows – as a matter of faith – that if he can survive the day-to-day fractures, he’ll capture the up-and-to-the-right arc that learning and hard work produces over time.”
To me, investing in stocks is, at its core, the same as having faith in the long-term potential of humanity. There are 7.8 billion individuals in the world today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life – this is ultimately what fuels the global economy and financial markets. Miscreants and Mother Nature will wreak havoc from time to time. But I have faith in the collective positivity of humanity. When there’s a mess, we can clean it up. This has been the story of our long history – and the key driver of the return my family’s portfolio has enjoyed immensely over the past 9 years, 7 months, and 6 days.
My dear portfolio, goodbye.
Disclaimer:The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.I, the author, will be making sell-trades on the stocks mentioned in this article over the coming weeks.
The leader of the US’s Central Bank has warned investors of the danger in stocks. Should we be worried for our investment portfolios?
Here’s an excerpt of a speech by the leader of the Federal Reserve, the central bank of the US, warning of danger in stocks in the country:
“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past.
But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?
We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy.
But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.”
Trouble ahead?
Are you worried about the implications of the speech? Don’t be. That’s because the speech was delivered on 6 December 1996 – more than 23 years ago – by Alan Greenspan, who was the chairperson of the Federal Reserve at the time. Greenspan’s speech has since become well-known for the phrase “irrational exuberance” because it happened only a few short years before the infamous Dotcom bubble in the US imploded in late 2000.
But what’s really interesting is that the S&P 500, the major benchmark for the US stock market, has gained526% in total including dividends, from December 1996 to today. That’s a solid annual return of 8%. This reminds me of two important things about investing.
Worries, worries
The first thing is, to borrow the words of the legendary fund manager Peter Lynch, “there is always something to worry about.”
The content of Greenspan’s speech could well be used to describe the financial markets we’re seeing today. The S&P 500 has bounced 36% higher (as of 28 May 2020) from its 23 March 2020 low after suffering a historically steep coronavirus-driven decline of more than 30% from its 19 February 2020 high. Moreover, the S&P 500 has a price-to-earnings (P/E) ratio of 22 today, which is not far from the P/E ratio of 19 seen at the start of December 1996.
Yet anyone who got scared out of the US stock market back then by Greenspan’s speech, and crucially, failed to reinvest,would have missed out on more than 23 years of good returns. Some individual stocks in the US have delivered significantly higher returns, so the opportunity costs for anyone who stayed out would have been immense.
Time heals
The second thing is, time can wash away plenty of mistakes in the financial markets.
The past 23-plus years from 1996 to today contained plenty of jarring episodes for the economies and the financial markets of the US and many other countries. Here’s a short and incomplete list: The 1997 Asian Financial Crisis; the bursting of the Dotcom bubble in late 2000 that I already mentioned; the 2008-09 Great Financial Crisis; Greece’s debt crisis in 2015; Italy’s banking troubles in 2015; and the US-China trade war in 2018.
Yet, investors who stayed invested have been rewarded, as Corporate America grew steadily over the years.
Words of caution
I’m not saying that the US stock market will be higher 1 or 2 years from now. Nobody knows. When the Dotcom bubble burst after Greenspan gave his famous “irrational exuberance” speech, the S&P 500 fell by nearly half. It recovered, only to then get crushed again during the 2008-09 Great Financial Crisis. The chart below shows this.
What I want to illustrate is that it makes senseto invest even when the world is mired in trouble, if we have a long time horizon for our investments.
Now, I want to stress that having a long time horizon is not a magical panacea.
If our portfolio is filled with stocks that have lousy underlying businesses, staying invested for the long run will destroy our return. This is because such a portfolio becomes riskier the longer we hold onto it, since value is being actively eroded.
If we invest in stocks at ridiculous valuations, staying invested can’t save us too. Japan’s a great example. Its main stock market barometer, the Nikkei 225 index, is today more than 40% lower than the peak seen in late 1989. This is because Japanese stocks were valued at nearly 100 times their inflation-adjusted 10-year average earnings near the late-1989 high. The good thing is Japan-level bubbles are rare. It’s the exception, not the norm.
So, if the stocks we own today have reasonable valuations and have decent-to-great underlying businesses, we can afford to be patient. In such cases, time can be a great healer of stock market wounds.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
Investing in stocks is often made overly complex. Here are 3 easy analogies using real-world phenomena to help you understand the stock market.
The word “analogy” is defined by the Cambridge Dictionary as a “comparison between things that have similar features, often used to help explain a principle or idea.” It is a useful way for us to understand a topic that’s complicated or new to us.
One topic that is often made overly complex is investing in stocks. Fortunately, I have three analogies – sourced from greater minds – that can help us cut through the fluff and get to the point about the core of stock market investing.
Watching the right thing
The first analogy is from Ralph Wagner, who ran the US-based Acorn Fund from 1970 to 2003. During his tenure, he led Acorn Fund to an impressive annual gain of 16.3%. This is also significantly better compared to the S&P 500’s return of 12.1% per year over the same period.
Wagner once said:
“There’s an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch.
But in the long run, you know he’s heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the dog watchers, big and small, seem to have their eye on the dog, and not the owner.”
In Wagner’s terminology, the stock price is the pooch, while the underlying business of the stock is the owner. Instead of watching the dog (the stock price), we should be focusing on the owner (the business).
My favourite example of this is Warren Buffett’s investment conglomerate, Berkshire Hathaway. The chart below shows the percentage change in Berkshire’s book value per share and its share price for each year from 1965 to 2018. There were years when the two percentages match closely, but there were also times when they diverged wildly. A case of the latter is 1974, when Berkshire’s book value per share grew by 5.5% even though its share price fell sharply by 48.7%.
Source: Berkshire Hathaway 2018 shareholders’ letter
In all, Berkshire’s book value per share increased by 18.7% per year from 1965 to 2018. Meanwhile, its share price was up by 20.5% annually over the same period. An input of 18.7% had led to a similar output of 20.5% over the long run despite wide differences at times during shorter timeframes.
Predictions are hard
Dean Wlliams is the owner of the second analogy. There are only two things I know about Williams. I couldn’t find anything else about him online – if you know more about him, please reach out to me! First, he’s an investor who was part of Batterymarch Financial Management. Second, he wrote one of the best investment speeches I’ve ever come across. The speech, delivered in 1981, is titled Trying Too Hard.
Here’s the analogy:
“The foundation of Newtonian physics was that physical events are governed by physical laws. Laws that we could understand rationally. And if we learned enough about those laws, we could extend our knowledge and influence over our environment.
That was also the foundation of most of the security analysis, technical analysis, economic theory and forecasting methods you and I learned about when we first began in this business. There were rational and predictable economic forces. And if we just tried hard enough… Earnings and prices and interest rates should all behave in rational and predictable ways. If we just tried hard enough.
In the last fifty years a new physics came along. Quantum, or subatomic physics. The clues it left along its trail frustrated the best scientific minds in the world. Evidence began to mount that our knowledge of what governed events on the subatomic level wasn’t nearly what we thought it would be. Those events just didn’t seem subject to rational behavior or prediction. Soon it wasn’t clear whether it was even possible to observe and measure subatomic events, or whether the observing and measuring were, themselves, changing or even causing those events.
What I have to tell you tonight is that the investment world I think I know anything about is a lot more like quantum physics than it is like Newtonian physics. There is just too much evidence that our knowledge of what governs financial and economic events isn’t nearly what we thought it would be.”
Newtonian physics – the laws of nature governing our daily life – is neat and tidy. You can calculate gravity, air resistance, motion etc. with precision. This is how NASA managed to calculate precisely how long it would take for a spacecraft to travel from Earth to Pluto. In January 2006, NASA launched the New Horizons spacecraft, which reached Pluto in July 2015. The five billion kilometre journey “took about one minute less than predicted when the craft was launched,” according to NASA.
Quantum physics – the laws of nature governing atomic or subatomic particles – is far messier. When I first learnt about quantum physics in school, I was fascinated by the idea that it is impossible to simultaneously measure a particle’s position and velocity. In fact, the act of measuring a particle itself can change the thing you’re trying to probe.
What Williams is trying to bring across in his analogy is that investing is messy, just like quantum physics. Investing does not lend itself easily to tidy predictions, such as those common in Newtonian physics. This is shown clearly in the tweet below by investor Ben Carlson.
The third analogy comes from Jeremy Grantham, the co-founder and investment strategist of the asset management firm GMO. At the end of 2014, GMO managed US$116 billion in assets.
Financial journalist Maggie Mahar shared the following quote from Grantham in her excellent bookBull: A History of the Boom and Bust, 1998-2004:
“Think of yourself standing on the corner of a high building in a hurricane with a bag of feathers. Throw the feathers in the air. You don’t know much about those feathers. You don’t know how high they will go. You don’t know how far they will go. Above all, you don’t know how long they will stay up…
…Yet you know one thing with absolute certainty: eventually on some unknown flight path, at an unknown time, at an unknown location, the feathers will hit the ground, absolutely guaranteed. There are situations where you absolutely know the outcome of a long-term interval, though you absolutely cannot know the short-term time periods in between. That is almost perfectly analogous to the stock market.”
Making sense of short-term events in the stock market is practically impossible – just like how it’s impossible to tell how a feather will travel when it’s in the air. But over the long run, it’s easier to make sense of what’s going on in the stock market. Over time, richly valued stocks and stocks with poor business results tend to come down to earth, while stocks with underlying businesses that do well tend to rise significantly. This is similar to how a feather will hit the ground eventually.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
We’re living in uncertain times. To help deal with the uncertainty, here are seven timeless investing rules for the stock market.
It’s now nearly 10 years since I first started investing in stocks for my family in October 2010. During this period, I also helped pick stocks professionally (from May 2016 to October 2019) while I was at The Motley Fool Singapore.
I’ve developed 7 personal investing rules for the stock market throughout these years that I think are timeless. I also think these rules are worth sharing now, since there’s so much uncertainty about the future with the world living under the shadow of COVID-19. In no particular order, here they are:
Rule 1: Focus on business fundamentals, not geopolitical andmacroeconomic developments
Peter Lynch, the legendary manager of the Fidelity Magellan Fund from 1977 to 1990, once said:
“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.”
Focus on business fundamentals to find great companies because it is great companies that produce great long-term stock market returns.
Warren Buffett’s investment conglomerate, Berkshire Hathaway, saw its book value per share increase by 18.7% per year from 1965 to 2018. In those 53 years, there was the Vietnam War, the Black Monday stock market crash in 1987, the “breaking” of the Bank of England, the Asian Financial Crisis, the bursting of the Dotcom Bubble, the Great Financial Crisis, Brexit, and the US-China trade war, among many other important geopolitical and macroeconomic developments. Over the same period, Berkshire’s share price increased by 20.5% per year – the 18.7% input led to a similar 20.5% output.
Rule 2: Think and act long-term
I believe that the stock market has a fundamental identity: It is a place to buy and sell pieces of a business. This also means that a stock will do well over time if its business does well. So to excel in investing, we need to identify companies that can grow strongly over the long run.
Jeff Bezos once said:
“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue.”
I believe Bezos’s quote applies to investing too. The simple act of having a long-term mindset gives us an advantage in the market.
Investing for the long run also lowers the risk of investing in stocks. In a column for The Motley Fool, Morgan Housel shared the chart below. It uses data for the S&P 500 from 1871 to 2012 and shows the chance that we will earn a positive return in US stocks for various holding periods, ranging from 1 day to 30 years. Essentially, the longer we hold our stocks, the higher the chance that we will earn a positive return.
Source: Morgan Housel; Fool.com
The caveat here is that we must be adequately diversified, and we must not be holding a portfolio that is full of poor quality companies. Such a portfolio becomes riskier the longer we stay invested, because value is being actively destroyed.
Rule 3: Don’t obsess over valuation – instead, focus on business quality
I think it’s far more important to be right about the quality of a business than it is to fret over its valuation. Yes, overpaying for a stock doesn’t make sense. But I think many investors don’t realise that certain stocks can carry what seems like high valuations and still do very well over a long period of time.
Terry Smith is an investor I respect greatly. He is the founder, CEO, and CIO (Chief Investment Officer) of Fundsmith, a fund management company based in the UK. In his 2013 letter to Fundsmith’s investors, Smith wrote:
“We examined the relative performance of Colgate-Palmolive and Coca-Cola over a 30 year time period from 1979-2009. Why 30 years? Because we thought it was long enough to simulate an investment lifetime in which individuals save for their retirement after which they seek to live on the income from their investment. Why 1979-2009? We wanted a recent period and in 1979 it so happens that Coca-Cola was on exactly the same Price Earnings Ratio (“PE”) as the market – 10 and Colgate was a little cheaper on 7x.
The question we posed is what PE could you have paid for those shares in 1979 and still performed in line with the market, which we took as the S&P 500 Index, over the next 30 years?
We found the answer rather surprising – it was 36x in the case of Coke and 34x in the case of Colgate when the market was on 10x. Another way of looking at it is that you could therefore have paid a PE of 3.6x the market PE for Coke and 4.9x the market PE for Colgate in 1979 and still matched the market performance over the next 30 years.
The reason is the differential rate of compound growth in the share prices (to a large extent driven by growth in the earnings) of those companies over the 30 years. They compound at about 5% p.a. faster than the market. You may be surprised that this differential can have such a profound effect upon the outcome. It’s the magic of compounding.”
Rule 4: Don’t use leverage
The stock market can move in surprising ways more often than we imagine.
On 12 August 2019, Argentina’s key stock market benchmark, the Merval Index, fell by a stunning 48% in US-dollar terms. That’s a 48% fall in one day.
According to investor Charlie Bilello, the decline was a “20+- sigma event.” Mainstream finance theories are built on the assumption that price-movements in the financial markets follow a normal distribution. Under this statistical framework, the 48% one-day collapse in the Merval Index should only happen once every 145,300,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000 years. For perspective, the age of the universe is estimated to be 13.77 billion years, or 13,770,000,000 years.
If we invest using leverage, we may be ruined whenever stocks lurch violently in their unpredictable yet more-frequently-than expected manner.
Rule 5: Volatility is normal
Volatility in stock prices is a feature of the stock market and not a bug. I say this because even the stock market’s best winners exhibit incredible volatility. We can see this in Monster Beverage, an energy drinks maker listed in the US.
Monster Beverage’s share price was up by 105,000% from 1995 to 2015, making it the best-performing stock in the US market in that timeframe. In another column for the Motley Fool, Morgan Housel shared how often Monster Beverage had experienced sickening drops in its share price:
“The truth is that Monster has been a gut-wrenching nightmare to own over the last 20 years [from 1995 to 2015]. It traded below its previous all-time high on 94% of days during that period. On average, its stock was 26% below its high of the previous two years. It suffered four separate drops of 50% or more. It lost more than two-thirds of its value twice, and more than three-quarters once.”
Wharton finance professor Jeremy Siegel once said that “volatility scares enough people out of the market to generate superior returns for those who stay in.” There really is nothing to fear about volatility. It is normal.
Rule 6: Expect, but don’t predict
The financial markets are incredibly hard to predict. So it’s important to me to stay humble. What I do to handle the uncertain future is to expect. The difference between expecting and predicting lies in our behaviour.
A look at history will make it clear that bad things – bear markets, recessions, natural disasters, diseases, wars – happen frequently. But they’re practically impossible to predict in advance. How many people six months ago even thought that a virus would end up crippling the global economy today?
If we merely expect bad things to happen from time to time while knowing we have no predictive power, our investment portfolios would be built to be able to handle a wide range of outcomes. On the other hand, if we’re engaged in the dark arts of prediction, then we think arrogantly that we know when something will happen and we try to act on it. Our investment portfolios will thus be suited to thrive only in a narrow range of situations – if things take a different path, our portfolios will be on the road to ruin.
Rule 7: Be rationally optimistic over the long run
There are 7.8 billion individuals in our globe today, and the vast majority of people will wake up every morning wanting to improve the world and their own lot in life. This is ultimately what fuels the global economy and financial markets.
Miscreants and Mother Nature will wreak havoc from time to time – we’re currently living through one such episode of Mother Nature’s wrath in the form of a coronavirus that mutated and became capable of infecting humans. But I have faith in the collective positivity of humanity. When things are in a mess, humanity can clean it up. This has been the story of mankind’s and civilisation’s long histories. And I won’t bet against it.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
The emergence of COVID-19 has caused significant changes to our lives, but it does not change the fundamental nature of the stock market.
Note: This article was first published in The Business Times on 13 May 2020.
Our lives have been upended.
Where once we could walk freely and gather in groups, we’re now huddled at home and have adapted to social distancing.
Where once parents would send their kids to school in the morning before heading to work, they now have to assume the tough twin-roles of educator and working-professional at home.
Where once malls and businesses were open, we now see shuttered stores all over town.
COVID-19 has brought tremendous changes to our lives.
And there’s a massive ongoing debate about how investors should be investing because of these changes.
Interest rates are at generational lows, and even negative in some instances. Central banks are racing to keep their financial systems – particularly the credit markets – humming.
Governments are handing out cash to save their economies and many are taking on tremendous amounts of debt to do so. Unemployment has increased sharply in some cases, or are expected to rise significantly.
Adding to the confusion is the massive rally that US stocks have experienced after suffering a historically steep decline of more than 30% in February and March. In Singapore, the Straits Times Index has also bounced 16% higher after falling by 32% from its peak this year in January.
What should investors do?
Plus ça change (the more things change)…
I will humbly suggest one thing.
Instead of focusing on positioning their portfolios to handle the things that are changing, investors should focus on the things that are not changing. This inverted thinking has tremendous value for investors.
Jeff Bezos is the founder and CEO of Amazon.com, the e-commerce and cloud computing giant based in the US. He once said:
“I very frequently get the question: “What’s going to change in the next 10 years?” And that is a very interesting question; it’s a very common one.
I almost never get the question: “What’s not going to change in the next 10 years?” And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time.”
Similarly, we can build a successful investment strategy around things that don’t change in the financial markets.
…plus c’est la même chose (the more they remain the same)
I believe that investors should only invest in things they understand. I only understand stocks well, so they are my focus in this article.
The first stock market in the world was created in Amsterdam in the 1600s. Many things have changed since. But stock markets around the world still share one fundamental attribute today: They are still places to buy and sell pieces of a business.
Having this understanding of the stock market leads to the next logical thought: A stock will typically do well over time if its underlying business does well too. That’s because a company will become more valuable over time if its revenues, profits, and cash flows increase faster than inflation. There’s just no way that this statement becomes false.
The fundamental attribute makes the stock market become something simple to understand.
But it also means that we have to be investing for the long run (with an investing time horizon measured in years) for us to take advantage of the relationship between businesses and stock prices.
Over the short run, the stock market is governed by the collective emotions of millions of investors. That’s not something that can be easily divined.
But over the long run, business-strength prevails.
An enduring investment framework
How then can we find businesses that can grow well over a long period of time, to utilise the unchanging long-run relationship between stock prices and business performances?
I cannot speak for everyone. But what I do is to reason from first principles. What characteristics do I want if I can design my ideal business from scratch?
There are six traits I have come up with, and they have served me well through my years of investing in both a professional and personal capacity. The six traits in a company are:
Revenues that are small in relation to a large and/or growing market, or revenues that are large in a fast-growing market.
A strong balance sheet with minimal or a reasonable amount of debt.
A management team with integrity, capability, and an innovative mindset.
Revenue streams that are recurring in nature, either through contracts or customer-behaviour.
A proven ability to grow.
A high likelihood of generating a strong and growing stream of free cash flow in the future.
A word of caution is necessary. Companies that excel in all my six criteria may still turn out to be poor investments. It’s impossible to get it right all the time in the investing game. So I believe it is important to diversify, across companies, industries, and geographies.
Don’t put your eggs in one basket
The concept of geographical diversification is particularly important for Singapore investors.
Look at the stocks in our local stock market benchmark, the Straits Times Index. There’s no good exposure to some of the important growth industries of tomorrow, such as cloud computing, DNA analysis, precision medicine, e-commerce, digital advertising, and more.
Chuin Ting Weber, the CEO of bionic financial advisor MoneyOwl, made a great point recently about global diversification. She said that as people who live in Singapore, we already have heavy economic exposure to our country through our jobs. If our investment portfolios also have a high proportion of Singapore stocks, we are taking on significant levels of concentration-risk.
The risks involved
Every investment strategy has risks, mine included.
A key risk is that companies that excel according to my investment criteria tend to carry high valuations. Even the best company can be a lousy investment if its share price is too high. So it’s important to weigh a company’s growth prospects with its valuation.
What’s not changing
The emergence of COVID-19, and the responses that countries around the world have mounted to combat the virus, may have caused huge changes to the growth prospects of many industries.
Travel-related companies, for instance, may suffer for some time until countries reopen their borders to accept international travellers at scale.
But crucially, I think that COVID-19 does not change the fundamental identity of the stock market as a place to buy and sell pieces of a business. So, I don’t think that the presence of COVID-19 changes the long-term relationship between stock prices and business performances in any way.
Most importantly, I don’t see COVID-19 changing humanity’s ability to innovate and solve problems.
There are 7.8 billion individuals in the world today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life – COVID-19 or no COVID-19.
This is ultimately what fuels the global economy and financial markets. Miscreants and Mother Nature will occasionally wreak havoc. But I have faith in the potential of humanity – and to me, investing in stocks is ultimately the same as having this faith.
Unless stocks become wildly overvalued, I will remain optimistic on stocks for the long run so long as I continue to believe in humanity.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.
