Three Types of Stock Investing Scenarios to Avoid
All investors are optimistic, every time they open up a position, but just like surgeons, sometimes the outcome doesn’t turn out as well as initially anticipated. When it comes to investing, I think this old Hindu proverb puts things into perspective:
“No physician is really good before he has killed one or two patients.”
So too, an investor does not become really good until he kills off some investment positions. But like surgeons, investors also have to understand the most important aspect of tragic events is learning from them. In many cases, unexpected outcomes are out of our control and cannot be prevented. This conclusion, in and of itself, can provide valuable insights. But on many occasions, there are procedures, processes, and facts that were missed or botched, and learning from those mistakes can prove invaluable when it comes to refining the process in the future – in order to further minimize the probability of a tragic outcome.
My Personal Killers
Professionally, I have killed some stocks in my career too, or they have killed me, depending on how you look at the situation. How did these heartrending incidents occur? There are several categories that my slaughtered stocks fell under:
- Roll-Up, Throw-Up: Several of my investment mistakes have been tied to roll-up or acquisition-reliant growth stories, where the allure of rapid growth shielded the underlying weak fundamentals of the core businesses. Buying growth is easier to create versus organically producing growth. Those companies addicted to growth by acquisition eventually experience the consequences firsthand when the game ends (i.e., the quality of deals usually deteriorates and/or the prices paid for the acquisitions become excessive).
- Technology Kool-Aid: Another example is the Kool-Aid I drank, during the technology bubble days, related to a “story” stock – Webvan, a grocery delivery concept. How could mixing Domino’s pizza delivery (NYSE:DPZ) with Wal-Mart’s (NYSE:WMT) low-priced goods not work? I’m just lazy enough to demand a service like that. Well, after spending hundreds of millions of dollars and never reaching the scale necessary to cover the razor thin profit margins, Webvan folded up shop and went bankrupt. But don’t give up hope yet, Amazon (NASDAQ:AMZN) is refocusing its attention on the grocery space (mostly non-perishables now) and could become the dominant food delivery retailer.
- Penny Stocks = Dollars Lost: Almost every seasoned investor carries at least one “penny stock” horror story. Unfortunately for me, my biotech miracle stock, Saliva Diagnostics, did not take off to the moon and provide an early retirement opportunity as planned. On the surface it sounded brilliant. Spit in a cup and Saliva Diagnostic’s proprietary test would determine whether patients were infected with the HIV virus. With millions of HIV/AIDS patients spread around the world, the profit potential behind ‘Saliva’ seemed virtually limitless. The technology unfortunately did not quite pan out, and spit turned into tears.
The Misfortune Silver Lining
These stock tragedies are no fun, but I am not alone. Fortunately for me, and other professionals, there is a nine-lives feline element to investing. One does not need to be right all the time to outperform the indices. “If you’re terrific in this business you’re right 6 times out of 10 – I’ve had stocks go from $11 to 7 cents (American Intl Airways),” admitted investment guru Peter Lynch. Growth stock investing expert, Phil Fisher, added: “Fortunately the long-range profits earned from really good common stocks should more than balance the losses from a normal percentage of such mistakes.”
Warren Buffett takes a more light-hearted approach when he describes investment mistakes: “If you were a golfer and you had a hole in one on every hole, the game wouldn’t be any fun. At least that’s my explanation of why I keep hitting them in the rough.”
Some investors purposely forget traumatic investment experiences, but explicitly sweeping the event under the rug will do more harm than good. So the next time you suffer a horrendous stock price decline, do your best to log the event and learn from the situation. That way, when the patient (stock) has been killed (destroyed), you will become a better, more prosperous doctor (investor).
Wade W. Slome is a CFA and CFP® at Sidoxia Capital Management.
Disclosure: Sidoxia Capital Management SCM and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article.