3 Investing Truths that took me Years to Learn
3 Investing Truths that took me Years to Learn
Investing is a process of lifelong learning. Today, I want to share three misconceptions I held throughout my investing journey and how I think about them today.
1. Every Stock can have Great Returns
There is a common misconception that you must find the few outstanding stocks that have the potential to outperform the market.
This is a very dangerous misconception. It causes investors to invest in unproven business models and expensive companies at the height of their bullish narrative.
Some of you might know the examples below. These are the 15 best-performing S&P 500 stocks over the last 20 years:
In addition to well-known companies like Apple, Nvidia, and Amazon, most of the companies on this list are little-known and in various industries.
Monster is a beverage company, Intuitive is a biotech company, Old Dominion Freight Line is a trucking company, SBA Communications is a real estate investment trust, Copart is a provider of online vehicle auction and remarketing services, and so on.
And these are just the examples of S&P 500 stocks. Internationally, there are thousands of these examples.
Also, you don’t need to find the greatest compounders. Many companies are bad investments at one price but great ones at another. It’s not (only) about finding the right company but about waiting for the right price.
If you know a handful of companies very well, you have a much better chance of outperforming than trying to find the “right” companies.
2. Inactivity vs. Activity
I used to have a black-and-white view on this topic. Most famous value investors praise inactivity and say that you only worsen your performance by keeping up with the markets and macroeconomics since they act as a call to action and scare you out of your stocks.
I used to agree with this opinion and therefore leaned heavily towards inactivity.
However, you see the same investors who are preaching “lifelong” holding periods having relatively high portfolio turnovers — especially in their early days, which are, almost without exception, the most successful phases of their careers.
As so often, the answer to this problem is… it depends.
In this case, it depends on your investing style.
If you look for compounders, you’ll do better if you practice inactivity. The requirement is intense and deep research before making an investment decision. Part of this must be identifying different future scenarios and their impact on your thesis and investment decision. You must understand the company on a deep level.
However, if you are looking for special situations or investing with short-term catalysts, inactivity is not the right approach. Circumstances can change quickly, and your investment thesis likely depends on very few or just a single event. If this is not happening, you must adjust, which likely means selling your position.
Even if the event is happening, the right decision will likely be to sell the position at a profit. Only in rare cases do these investments turn into long-term holdings.
Because of these different processes, knowing what you are looking for when you research companies is so important. Depending on your vision for the company, you have to act when you’ve invested.
Inactivity is best suited for investments made with a long-term vision. Activity is best suited for short-term investments.
Last week, I co-hosted an episode on S&P Global with Shawn O'Malley for the Millennial Investing Podcast. This week, we discussed Alibaba. The conversation was recorded a couple of weeks ago, before the price increases.
It got a bit technical, and we had the same sound problems as in the last episode, but I still think it's interesting for everyone who wants to look deeper into Alibaba's business. (I promise future episodes will be of much higher quality. I'm working on improving my podcast skills 😉 )
3. Not all Speculation is Wrong
This might be unpopular, but I think it’s important to talk about this. A big part of the value investing philosophy is to differentiate between investing and speculation.
The father of Value Investing, Benjamin Graham, said in his famous book The Intelligent Investor:
“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting this requirement are speculative.”
In addition to this quote, I would add another aspect to speculation. What if you research a company thoroughly and conclude that it has asymmetric upside potential but doesn’t offer a margin of safety?
Imagine a stock where you assess that you could lose 50% if it goes wrong but make 3x if it turns out how you hope. Applying 50% probabilities to both scenarios and investing $100, this investment would have an expected value of $175.
The expected value would suggest that you invest. However, the answer wouldn’t be as clear from a value investing perspective. If you could take that gamble infinitely often, obviously, every value investor would also take it. But you can’t. Remember that one of the most important rules is not interrupting the compounding process. A 50% loss of capital would do just that.
I would argue that making these bets depends on two main factors:
Time Horizon
Earnings Power
The longer your investing time horizon and the less earnings power you currently have compared to the rest of your investing career, the more sense it makes to take such a bet.
If you have anything to add to this list from your own experience, our Discord Community would be the perfect place to do this. It’s available for all paying subscribers:
Have a great day!