STOP Speculating – Anchor Yourself with a Value Philosophy!
We have been adamant that we have been in a financial bubble for all risk assets, especially technology stocks and cryptocurrency. The evidence is right in front of our eyes, but as so often happens, we fail to recognize it. Much like other stock manias, all you need to do is watch investor behavior. Everyone has been piling into these high-flying technology stocks at ridiculous valuations.
Yes, many are good companies that were growing their revenues exponentially, which was mostly a pull-forward of demand due to the pandemic. However, they were trading as if that growth was going to continue perpetually and we simply know that is not the case. What many investors don’t understand is when these types of stocks have tremendous euphoria built into their stock price, essentially priced for perfection, one little mishap can cause the stock to blow up. Just this week we saw several stocks decline 25% in one day!
Time and time again investors buy stocks based on some dream of the future. Successful investors only care about paying a reasonable price for any business. Great companies are not necessarily great stocks and vice versa. We don’t want to get caught in a situation where a company that isn’t earning money can decline 50-80% in a short period time, as many of these tech companies have done. We just aren’t interested and we don’t believe you should be either.
Below is an example of Cathie Wood’s Ark ETF that is solely focused on innovative, disruptive stocks. The fund went on a tear since March 6, 2018 and then collapsed. So, in just over 4 years, the fund has ‘round tripped’ and even early investors that held on have made no money. Imagine if you were one of those that bought near the top, as most were.
The S&P 500 is currently trading at roughly 18X estimated 2023 earnings. Many of these high-flying stocks were trading at crazy multiples on the same basis. Here are just a few examples of how irrational markets were pricing these stocks at the peak:
The problem when you experience large losses is that you need to make up those losses before you can begin to compound your wealth again. And you need extraordinary returns to get there. As you can see below, when you are down 50% in an investment, your investment needs to increase by 100% just to breakeven. That can take a long time.
Speculation in crypto markets is another example. Just recently, the crypto market witnessed one of its most devastating losses as Terra USD, a supposed ‘stablecoin’, theoretically tied to the value of the dollar, completely collapsed from its intended value of $1 to effectively zero. Bitcoin and Ethereum are both down more than 50% from their respective peaks, wiping out of billions of dollars of wealth. While many early investors are still profitable, most were buying at much higher prices hoping to get rich quick and got hurt very badly.
It is very unfortunate we go through these cycles, but greed is universal and it repeats time and again. People want to get rich quick, but real wealth is accumulated over time. Trying to get rich quick can be devastating to your financial future.
The way to grow wealth is first; learn how to save, second; invest in assets that have proven to grow by 8% or more over time, and third; don’t over pay for assets. Would you buy an investment real estate property that has a capital rate of 3-4%? Absolutely not, but 6% or more can be very attractive. You have to stack the odds in your favor, and by speculating in high-flying technology stocks, cryptocurrency, and meme stocks, you are doing the opposite.
We have always found that proven great investors provide sage advice, and Warren Buffet is clearly one of the best. His investment track record since 1965 has nearly doubled the return of the S&P 500. Here are the high-level rules that Warren Buffet follows:
- Don’t look at a stock like it is a ticker symbol with a price that goes up and down. You are buying ownership of a company; a slice of a company’s profits into the future.
- Buffett says, ‘I haven’t the faintest idea where the stock market is going to go next week, next month, or next year’. He mostly cares about finding a business, not a stock, that is attractively priced.
- Own businesses that you can understand, that have sustainable competitive advantages, that have favorable long-term prospects, and are operated by honest, competent people.
- Buy at an attractive price/multiple. Paying too much for a good business can be as bad as buying a bad business.
- Be greedy when others are fearful and fearful when others are greedy. Investors are generally irrational. It pays to be contrarian. Market downturns typically over-correct and that spells opportunity for disciplined investors.
- You have to view your stock investments the same as if you were a business owner. Owners don’t care about how the outside world might value that business. All that matters is the cash flow that business can produce. If real estate investors were able to sell their properties like stocks, it is unlikely they would be as successful. They would often be too tempted by vagaries of minute-to-minute pricing.
- Don’t time the market. He says, “Picking bottoms is not our game. Pricing is our game. And that’s not so difficult. Picking bottoms, I think, is probably impossible.”
The bottom line; Don’t speculate! Can you get lucky? Yes, but eventually your luck runs out. Invest in good quality business that are trading at reasonable prices and over time, you will do just fine. Don’t worry about the market day to day. You can’t control that.
Friend of mine whose son plays on my son’s lacrosse team is very close with NFL star Tom Brady. I asked him how he would describe Tom Brady’s mindset.
He said, “Tom believes that whatever you can’t control, don’t worry about it. Whatever you can control, PERFECT IT!” Wow, love that and so true!
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