Geoff Gannon June 30, 2012

How to Lose Money in Stocks: Look Where Everyone Else Looks – Ignore Stocks Like These 15

This isn’t an article for traders. It’s meant as advice for long-term value investors.

I’ve been reading Howard Marks’s The Most Important Thing. This got me thinking about risk. And how I don’t talk about risk enough on the blog.

I don’t want to talk about risk in theory. I want to focus on the practical risks value investors – especially long-term value investors who focus on picking specific stocks – face each and every day.

How do value investors screw up?

How can they have the right philosophy and yet implement it so badly, they actually lose money in some of their investments?

One way is to buy and sell stocks at the wrong times. I’ll talk about that tomorrow. Today, I want to talk about the umbrella category that falls under: acting like everyone else.

It’s risky to act like everyone else.

And one way investors can act like everyone else is by looking at the same stocks everybody else looks at.

Another way is by entering and exiting stocks along with the crowd.

Both are risky mistakes.


How Mutual Fund Investors Manage to Do Worse Than the Funds They Buy

Mutual fund investors are masters of bad timing. Usually, they are pretty good at knowing what fund is best. It’s no secret that Bruce Berkowitz is a good investor. But even investors who know that – and who therefore trust Berkowitz with their money – manage to destroy the profit potential in partnering up with a superior investor.

Morningstar keeps data on just how bad mutual fund investors are when it comes to timing their entrances and exits. For example, over the last 10 years, Bruce Berkowitz’s Fairholme Fund (FAIRX) has returned 9% a year. The average Fairholme investor has earned just 1.7% a year.

New money enters the fund just before performance goes bad. And money exits the fund just before performance turns right back around.

I’ll talk about the issue of terrible timing in another post. Today, I just want to use this terrible timing as evidence. It’s evidence that following the crowd is not safe.

Following the crowd is so risky that even if you are right about which fund manager to invest with, you can be wrong enough in your entrances and exits that you fritter away 7% a year on nothing but needless activity.


Does the Average Investor Really Match the Market?

I’ve never believed this for a second. The truth is that if you can find an entirely arbitrary allocation (50% bonds/50% stocks) or a hedge fund or a program or system or whatever that keeps you invested enough at all times in good enough assets – you’ll do better than most investors.

Most investors think their problem is figuring out what assets have the best long-term returns, which managers are the best investors, and what approaches to investing work.


Investing is More about Practical Psychology than Theoretical Efficiency

My constant contention has been that investing is more like dieting than investors admit. The problem has never been that science can’t figure out which diets works. I don’t even think – practically – it’s worth the time of most fat folks to give a moment’s consideration to whether one diet is more or less efficient, effective, safe, etc. than another. A lot of diets are good enough. That’s all that matters.

Because chances are you won;t stick to any of them. That’s where your research time should be spent. Don’t worry which diet is best. Worry which diet you can stick to.

The goal is to find an adequate approach you can see through forever.

I’ve proposed many such stock picking systems before. You can use Joel Greenblatt’s magic formula if you want.

But you can use entirely different systems – often untested – which I promise you will tend to work well enough for you if you stick to them.

I’ll offer a simple, easy example. I ran a screen of StockScreen123 to do this for you. There’s nothing magic about it. But it’ll work the same way most diets do. If you stick the names on this list and you never backslide – you’ll get decent results.

But before I get to the list of the kind of stocks you’re allowed to eat on this diet – let’s talk about the kind of weight you can expect to lose.


Aim Lower, Be Happier

Yes, it’s possible to earn 30% a year over a decade. You know Warren Buffett’s record from his partnership days. You’ve probably seen the table of annual returns in Joel Greenblatt’s “You Can Be a Stock Market Genius”.

Should you aim for that?

If your plan to devote yourself to extreme concentration, constant – like every waking hour of your life – intense focus on investing, a life of continuous learning, deliberate practice, etc. – sure, go for it.

It’s possible. Don’t let anyone tell you it’s not. Because somebody is going to do it. Somebody will earn terrific returns purely through value based stock picking that will set them apart from the pack over the next 5, 10, and 30 years. You could be that someone.

A lot of people reading this blog have that potential. Some of you are probably too old. No offense. It’s just that the later you get addicted to some pursuit – the harder you have to work at learning it. Some lack the right temperament. Most could never devote themselves to investing the way someone like Warren Buffett does.

But those are self-imposed shackles. It’s probably not that you lack the brainpower. It’s definitely not that the pursuit of investment knowledge is closed off and made available only to a chosen few. It’s available for anybody. It’s not hard to get better at investing.

But most investors are never going to get that good. I’m not sure most investors realty want to attempt to make 30% a year for the next 10 to 15 years.

If you knew what that entailed – what young Warren Buffett’s life was like – I’m not sure a lot of people are eager to make that trade. They may say they are. But it doesn’t require just a long-term commitment. It requires every day commitment. It requires thinking about stocks first thing in the morning and last thing at night.

From talking to a lot of investors – I’d say most people’s goals are more humble. They want to work hard at investing. They want to learn a value investing based system. They want to apply it. They want to stick to it forever.

What can people like that expect?

What should you really aim for?

I’d say you should aim to earn 7% to 15% a year for the rest of your investing life. Not 7% to 15% next year. Not beating the market. If you do 7% to 15% over the long-term, you’ll have a decent chance of beating the market. And – if you do even just a decent job of saving up money – you’ll live quite well on 7% to 15% a year.

Is it really possible to achieve 7% to 15% a year?

For value investors, I think it is. And I’ll try to show you a way – not the way, but one of many ways – that can get you to your goal.


A Simple, Successful Strategy You Can Stick To

That’s all most value investors should hope for. It’s all most investors should hope for.

One thing to think about is how you want to spend your time investing. Do you like analyzing companies? Learning about competitive advantages? Assessing management?

Great. Then let a computer take care of price and hype for you. Tell the computer to go out and find you some decently reliable, decently cheap, decently unhyped stocks – and then you do the rest.

That’s the strategy I’ll be talking about today.

The exact details of this screen – which I ran on StockScreen123 – aren’t important. The basic idea is.

Here’s the basic idea.

A good investment is likely to be the purchase of the equity of a good company that is believed to be:

  • Reasonably reliable in terms of past profitability
  • Reasonably cheap in terms of EV/EBITDA
  • And reasonably unhyped in terms of analyst attention

That’s it. I’m agnostic as to whether you use a Ben Graham approach, a Phil Fisher approach, or a Peter Lynch approach.

Maybe you’re looking for cheap stocks based on assets, the past earnings record, etc. Maybe you’re looking for the best organization. For a company with some real business momentum – a turnaround or a fast grower. Or maybe you’re looking for a moat.

The stock market isn’t perfectly efficient. But it’s not like Wall Street is an undiscovered little bistro either. The major stocks are in the guidebook. If you know railroads, cruise lines, grocery stores, cell phone makers, superstores, etc. – so do a lot of other folks. And probably a lot better than you do.

I’m not saying you can’t make money off those folks. To the extent I’ve made money buying something in the stock market, it’s certainly not because I had a higher IQ than the seller. And it’s probably not that I had superior knowledge.

I’ll talk another time about how you really make money in stocks. What people will pay you to take from them – illiquidity, uncertainity, unpleasantness, inconvenience– etc. But these posts are about risk rather than reward.

So, I’m laying out a list of stocks here which – if you constantly create a similar menu to choose from every 6 months or a year – will give you a selection that allows you to practice an approach to investing that utilizes your talents and interests without introducing tons of risks.

The idea with today’s list is to reduce the risk that you’ll look at the same stocks everybody else does.

Once again, the criteria are:

  • Reasonable past profits
  • Reasonable price
  • Reasonably unhyped

And the stocks are:

  1. The Eastern Company (EML)
  2. Arden (ARDNA)
  3. Weis Markets (WMK)
  4. Oil-Dri (ODC)
  5. Sauer-Danfoss (SHS)
  6. Village Supermarket (VLGEA)
  7. U.S. Lime (USLM)    
  8. Daily Journal (DJCO)
  9. Seaboard (SEB)
  10. American Greetings (AM)
  11. Ampco-Pittsburgh (AP)
  12. International Wire (ITWG)
  13. Terra Nitrogen (TNH)
  14. Performed Line Products (PLPC)
  15. GT Advanced Technologies (GTAT)

I don’t think that’s an especially good list of 15 stocks. But I think it’s a good list of the kind of stocks that everyone else ignores.

You should start your search for decent returns among the stocks other people don’t pay enough attention to.

You should start with stocks like those 15.