I was in Melbourne last week filming this year’s The Path Ahead DVD with Alan Kohler and Robert Gottliebsen. This is the third time Alan has asked Monique and I to participate, and in addition to enjoying it immensely, I am incredibly humbled by the invitation.
We sit around the breakfast table, enjoy some wonderful pastries, fruit and cheeses (a welcome break from my Dr Ross Walker breakfast regime) and I get to debate and hear a range of views about markets and the big picture issues for investors. The dialogue becomes quite animated at times, and I have to admit to often forgetting the four or five cameras recording our every utterance.
Tony Hunter from the ASX holds court, and directs questions that have been received by Alan to the panel, and almost always without notice. I thought I would write about this year’s experience only because one of the questions got me thinking about the clichés that investors often have at the back of their mind when making investment decisions.
Relying on investing clichés can be dangerous, if not because they are prevarications, but because they are the domain of the lazy who seek to grab the attention of those whose concentration has been diminished by the constant noise of the markets – much of which is useless and information-free (the noise that is).
Here is a few that came to mind immediately (some are useless but perhaps others aren’t); Sell in May and go away. Buy the rumour, sell the fact. Don’t catch a falling knife. Feed the ducks while they’re quacking. Buy dips. Buy low and sell high. Only buy stocks that go up. This time its different. The trend is your friend. You can’t go broke taking a profit. Its time in the market not timing the market that counts.
You may have a few too, and I would love to hear them. Let me know if any have helped or hindered and feel free to add them by clicking ‘Leave a Comment’ at the bottom of this post.
There is no doubt you have heard many, if not all, of them before. They have become part of investing lore and yet they lead more to pain and suffering than they do to enlightenment. So why do they survive? Is it because there is truth in them?
I believe it is because there is a steady stream of new investors entering the market for whom the cliché has not yet become one. They run the risk of seeing the investing cliché as a truth – to be memorized and applied – and in doing so, they are guaranteed to repeat the mistakes made by the many that came before them.
Cliché 1: You can’t go broke taking a profit
Think about the statement, You can’t go broke taking a profit; A new investor is almost certain to go broke doing just that. Why? Because a new investor will inevitably purchase a share only to see the price decline. Buying a low quality company (not one of my A1’s for example) or paying too a high a price (not estimating the intrinsic value of a company) will inevitably lead to a permanent loss of capital. The share price goes down and the investor, not wanting to accept a loss, holds on in the hope that one day the shares will recover. Then suppose the next investment decision leads to a gain; do you think the investor will hold this share for very long? The short answer is no. The fear of repeating the first mistake, resulting in another loss, is just too great. Better to take a small profit now than to see the shares fall again and have another loss. The end result of repeating this numerous times is that the investor has several large losses and several small profits. The net result, of course, is a loss. You can go broke taking a profit just as surely as you can go broke saving money buying excessively-priced items that are on sale.
A further example refers to inflation, and its effect on the purchasing power of your money. Trading frequently involves substantial frictional costs. Brokerage, slippage and spreads seriously impinge on the returns otherwise available from a buy and hold strategy. Earning 15 per cent from buying and holding is always preferable to 15 per cent from trading, and that’s even before tax is factored into the equation. Suppose however, you don’t even achieve 15 per cent from trading frequently; after 20 years, you merely match the rate of inflation. Arguably, you have not lost purchasing power, but you have not gained any either. You have been taking profits but have not made any.
Similarly, if you sell a stock (using rising or trailing stops, for example) and make a 100 per cent return, but the shares rise 400 per cent, I would argue you have left a great deal of money on the table. You have certainly lost money taking a profit.
Cliché 2: Its ‘Time in the market’ not ‘Timing the market’ that leads to success.
Another cliché that comes to mind is the idea that time in the market is the key to success rather than timing. At the outset, let me state that I don’t believe that timing the market or share prices works. Nor do I believe that time in the market works always, and if it sometimes does, the time can be so long that the returns are meaningless. Take for example the investor who purchased shares in Macquarie Bank at $90 some years ago; they are still waiting for a positive return. Or what about the investor who bought shares in Great Southern Plantation when the company listed? No chance of a positive return at all. If you purchased shares in Qantas or Telstra ten years ago, you would now have an investment with less value than you what commenced with.
Time in the market is no good if you buy poorly performing businesses or pay prices that are far above the intrinsic value of a company. For the seventeen years bound by 1964 and 1981 the Dow Jones rose just 1/10th of one percent. Time, it seems, was not the friend of the merely patient investor. I can show you equally long periods of low returns on the Australian market too.
The point however is that time is only the friend of the investor who buys wonderful businesses at large discounts to intrinsic value. Otherwise, time is an enemy that steals returns just as surely as it steals a great day.
Don’t use time then as a band-aid to heal your investing mistakes. Stick to A1 businesses bought at discounts to intrinsic value and time will be your friend. So what are the businesses that time has befriended the most? What businesses have been increasing in intrinsic value the most over the last three, five or ten years?
The following Table should offer the answers.
Remember, these companies may be higher quality (Some are my A1′s), but they might not currently be cheap and I have not discussed the path of their intrinsic values in the future, which arguably is more important for the investor. Be sure to seek personal professional advice before transacting in any security.
|Company ASX Code||Annual Gain in Intrinsic Value||Company ASX Code||Annual Gain in Intrinsic Value|
|MND (Monadelphous)||30%||CAB (Cabcharge)||25%|
|WOR (Worley Parsons)||61%||ANG (Austin Eng)||98%|
|BTA (Biota)||38%||WEB (Webjet)||24%|
|COH (Cochlear)||18%||SUL (Supercheap Auto)||17%|
|RKN (Reckon)||29%||REX (Regional Express Airlines)||47%|
|CRZ (Car Sales)||124%||CPU (Computershare)||36%|
|REA (Realestate.com)||78%||TRS (The Reject Shop)||28%|
|CSL (CSL)||39%||REH (Reece)||21%|
|NMS (Neptune)||25%||IRE (Iress market tech)||19%|
|ORL (Oroton)||27%||ARP (ARB)||19%|
|JBH (JB Hi-Fi)||85%|
The table reveals the companies that have demonstrated the highest growth in intrinsic values over the years and perhaps unsurprisingly, if my method for calculating intrinsic value is any good, you will find a very strong correlation between the increases in values and the increases in share prices.
If you have any questions of course, or would like to contribute a cliche you once thought of as a lore to live and invest by but now see it for what it is, feel free to share by clicking the ‘Leave a Comment’ link below.
Posted by Roger Montgomery, 22 May 2010