Want outperforming stocks / winning stocks ? Focus on quality not quantity.
When I was in high school and college, kissing all the pretty girls was not a realistic goal. The same principle applies to stock picking – you can’t buy all the outperforming stocks. As far as I’m concerned, there will always be some people who are smarter, better looking, and wealthier than I am, but that has little to do with whether I can continue to outperform, if I stick to my systematic, disciplined process. In fact, many smart people are horrible investors because they overthink the investing process or suffer from “paralysis by analysis.” When it comes to investing, the behavioral ability to maintain independence is more important than being a genius. If you don’t believe me, just listen to arguably the smartest investor of all-time, Warren Buffett:
“Success in investing doesn’t correlate with I.Q. once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
Even the best investors and stock pickers of all-time are consistently wrong. When selecting stocks, a worthy objective is to correctly pick three outperforming stocks out of five stocks. And out of the three winning stocks, the rationale behind the outperformance should be correct in two out of those three stocks. In other words, you can be right for the wrong reason in one out of three outperforming stocks. The legendary investor Peter Lynch summed it up when he stated, “If you’re terrific in this business you’re right six times out of 10.”
Yes, it’s true, luck does play a role in stock selection. You just don’t want luck being the major driving force behind your success because luck cannot be replicated consistently over the long-run. There are so many unpredictable variables that in the short-run can work for or against the performance of your stock. Consider factors like politics, monetary policy, weather, interest rates, terrorist attacks, regulations, tax policy, and many other influences that are challenging or impossible to forecast. Over the long-run, these uncontrollable and unpredictable factors should balance out, thereby allowing your investing edge to shine.
Although I have missed some supermodel stocks, I have kissed some pretty stocks in my career too. I wish I could have invested in more stocks like Amazon.com Inc. (AMZN) that have increased more than 10x-fold, but other beauties like Apple Inc. (AAPL), Alphabet Inc. (GOOG), and Facebook Inc. (FB), haven’t hurt my long-term performance either. As is the case for most successful long-term investors, winning stocks generally more than compensate for the stinkers, if you can have the wherewithal to hold onto the multi-baggers (i.e., stocks that more than double), which admittedly is much easier said than done. Peter Lynch emphasized this point by stressing a focus on the long-term:
“You don’t need a lot of good hits every day. All you need is two to three goods stocks a decade.”
Sticking to a process of identifying and investing in well-managed companies at attractive valuations is a much better approach to investing than chasing every beauty you see or read about. If you stick to this simple formula, you can experience lovely, long-term results.