Some Thoughts On Roller Coaster Investing
Take a look at this roller coaster stock price chart.
Was Ben Graham's big purchase of GEICO shares actually a value investment? Perhaps it was contrary to what many believe. "In 1948, we made our GEICO investment and from then on, we seemed to be very brilliant people." -- Benjamin Graham, 1976 Both Benjamin Graham and Warren Buffett can attribute a large part of their Read More
The stock crashed by 63% in just 118 days between late 2008 and early 2009. Then, after a rise over the next few months, it dropped 31% in just 15 days.
Now look at the stock price chart of a different company which too looks like a roller coaster.
The stock price fell by 20% in just 58 days.
Now look at another roller coaster chart of a different company.
The stock price of this company fell by 24% on 44 days, then shot up and then fell by 20% in 44 days. What a roller coaster!
Now look at the stock price chart of another company. A roller coaster again.
The stock price fell by 31% in 127 days!
You just saw four charts of four different companies.
Did you? Actually, no. I lied.
What you just saw were four charts (covering different periods) of the same company over the last five years and that company is called Wabco.
I never owned shares in it, but I wish I had. That’s because it’s a great, scalable, highlyprofitable business run by a great team of managers. And boy, has it made money for it’s long term investors. An 18-bagger in five years.
And lest you think that those returns are influenced by the choice of start and end dates (of they are), here are 3 year rolling period returns of the stock over the last 5 years.
Those, by the way, are average annual returns. Wabco beat the shit out of Nifty consistently.
But what about those stock price declines? Where the bleep are they in the chart? Can’t spot them?
Turn the page then.
Here they are, those “big,” “ugly,” “horrible,” “gut-wrenching” stock price crashes.
Those little red rectangles? Yes those ones. Those little blips represent those big, ugly, horrible, gut-wrenching stock price crashes. The “roller coaster” journey of Wabco’s stock is barely visible if you look at its 5 year chart.
For investors who bought Wabco stock five years ago and have held it till now, those major declines didn’t matter. For those who got in after those declines, they were a boon. And for my friend Ian, who understands the process of long term wealth creation, such declines are a wonderful opportunity to average up which is so contrary to popular wisdom amongst value investors.
Anecdotal evidence? Not representative? Wrong!
Take the stock price performance of almost any great business over a fairly long time period and you’ll see the same roller coaster pattern play out. There will several instances where the stock will drop a lot. Sometimes it will drop by 50% or even more. If you owned it before the crash, it will feel horrible afterwards. But if you owned a great business - and that is a big if, and if the valuation was not crazy expensive relative to its long-term potential earning power, then selling out would almost certainly be a bad idea. It would be a bad idea even if you could correctly anticipate that a significant stock price decline was imminent.
Stay Or Sell In Anticipation Of Possible Market Downturns
“Should an investor sell a good stock in the face of a potentially bad market? On this subject, I fear hold a minority view, given the investment psychology prevalent today. Now more than ever, the actions of those who control the vast bulk of equity investments in this country appear to reflect the belief that when an investor has achieved a good profit in a stock and fears the stock might well go down, he should grab his profit and get out. My view is rather different. Even if the stock of a particular company seems at or near a temporary peak and that a sizeable decline may strike in the future, I will not sell the firms’s shares provided I believe that its longer term future is sufficiently attractive. When I estimate that the price of these shares will rise to a peak quite considerably higher than the current levels in a few years time, I prefer to hold. My belief stems from some rather fundamental considerations about the nature of the investment process. Companies with truly unusual prospects for appreciation are quite hard to find for there are not too many of them. However, for someone who understands and applies sound fundamentals, I believe that a truly outstanding company can be differentiated from a run-of-the-mill company with perhaps 90 percent precision.
It is vastly more difficult to forecast what a particular stock is going to do in the next six months. Estimates of short-term performance start with economic estimates of the coming level of general business. Yet the forecasting record of seers predicting changes in the business cycle has generally been abysmal. They can seriously misjudge if and when recessions may occur, and are worse in predicting their severity and duration. Furthermore, neither the stock market as a whole nor the course of any particular stock tends to move in close parallel with the business climate. Changes in mass psychology and in how the financial community as a whole decided to appraise the outlook either for business in general or for a particular stock can have overriding importance and can vary almost unpredictably. For these reasons, I believe that it is hard to be correct in forecasting the short-term movement of stocks more than 60 percent of the time no matter how diligently the skill is cultivated. This may well be too optimistic an estimate. On the face of it, it doesn't make good sense to step out of a position where you have a 90 percent probability of being right because of an influence about which you might at best have a 60 percent chance of being right.
Moreover, for those seeking major gains through long-term investments, the odds of winning are not the only consideration. It the investment is in a well-run company with sufficient financial strength, even the greatest bear market will not erase the value of holding. In contrast, time after time, truly unusual stocks have subsequent peaks many hundreds of percent above their previous peaks. Thus, risk/reward considerations favor long-term investment.
See full PDF below.