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Conversations about investing often focus on big winners. Everyone wants to speak about the “Home Run” with a particular stock or investment position. Family members ask how to find that “One” stock and how to manage a stock that’s risen several hundred percent.
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These conversations and questions are good but don’t mirror normal investing. Most investors don’t hit “home runs” often, if ever, and the same statement holds for stocks that have risen several hundred percent.
Picking a big winner while investing is a basic universal desire of virtually every investor. Most investors hope to invest in a Penny Stock that will eventually return millions of dollars in profits.
Of course, these statements also include me! I’ve done very well during my investing career, with returns on individual stocks that have exceeded several hundred percent and a few that have exceeded several thousand percent. But, after investing for 50+ years, I still haven’t found the “one stock!”
It’s taken over 50 years, but I’ve realized that finding the “one stock” isn’t necessary to be a successful investor.
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Probability
I’m returning to my Title about singles versus home runs. While it’s difficult to give precise probabilities without individual player statistics, hitting a Single is statistically much more likely than hitting a Home Run. A batter might have a 20-30% chance of hitting a Single in a given at-bat, whereas the chance of hitting a Home Run might be closer to 3-5%. Statistically, a batter would be successful about four out of every 10 at-bats if hitting singles versus four out of every 100 at-bats if attempting to hit home runs.
If you think about investing with the same probability of outcome, someone’s chances of picking a Home Run stock are about 3-5%. Finding a single stock that makes you a multimillionaire is extremely low, akin to winning the lottery, as it requires luck, exceptional investment timing, and selection.
High Risk, High Reward: Investing in the stock market, while potentially lucrative, carries inherent risks, and the chance of a single stock skyrocketing to millionaire-making levels is statistically improbable.
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I remember talking with another gym member early one morning many years ago. It was the day that Amazon stock went public. Amazon went public on May 15, 1997, and the IPO price was $18.00. $10,000 invested in Amazon stock in early 2000 would be worth $627,000 at the time of this writing. That’s nearly a 6,300% return over the 25 years in question. If I had invested $100,000 in Amazon stock on May 15, 1997, that position would be worth $6.27 million today!
It’s easy to say now that I was stupid not making the purchase. But it’s also important to realize that $100,000 in 1997 represented a large portion of my investment portfolio that I would have invested in an online bookseller. No one realized at that time that Amazon would become the retail giant that it is today. A $100,000 investment in 1997 would have been an extremely high-risk investment!
Let’s look at another stock called The Children’s Place, Inc. The Children’s Place (PLCE) had its IPO in 1997. Unlike Amazon, The Children’s Place has not been a stellar performer. Return on Equity (ROE) to date is -521.67%.
While Amazon has risen more than 6300%, The Children’s Place has had a -521.67% return on equity. $100,000 invested in Amazon would have realized a 6.2 million dollar profit, while $100,000 invested in The Children’s Place would be virtually worthless today. That’s the problem with risking large sums of money on unproven stocks. The chances of losing money are higher than the probability of making a lot of money.
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Diversification: Most investors take positions in many different stocks instead of gambling on individual stocks and risking large sums of money. Financial experts generally advise diversifying investments across multiple assets to mitigate risk rather than relying on a single stock.
How did I manage to diversify my investments? There are multiple ways to attack this problem, but the easiest way to diversify portfolio holdings is through Mutual Funds or ETFs. The amount and scope of diversification will depend on the type of mutual fund or ETF. The level of diversification can be expanded or narrowed by using broad index funds or narrow sector funds. Even sector funds will provide diversification in a narrow area or sector of the general stock market.
Investors can also diversify among asset classes, which also functions to reduce risk. Investing in different types of asset classes in countries worldwide is the best way for most investors to achieve maximum diversification. See: LONG-TERM INVESTMENT STRATEGIES: SEPARATING FACT FROM OPINION, MASTERING THE PORTFOLIO: UNDERSTANDING THE NUTS AND BOLTS, and STOCK INVESTING 101: FROM BASICS TO BUYING STRATEGIES.
Time Horizon: I’ve been investing for a long time. It’s taken over 50 years of hard work and investment to grow my present Net Worth. Building wealth through stock investments typically requires a long-term perspective, with gains most often achieved through consistent returns over years, not overnight. Barry Bonds, the historical Major League home run champion with 762 career home runs, didn’t hit all of his 762 home runs in his first game or even his first season. He compiled his winning record over his entire playing career. Like Barry Bonds, my winning record has taken years of work and investing. There is an old stock market adage that is appropriate and speaks about “time in the market” versus “timing the market.” It states that investors should be more concerned about staying invested over long periods instead of moving money in and out of the market to anticipate future market conditions.
There are stories about individual investors who amassed multimillion-dollar portfolios on very modest incomes by purchasing shares in good companies and holding these shares for 40 to 60-year periods. Even modest investments can become small fortunes given enough time to grow and compound.
Market Conditions: Economic downturns or unforeseen events can negatively impact even the most promising stocks, highlighting the importance of risk management. No one can correctly anticipate future market conditions. The “COVID Crash” of the 2020 stock market and the subsequent meteoric rise after the market crash are classic examples of no one anticipating the market downturn or the recovery. Market conditions are another factor in the randomness and difficulty in trying to hit home runs with stocks. By buying small lots of shares over time and allowing these shares to appreciate over long periods, the investors noted above mediated the negative impact of short-term market conditions.
Luck vs. Skill: While some investment success is related to skill, a significant portion is often attributed to luck, as unforeseen events can influence stock prices.
I was a member of a successful Investing club for many years. Most individual stock clubs are set up similarly to mutual funds. Members by shares in the club, and each share represents a portion of the total assets of the club. One of the considerations of stock investing within clubs is that the club must sell stocks to redeem shares in the club when a member leaves.
At one point, we received notification of a member leaving in several months. He was a long-term club member and held a significant portion of the outstanding shares in the club. His significant holdings meant we would have to sell a large portion of the assets in the club to redeem his shares.
Members were discussing when and how would be the best way to sell the stocks necessary to redeem his shares. Most members favored using a dollar cost averaging approach over the next six months to gradually sell stock holdings until we could redeem the member’s shares. Here, one of the members stated we knew how much cash we needed to generate, and we knew the present level of the stock market. He recommended we sell all the stocks we needed immediately. After several minutes of discussion, we decided to move forward with his suggestion and sold the stock positions necessary to redeem his club shares. Over the next six months, the market declined by approximately 30%. By selling the day after our stock club meeting, the club sold stocks at higher positions and made a much higher profit.
There was no exceptional wisdom involved in our club’s decision. Our club acted on a statement of fact, and the decision to sell was purely a lucky choice. In this case, our lucky choice generated an additional 20 to 30% profit on our stock sales.
Some would argue that our wisdom and experience guide our decisions. The truth is that it was a lucky choice!
Market Volatility: Market volatility can quickly turn a single into a home run or vice versa.
A stock purchase can be adversely affected by purchasing the right stock at the right time, the right stock at the wrong time, the wrong stock at the right time, or the wrong stock at the wrong time.
What do I mean? Rates of return can be very different based on when the stock is purchased. A stock purchased early in an upmarket cycle will have a much higher rate of return than a stock purchased when fully valued. In the same light, an investor can purchase a stock at the right time while not having significant movement in the stock price. The stock may not rise because the stock is in the wrong market sector or the company fundamentals prevent growth and stock appreciation. Stock prices are subject to fluctuations and market conditions, making it difficult to predict long-term performance and even harder to find a stock that consistently outperforms.
Merely purchasing the right stock is not enough. Stocks purchased at the right time will maximize profits.
Finding a “Winner” is Difficult: Identifying a stock that will become a “millionaire-maker” requires extensive research, analysis, and a degree of foresight that few investors possess.
Even the most accomplished or well-known stock investors have stories of the “one that got away.” These are stock investments that they declined that ultimately became home runs. There are also stories of losses from stocks purchased that underperformed or ceased to exist.
Most of these investors have teams of advisors and analysts to help in stock selection and purchase decisions. These stories speak to the difficulty in purchasing the next big winners or home runs.
Dividend Stocks: Dividend-paying stocks provide a steady income but are not the primary path to millionaire status. Dividend-paying companies are usually more mature companies. These companies are considered more conservative investments and are associated with wealth building more than rapid growth.
Dividend stocks can be a great way to accumulate wealth, but aren’t considered “rocket ships” nor do their holders need to have “diamond hands!”
Dividend-paying stocks start as small companies with rapid growth. Eventually, growth slows, and excess cash is distributed to stockholders as dividends.
If dividend stocks are purchased in the early years of rapid growth, the same stock would be considered a home run!
Timing is key, and most investors don’t have the wisdom, patience, or mental fortitude to remain invested when a company experiences growing pains that can negatively impact short-term stock prices.
Patience is Key: Building a substantial portfolio and achieving millionaire status through investing typically requires patience and a willingness to weather market fluctuations. In my podcast titled PUTTING IT ALL ON THE S&P 500: WISE OR RISKY? I spoke about Monster Energy stock, one of the best stock performers over the last twenty years.
Monster beverage corporation has a 20-year trailing positive total return of 87,560% and a total return to date of 135,316%. A $10,000 investment in Monster Beverage Corporation in January 2014 would be worth nearly $7,034,230 or roughly a 70,242% increase (adjusted for splits and dividends).
But, to generate that maximum return, you would have had to tolerate losses of -96 1/2%, -69%, -51 1/2%, -47.81%, and -33.4% while staying invested for the life of the stock without selling at any point (At the point of the -96.53% loss on August 10 of 1986, it took 4158 trading sessions, or until May 6, 2004 [almost 18 years] to recover the loss.)
Loss aversion dictates that very few people could stomach a -96 1/2% loss that extends over 18 years. I know I couldn’t tolerate that magnitude of a loss for that period, and most investors couldn’t either.
So, turning a $10,000 investment into $7+ million is not an easy or comfortable task.
I think it’s now a little easier to see how hard it is to hit a “home run” when investing in individual stocks. An investor needs to pick the right stock at the right time, invest a significant amount of money in this risky stock, have the mental fortitude to hold this stock over long periods, and courage to face market volatility while suffering severe losses.
This same investor must “swing for the fence” knowing the mathematical probability that any given individual stock will fail to outperform the market.
An investor must have faith and confidence. They must feel they have found the “needle” in the stock market “haystack,” and that this particular investment will handsomely reward them.
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Final Thoughts
Creating this blog jogged a memory of a story titled “ACRES OF DIAMONDS.” I will not relate the whole story here, but it’s worth reading.
Like the moral of the “Acres of Diamonds” story, investors should realize happiness and contentment are possible with average market returns (and without taking extraordinary risks or desiring to hit home runs.)
It’s not imperative to hit home runs to be happy, and people can have “Enough” without generating extraordinary gains with home run stocks.
Investors wanting to hit a home run can allocate a small (2-3%) portion of their portfolio to purchasing risky growth stocks that have the potential to multiply rapidly. If any of these stocks become a “home run” you are better off. If the stock price doesn’t rise, you have only lost a small portion of your portfolio. Most retirement funds should be in mutual funds that follow traditional stock market indexes.
It’s also important to realize that most investors lack the knowledge, courage, fortitude, patience, and ability to withstand the volatility and pain when purchasing small growth stocks.
Most investors also lack the resilience to hold these growth stocks over long periods, period drawdowns, and market cycles.
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