“Human beings, almost unique in having the ability to learn from the experiences of others, are remarkable for their apparent disinclination to do so.”
Douglas Adams
The stock market is comprised of companies operated by human beings. Like human beings, companies experience several developmental stages. Some, having been established on a faulty premise, will not make it past their infancy. Most experience a full adolescence, though a few, being too aggressive for their own good will meet an untimely end. Those that remain generally experience adulthood endowed with some measure of prosperity and the best of these go on to enjoy an old age replete with wealth and respect
Like people, as companies wend their way through life doing what they do and trying new things they experience both successes and failures. Fail enough times and the market will not reward them with additional capital. Eventually their revenue stream dries up and they expire. Those that mostly succeed are rewarded. Their revenue streams increase and so they have more capital with which to go out and succeed some more. Seems somehow Darwinian doesn’t it?
If there were awards for investment mistakes the winners would surely be those that buy stock solely on the suggestion of others.
Wealthy Aunt Agnes buys Mega-Mart and suggests that her family do as well. Nephew Walter, who figures that if she’s rich she knows what she is doing, takes her advice.
Barry, vice-president of sales, holding court over lunch, regales his protégé with tales of triple digit returns from Widgets-R-Us. Afterward, barely able to contain his enthusiasm, the youngster dashes back to the office where having more money than good sense; he loads up on widget stock.
Vanessa listens raptly as her broker serenades her with tales of XYZ Corp. Earnings per share growth, quarterly revenue increases, and barriers to entry, analysts’ estimates and fifty two week highs. Feeling tingly all over she breathlessly places her order.
Examples like this are never-ending. The consequences of this kind of behavior will eventually prove to be terminal.
Confident Trader™ members discover that great opportunities present themselves frequently. They also learn not simply to trust, but also to verify.
“Ask advice from everyone, but act with your own mind”
Yiddish Proverb
Anyone who was invested in the stock market during the mania of the late 90’s understands that the stock market can be a risky place. Many individual investors, because they lacked the experience to recognize ample signs of warning that something nasty was on the way, watched haplessly as not only their profits but a good deal of their principal was consumed by a particularly ill tempered and voracious bear.
Investing is a business in which we are paid for accepting risk. As long as we make a distinction between measured risk and recklessness things generally work out well. On the other hand, when we focus on trying to avoid risk we frequently end up paying instead of being paid. Is the stock market a risky place? Absolutely. So is the freeway, and over time you’ve likely learned to how to cope with it quite well. Is the stock market at times confounding, turbulent and unpredictable? You betcha! But these same things can probably be said about your workplace on occasion, and chances are you’ve learned how to cope there, too.
A question I would ask in my practice was: “If you were going to start investing on your own today, what would be your primary concern? Which one thing would be most important to you?” Almost without exception the answer I received would be in some way, shape, or manner, ” That I not lose money.” Most people choose to begin the selection process by searching for stocks that will not lose them money, i.e. safe stocks. This, to be blunt, is bass ackwards.
Stop for a moment. Think about this. Define a safe stock. I’m serious. Take one minute, close your eyes and define a safe stock. After you’ve done this continue reading.
You probably came up with things like: large established familiar company, strong balance sheet, low P/E ratio, high cash to debt ratio, industry leader, well funded R&D department, an effective established management team, steady growth, low volatility etc. Fine. But there are some other things that need to be factored into the equation.
Perhaps the most overlooked is this: any stock you buy carries with it a risk certain of about 15%. This means that there are a plethora of factors that can cause a stock’s price to correct as much as 15% or more literally overnight. For example:
Key management might turn over, a competitor beats them to market with a new product or service, quarterly earnings miss analysts’ estimates by two cents, there is a scandal and the last two years’ filings have to be redone, to mention just a few.
Or maybe so much time passes without any exciting news that the market simply loses interest and the price tapers off because there are too few buyers.
Or maybe the whole sector cycles out of favor because the market concludes that the grass is greener in the next pasture. The company still has a crack management team, still maintains strong revenues and earnings, still has lots of cash and little debt, continues to come to market with new products which keeps it competitors at bay, but nobody cares. With no demand for the stock the price falls.
Through no particular fault of its own and for no apparent reason the stock tanks and the shareholders lose money. This happens all the time.
So here you have a stock, which if everything goes well, could make you 20% or so over the next couple of years. On the other hand, as we’ve seen, if things don’t go well, the same stock could easily lose you 20% or so in an equal amount of time. Risk-reward ratio? About1/1. Odds? 50/50. This is not good. This is no way to buy a stock. Many people have a whole portfolio full of stocks like this, and that pretty much leaves it all up to chance.
Safe? Hardly.
“You keep going to the bank of chance and one day you’ll be overdrawn.”
Waylon Jennings
At Confident Trader™ we discovered long ago that if one focuses first on reward, the aspect of risk will to a great extent take care of itself. Rarely will we even consider a stock unless we find that most of the elements are in place to produce a strong probability that the price will rise at least 200% over the next couple of years. In that environment a whole lot of things have to go wrong in a big way to turn the trade into a loser. “To identify the big winners of tomorrow one must first study and quantify the exact characteristics shared by the big winners of the past…and then buy only those stocks displaying those same characteristics”.
Would you rather hope for “safe” conventional returns of 8%, 10%, or 12% per year? Or would you prefer to target 30%, 40%, or 50% per year? If you shoot for 50% and miss by half you’ve still done pretty darn well. If you completely blow it, and at the end of the year when you do the math your portfolio is only up 10% to 12% you’re a miserable failure. So what? In a year when this strategy produces only “average” returns, the broad market indexes and 95% of all mutual funds likely finished in the red. The majority of investors would be thrilled.
Confident Trader members consistently outperform the markets because they know how to identify those few stocks that have a high probability of bringing outstanding returns.
“In the long run men hit only what they aim at. Therefore they better aim at something high.”
Henry David Thoreau
