Lessons Learned Since 1989
It was nearly 20 years ago today I began writing for this newsletter, and reflection in the form of bullet points seems a fitting way to mark such an anniversary. So at the risk of repeating themes familiar to long-time readers, I give you my six most valuable investment lessons of the past two decades:
The objective is to make money, not prove how smart you are. With stocks, the difference between being wrong and being early is often slight, and those with patience are more likely to see their predictions of higher share prices come true. This trap is especially likely to ensnare analysts and newsletter editors, but we all risk a little ego when we buy a stock. Because we like to be proved right, investors tend to hold losing stocks too long and sell winning stocks too early. Do not fall into this trap; judge your stocks based on their potential to appreciate, not on their distance from your purchase price.
If a stock is not a buy, it is a sell. Only by having your money in your best ideas can you maximize your portfolio’s upside potential, and you can’t have your money in your best ideas if you’re holding second-best ideas that once ranked among your favorites. Often the best time to sell a stock is when you still like it; if you always wait for a company to do something wrong before selling, you’ll tend to sell at lower prices.
Don’t let others define your opportunity set. Aggregated measures of market valuation, like the price/earnings ratio of the S&P 500 Index, can help put market swings in historical context. But unless you’re buying an index fund, the valuation of the capitalization-weighted S&P 500 Index may not be the best indicator of where you should invest. For example, anybody who says the stock market is overvalued today because the S&P 500 Index has a trailing P/E of 137 suffers from simple-mindedness. Excluding unprofitable companies and those with P/E ratios above 75, the median S&P 500 stock has a P/E of 13 — below the norm of 18 since 1990. While the median P/E may not be the best gauge of whether the entire market is fairly valued, it suggests many stocks are modestly valued.
Above all else, discipline and humility are crucial to success. Unless you have a systematic, repeatable process for picking stocks, you’ll be hard-pressed to replicate your successes or learn from mistakes. And if you enjoy a run of strong returns, celebrating or concluding you are innately insightful are among the worst things you can do. When things go your way, it is doubly important to keep your head in the game and apply your system.
Your portfolio’s monthly or yearly correlation with the S&P 500 or any index is irrelevant. What matters are your returns — and the risk you’re taking to achieve those returns. Risk should be defined as the potential for loss, not the threat of underperforming an index.
While not perfect, our approach works. Our stock picks don’t always work out, and we don’t pretend to know exactly where the market is headed. But we’ve consistently outperformed by remaining true to our disciplined approaches for stock-selection and market-timing. According to the independent Hulbert Financial Digest, the Forecasts is among a select group of newsletters that have outperformed the market based on both overall returns and market-timing for the 15 years since June 1994, around the time I took charge as editor. The Forecasts is among the few newsletters that have outperformed over the past three, five, and 10 years.