With meme-stocks constantly in the news these days, the investing media spends a lot of time (perhaps too much) talking what meme stocks are doing on any given day.
“Gamestop shoots up 20% today!” “Investors retreat, as BBY crashes by 25%!” “AMC spikes 100% in a single day!”
Every day it’s the same nonsensical reporting about the stock price of each touted meme stock. As if the stock price contained some kind of valuable information. Unfortunately, very little effort is spent on understanding the long-term outcomes of owning these investments.
That’s probably because most of these meme stocks are actually pretty dodgy businesses. Businesses you wouldn’t want to own in 20 years. As a result, investors in meme stocks are unlikely to hold for very long. These investors are simply waiting to catch a big share spike, and then cash out.
THIS is the difference between a short-term speculator (a gambler) and a long-term investor. Speculators are ultimately looking to sell that stock to another investor at a higher price (the Greater Fool Theory). Meanwhile investors look to profit from the growing value of a company as it compounds over time.
Almost by definition, real investors must be long-term holders of assets due to the slow nature of compounding.
When Mr. Market Works Against You
It’s been said that the best way to earn money from the stock market is extreme patience. In other words, holding stocks for the long term while they quietly compound for years and years. It’s an old way to make money, but also a VERY GOOD way to make money. Provided you’re patient enough.
Sure, speculators can make fast money doing a little gambling on these meme stocks… but they can lose money just as quickly. The outcome is essentially random. Just like rolling the dice in Las Vegas.
Conversely, the beauty of being a long-term stock holder is that winning it isn’t random. It’s just basic math. Value will compound over time, and the stock price should (eventually) reflect that growing value.
Notice I said, “should”.
At times Mr. Market does not reflect the true value of a stock in its stock price. The Market only does so in fits and starts. There can be long periods (sometimes even decades) when stocks (or other investments) simply don’t “go up”. Holding for the long-term can be a very difficult proposition when this happens.
Ask yourself — How long could you hold onto a stock (or fund, or ETF) that stayed flat for years? Could you hold for at least one year? That’s easy enough. I think most people could manage at least a year without too much trouble.
How about 5 or 10 years? It’s only at this point when I start to consider a holding period “long-term”.
It’s during these long “doldrum” periods, when human patience begins to fail. Holding for the long term becomes a tricky proposition when your investments fail to rise year after year. Most investors might be patient enough to last a year without earning a return, but how long before your eyes begin to wander?
Eventually, patience runs out.
Know When To Hold Em
Holding a stock can be a lot like trying to ride a bull. The ride can be exceedingly wild — because the stock market can literally do any random thing during your holding period.
The trick, (of course) is not falling off that bull. Ultimately, it’s the final destination that matters — not the journey of the stock between the time when you buy and when you sell. Anything in-between those buy and sell points is simply noise created by the Market.
So how do we know to keep holding if Mr. Market doesn’t agree with our assessment?
Avail yourself to the fact that as long as the business is compounding value at good rates of return, you shall be rewarded. (Eventually… it might take awhile.)
This is not a measure that can be found in the stock price however. Investors must look much deeper than just the cover of the book. They must pay great attention to other metrics — like earnings, free cash flow, book value, ROA, ROE, and returns on reinvested capital.
And then completely ignore the stock price.
(Note: A healthy growing stream of dividend is often associated with firms able to compound capital, but this is not always the case. Many investors have been caught in value traps chasing a stream of dividends, so be forewarned!)
I like to regularly remind myself that as long as the business is compounding value, there should be no need to worry about what Mr. Market is doing.
And Know When To Fold Em
Eventually there does come a time when its finally time to part ways with an investment. Many investors have trouble with this. You wouldn’t believe how many times I’ve heard the lament, “I sold and then the stock went up!”
There’s a number of popular ideas about when to sell a stock.
If you’re a value investor, you might say, “I’ll sell when the stock exceeds it’s fair value.” But this idea has problems. You could make errors in your valuation of the stock. The stock could also be temporarily overvalued (as good stocks often are). As long as the business continues to improve, the overvalued stock could continue to rise (and continue being over-valued). Netflix investors know this situation very well — The stock has been overvalued for as long as I can remember.
If you’re a growth investor, you might say, “I’ll sell when the stock’s growth slows.” This idea also has problems. Growth isn’t like a light switch ‘on’ or ‘off’. Growth can ebb and change constantly. A stock can also grow extremely slowly for decades. I like to call these stocks “slow growth monsters“.
My personal theory about when to sell is much simpler — Sell when you need the money, or when the investment no longer compounds at desirable rates of return. Simply put, when the investment is no longer “improving” at rates that seem desirable, it’s finally time to move on!
As long as your investment can be seen to be improving at good rates of return over time, there really should be no reason to sell. Just stay put and keep holding. Over time Mr. Market should reward you for your patience as value compounds.
Unfortunately blips do happen. Black-swans come out of nowhere (like COVID-19) and screw things up royally. Last year the world went topsy-turvey, and many businesses lost money. Stock prices tanked (at least for awhile). Does this mean investors should immediately sell? No, of course not! It makes sense to give your investments time to recover. Usually it takes more than one year to right the ship after a terribly disruptive event.
I try to give my investments at least 3 years to turn things around before I make any big decisions about selling.
Try to view these blips not as problems, but as opportunities. A chance to buy shares at a much lower price than the market would normally allow. So far this has worked out splendidly for me during each of the last 3 recessions. I took the opportunity to add to my existing positions at bargain rates.
Some of those investments went on to earn 1000%+ returns. But extreme patience was required. I suffered for years through negative returns and even dividend cuts … until I was eventually rewarded.
It just goes to show, real investing has very little to do with the stock price.