Back to the Future and a lesson in investing
“Of all sad words of tongue or pen, the saddest are these: it might have been.”
- John Greenleaf Whittier
October 21 was Back to the Future day. This was the day that Marty McFly travelled to from 1985 in the second Back to the Future movie.
A lot of what was portrayed in the movie never really came to pass: think hover boards and making payments with only your thumb print. It's very easy to point out what the filmmakers got wrong about what was going to be. It may be more humbling to acknowledge all the money you missed out on by not investing in some of the best stocks over the past 30 years.
Philip van Doorn, at MarketWatch, put together an interesting list of the top performers in the S&P 500 from 1985 to now (see table).
Besides the fact that the returns are mind-numbing, it is worth noting that some are actually household names. In fact, it may make some feel a bit embarrassed to not have bought a stock like Nike, which, at the time, was a well-known footwear company and was sponsoring Michael Jordan.
This look back reminds me of a book I read a few years ago. 100 to 1 In the Stock Market by Thomas Phelps is a book written in the 1970s and is out of print. Its story, however, is far from irrelevant. In the book Mr Phelps chronicles more than 365 stocks that, during the 40 years studied, returned 100 to 1 on the investment dollar. As he states: “Most people try to make a few points quickly on their stock market speculations, but not one in a thousand seriously plans and acts as one must to make a fortune.” His philosophy: “Buy right and hold on.”
This is obviously easier said than done but a few items worth considering to enhance your odds when trying to bag a huge winner would likely include the following:
1. Never sell. Warren Buffett is famous for suggesting his holding period is forever. Mr Thomas's book profiles a man named Mr Blank who, at the time, amassed an enormous fortune by buying companies for the long run. When asked what the secret to his success was he simply said: “I never sell anything.” Again, easy to say and hard to do. This is where behavioural bias and factors can hold most back. You have to have the intestinal fortitude and confidence to watch positions get cut in half or more during certain periods. Most can't stomach this volatility nor do they have the faith to stick with companies that continue to perform exceptionally while prices fluctuate. Hint: Focus on fundamental value and not price. For example, look at the company's yearly return on capital and return on equity year-on-year rather than the stock price.
2. Buy Small. If you think Exxon Mobil or possibly even Apple will give you a 50,000 per cent return over the next 30 years I fear you are likely to be disappointed. Size militates against great growth. The law of large numbers applies here. Hint: Think small cap stocks.
3. Buy Growth. Too obvious? Maybe. It is mathematically impossible, of course, to generate huge returns by investing in a company at a fair price with little to no growth. The miracle of compounding is what works. Business that can compound earnings at a high rate AND reinvest profits at this rate for a prolonged period of time is what matters.
If my company has a return of equity of 20 per cent per year and can compound this consistently for 30 years my equity will be over 23,000 per cent higher. The key here is the rate, the time and the consistency. Finding companies that have this ability is rare but not impossible. Hint: focus on a company's economic moat, or its competitive advantage. Companies with wide moats have pricing power, branding and market demand that it can defend against other competitors through time.
4. Buy Potential. Obviously growth hits limits early in small markets. One needs to assess what the total addressable market is for a product or service. The larger the market, the larger potential for sustained growth over many years. Hint: focus on unique products in areas that appeal to huge constituents or customers around the world. Focus on products that are considered essentials: needs not wants. (Although some products evolve into necessities over time: think of your mobile phone)
5. Buy Unknown. Glamour is often overpriced. Price does matter. If a company is projected to grow 15 per cent per year for the next five years, but trades at 1,000 times earnings, you are likely to be disappointed when you open your broker statement five years from now. Overpaying, no matter how exciting the story, severely hampers your chances for outsized returns. If you buy stocks with huge multiples you likely have paid far too much for future growth in advance. Hint: Buy more obscure and less followed names with less “sexy” front page stories but extremely effective and progressive businesses.
The hunt for “elephants” in the stock market is the stuff of legends. It's not easy and requires a great deal of skill, patience, and luck. Unless, of course, you have a time machine.
Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd. and can be reached at email@example.com. Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy