The greatest secrets of investing are neither taught in schools nor at traditional financial firms.
As an investor of six years, I am fortunate to have learnt from the best, and would like to share 16 of the greatest lessons I have picked up.
Stocks are part-ownership stakes in real businesses.
Stay focused on the business narrative, not the price narrative.
Over the long term, the key determinant of whether the share price rises or falls will depend on the business itself, and whether it has growing revenues, profits and free cash flows.
Over time, stock prices converge to each business’ intrinsic value.
But the rate of return at any point in time differs, depending on your original purchase price.
A great business does not always make a great investment.
The rate of return is generally predicated on the growth in revenues that leads to growth in earnings or cash flows.
These factors play a part in determining if its stock price will rise.
If a company’s free cash flow per share grows by 10 per cent, and valuation multiples remain unchanged, then its intrinsic value grows by 10 per cent.
The stock price should eventually also rise by a similar amount.
Short term versus long term.
In the short term, the stock market is a voting machine filled with noise and randomness.
In the long term, it is a weighing machine driven by business fundamentals, growing revenues, profits and free cash flows per share.
On any day (using the S&P 500), the odds of making money are just slightly better than a coin toss.
But over 10- and 20-year holding periods, the odds of making money rise significantly to 88 and 100 per cent, respectively.
To swing those odds in your favour, increase your time horizon and holding periods.
Businesses that grow and generate strong returns on capital significantly above their cost of capital, and are able to reinvest at high rates over long periods of time, create the most value and shareholder returns.
They tend to have scalable disruptive and innovative products or services supported by tailwinds, addressing large markets and providing tremendous customer value.
As a result, they are able to capture a sizable portion of that value that is reflected in their revenues and profits.
Members of this elite cohort tend to be top dogs in their respective niches or “winners-take-most” industries, and have strong competitive moats and advantages.
Add to your winners, don’t double down on your losers.
As an investor, your job is to find great companies and hold them tenaciously over time to yield multiples of your original investment.
In short, find excellence, buy it, hold and add to it. Sell mediocrity.
Only a few stocks are worth investing in.
The vast majority of stocks will underperform.
A small minority will generate the bulk of your returns.
A study of over 63,000 global companies over the last 30 years (1990-2020) found that more than half of businesses (55 per cent) lost money.
Only around 1 per cent accounted for about 90 per cent of overall returns.
An even smaller 0.25 per cent – or a little over 150 companies – accounted for around 56 per cent of all returns.
So, pick wisely.
Don’t go fishing in the vast ocean; instead, go fishing in ponds and rivers, where the best fish are easier to identify and catch.
Price matters, pay up for great, but not too much.
Buy an above-average business at too-high a valuation, and you might end up with a below-average return.
A below-average business, even at a low price, often does not work out.
Market crashes are inevitable.
Human psychology is a huge factor in investing, and that’s why there are boom-bust cycles.
The S&P 500 falls 10 per cent every year on average, 20 per cent or more every four to five years, and more than 30 per cent every 10 to 20 years.
Market declines are a feature, not a bug.
Market volatility exposes manic investors and presents the best buying opportunities.
If you are going to be a long-term net buyer of stocks, you should be jumping for joy at lower prices instead of feeling depressed.
It is about not missing the best days.
In investing, missing the best days is far worse than missing the worst days.
If you were fully invested in the S&P 500 over the last 20 years (2003-2022), you would have achieved 9.8 per cent annualised return, a 5.4x total return.
But missing the 10 best days significantly reduces your return to just two times, or 5.6 per cent per annum.
Miss the best 30 days, and returns drop to a measly 0.8 per cent per year, or 0.1x.
But the best days often occur after the worst days.
Trading in and out in attempts to capture all the highs and the lows are a fool’s errand. Buy-and-hold beats frequent trading.
If it’s going to be a winner, a little is all you need. If it’s going to be a loser, a little is all you want.
Done right, power laws will drive your biggest winners to account for the majority of your gains, which will far outweigh all the losses from your losers combined, many times over.
Skew probabilities and payoffs in your favour.
The key is to stack the odds of success higher, and its associated payoffs will naturally shift in your favour.
And avoid anything that increases your probability of failure; avoid unlimited downside at all costs.
Examples include the use of leverage, short-selling and selling options.
Stock price volatility is not risk, permanent loss is.
Volatility does not equal risk.
It is permanent loss that you should avoid at all costs.
The best investors were great because they were never completely wiped out and thus could keep compounding capital over long periods of time.
Successful investing is not gunning for the highest returns, but the best return you can sustain for the longest period of time.
Don’t expect to get rich quick. It will be a slow grind initially, but with time, the rewards can be exponential.
The most important factor in compounding your returns is time.
The durability, endurance and longevity of a business are the key determinants that enable compounding to happen.
Being average to win.
Most investors don’t beat the market average over long periods of time; only a small handful do.
The 2022 SPIVA Scorecard for US Equity Funds shows that if you beat the benchmark average for one year, you will be in the top 50 per cent.
Beat the average for three years, and you are in the top 22 per cent.
Doing so for five years gets you in the top 12 per cent; over a decade and you are in the top 7 per cent.
The key is consistency.
If you are able to be above average for a long time, eventually you will be among the best.
Vision, courage, temperament and patience.
Last of all, you need to have the vision to identify the stocks, the courage to buy, the temperament to add to them, and the patience to hold them.
Possessing these attributes over the long term is what makes investing work.
Note: An earlier version of this article appeared in The Business Times.
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The writer is the founder of Vision Capital and author of the book, Vision Investing: How We Beat Wall Street & You Can, Too!
Disclosure: Eugene Ng does not own shares in any of the companies mentioned.