It’s great to learn from our own mistakes. But it’s even better to learn from those of others. COVID-19 has brought extreme market volatility and economic distress to the world. In a time like this, it’s easier for us to make investment mistakes.
I’m here to share the eggs I’ve had on my face in the stock market and what I’ve learnt from them, so that you can benefit from my errors.
The backdrop
I started investing for my immediate family on 26 October 2010. The portfolio I help manage consists of stocks listed in the US market. There are currently over 50 stocks in it.
Some of the biggest losers in the portfolio include Atwood Oceanics, Ford (NYSE: F), Gilead Sciences (NASDAQ: GILD), GoPro (NASDAQ: GPRO), National Oilwell Varco (NYSE: NOV), Tapestry (NYSE: TPR), Under Armour (NYSE: UAA), and Zoe’s Kitchen.
Atwood Oceanics and Zoe’s Kitchen were privatised in October 2017 and November 2018, respectively, and I sold their shares on September 2016 and November 2018. I sold National Oilwell Varco in June 2017. I still own the other stocks mentioned.
Lesson 1: It’s okay to fail if you have the right investment framework
My family’s investment portfolio has clearly had many epic losers. But from 26 October 2010 (the inception of the portfolio) to 29 March 2020, the portfolio has still grown in value by 16.0% annually, without including dividends. This is significantly higher than the S&P 500’s return of 10.7% per year over the same period, with dividends.
It’s okay to have multiple failures in your portfolio. There’s an investment framework that I’ve been using for my family’s portfolio for years. It has guided me towards massive winners, such as Netflix (NASDAQ: NFLX), Amazon (NASDAQ: AMZN), and MercadoLibre (NASDAQ: MELI). The winners in the portfolio have more than made up for the losers.
If you’re investing with a sound investment framework, then don’t beat yourself up too hard if some of your stocks are down big. Look at your performance from a portfolio-perspective, and not harp on how each position is doing.
Lesson 2: Diversify smartly, and stay away from commodity-related companies
Atwood Oceanics and National Oilwell Varco are companies in the oil & gas industry. When I invested in them, Atwood was an owner of oil rigs while National Oilwell Varco was supplying the parts and equipment that kept oil rigs running.
They were among my first-ever investments, back when I was a greenhorn in the stock market. I invested in them because I wanted to be diversified according to sectors. I also thought that oil & gas was a sector that is worth investing in since demand for the commodities would likely remain strong for a long time. My views were right, but only to a small extent. I was wrong on two important areas.
First, it is important to be diversified according to sectors (and geography too!). But there are some sectors that are just not worth investing in for the long run because their economic characteristics are poor. For instance, the energy, materials, and transport sectors have historically produced poor returns on invested capital. This is illustrated in the chart below from a 2006 McKinsey report which mapped out the average return on invested capital for various sectors from 1963 to 2004. Charlie Munger, Warren Buffett’s long-time lieutenant, once said:
“Over the long term, it’s hard for a stock to earn a much better return that the business which underlies it earns. If the business earns six percent on capital over forty years and you hold it for that forty years, you’re not going to make much different than a six percent return – even if you originally buy it at a huge discount.”
Second, demand for oil did indeed grow from 2010 to 2016. But oil prices fell significantly over the same period. The trends in oil consumption and oil prices for that period are depicted in the chart below.
The sharp fall in oil prices despite the rising demand illustrates the difficulty in predicting oil prices. In fact, it’s practically impossible. I recently learnt about a presentation that Peter Davies gave in 2007 titled What’s the Value of an Energy Economist? In it, he said that “we cannot forecast oil prices with any degree of accuracy over any period whether short or long.” Back then, Davies was the chief economist of British Petroleum, one of the largest oil & gas companies in the world.
With lower oil prices, the business results and share prices of Atwood Oceanics and National Oilwell Varco plummeted. The chart below shows National Oilwell Varco’s share price and earnings per share from 2010 to 2016 (data for Atwood Oceanics is not available since it’s now a private company). I think the predicament of Atwood Oceanics and National Oilwell Varco can be extrapolated to other commodity-related companies. It’s tough to predict the price movements of commodities; this in turn makes it difficult to have a good grasp on the business results of a commodity-related company over a multi-year period.
Lesson 3: Not selling the losers is as important as not selling the winners
You’ll notice that my family’s portfolio is still holding onto many of the big losers. The sales of Atwood Oceanics and National Oilwell Varco happened because of something that Motley Fool co-founder David Gardner shared a few years ago:
“Make your portfolio reflect your best vision for our future.”
Part of the vision I have for the world is that our energy-needs are entirely provided by renewable sources that do not harm the precious environment we live in. For this reason, I made the rare decision to voluntarily part ways with stocks in my family’s portfolio (referring to Atwood Oceanics and National Oilwell Varco).
I sell stocks very rarely and very slowly. This aversion to selling is by design – because it strengthens my discipline in holding onto the winners in my family’s portfolio. Many investors tend to cut their winners and hold onto their losers. Even in my earliest days as an investor, I recognised the importance of holding onto the winners in driving my family portfolio’s return. Being very slow to sell stocks – even the big losers – has helped me hone the discipline of holding onto the winners. And this discipline has been a very important contributor to the long run performance of my family’s portfolio.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.