There are many who would caution against blindly copying the actions or acting on tips from investing experts. Such concerns are well-founded as you just never know what their true motives are for any particular investment. Bad consequences for following blindly For instance, my American colleague Morgan Housel once shared how he had made his “worst investment” seven years ago at the onset of the Great Financial Crisis that was brought about largely due to the collapse of the American housing market. Back then, Morgan saw one of his favourite investors investing in a specialty mortgage lender and promptly…
There are many who would caution against blindly copying the actions or acting on tips from investing experts. Such concerns are well-founded as you just never know what their true motives are for any particular investment.
Bad consequences for following blindly
For instance, my American colleague Morgan Housel once shared how he had made his “worst investment” seven years ago at the onset of the Great Financial Crisis that was brought about largely due to the collapse of the American housing market. Back then, Morgan saw one of his favourite investors investing in a specialty mortgage lender and promptly followed suit without doing any prior research on his own.
Eventually, the company went bust, Morgan lost big, and the investor made a solid return in the process. Why the dichotomy? Turns out, the investor “also controlled a large portion of the company’s debt and preferred stock, purchased at special terms that effectively gave him control over its assets when it went out of business.”
The full details aren’t clear, but I’ll hazard a guess that the investor had bought shares of the lender so that he could have a large say among common shareholders and force the company to not fight for its survival. That way, as a large holder of the company’s debts and preferred shares, the investor would be able to profit when he attained control of the company’s assets after bankruptcy.
So, long story short, Morgan had bought shares in the company thinking it’ll survive and rebound, blindly following one of his favourite investors. Meanwhile, the investor had bought shares in the company wanting (and perhaps, orchestrating) it to fail. That might seem like a rare situation to be in, but the fact is, we can never be too sure about the real intentions each ‘guru’ has with any particular investment.
Why it’s difficult to follow blindly
On the other hand, there can also be expert investors like Warren Buffett whose intention when buying shares in a company are almost always the same: He’s buying great companies at reasonable prices and holding them for the long-term. If an investor is confident of Buffett’s investing acumen and modus operandi, why not do the same as he does? After all, some of his famous long-term investments in companies like Coca-Cola and American Express have gone onto deliver tremendous total returns (for instance, Coca-Cola and American Express have gained 475% and 1,426% respectively over the past 20 years after accounting for dividends). So why shouldn’t other investors blindly copy someone like Buffett?
That’s because doing what Buffett (or Sir John Templeton, or Peter Lynch, or any other great investor) is doing – buying and holding great companies for the long-term – is one of the hardest things for investors to do.
Consider this. Over the 20 year period ending on 2003, the S&P 500 (a broad market index) in the USA had achieved a compounded annual return of 13%. All an investor had to do in 1983 was to buy the index, sit on his ass, and do nothing for the next 20 years. But as it turns out, the average equity mutual fund (the equivalent of unit trusts here) investor there earned annual returns of just 3.5% because they were too busy buying and selling funds to try and catch market peaks and bottoms. Louis Pascal once said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone,” – the average mutual fund investor just couldn’t sit still.
Now, even if someone like Buffett had told other investors in 1983 to buy the S&P 500 index and hold for 20 years to earn a 13% return, would most investors be realistically able to follow such an advice? My guess is no. That’s because from 1983 to 2003, the American stock market saw huge booms and busts (falling by more than 20% in a single day in Oct 1987, for instance). That level of volatility would likely have scared off weak hands who could not appreciate the importance of patience and who lacked historical knowledge of how the stock market, despite having always been volatile, had managed to continue an almost inexorable upward march over the long-term.
This brings me to the most important thing – actually, two things – about expert investing tips that any investor must realise before they act on the information: 1) They have to know what the stock market is about; and 2) they have to understand that substantial and lasting gains can only come with patience.
1. What the stock market is about
So, what exactly is the stock market? While this might sound like an archaic principle in this era of adrenaline-doused high-speed trading, the stock market is simply an exchange where investors can buy partial ownership of living, breathing businesses.
But the thing is, the market is also governed by fear and emotions and this causes share prices to gyrate wildly – and often without rhyme or reason – over the short-term. Over the long-term however, share prices tend to gravitate toward the true economic value of their underlying businesses as teased out from the company’s sales, profits, cash flows, financial stability, strength of its management team, and future prospects etc.
2. The importance of patience
The tendency for the market to reflect a share’s true business value over the long-term also leads us to the importance of being patient when we invest.
A really intelligent investor 20 years ago might have spotted how companies like United Overseas Bank (SGX: U11), Keppel Corporation (SGX: BN4), Oversea-Chinese Banking Corporation (SGX: O39), and SembCorp Marine (SGX: S51) would be earning profits today that are multiples of what they earned back then. By extension, that would also mean their shares being worth substantially more today than what they were 20 years ago.
|UOB||Keppel Corp||OCBC||SembCorp Marine|
|10 April 1994:
|10 April 2014:
|Change in EPS||253%||296%||354%||531%|
|10 April 1994:
|10 April 2014:
|Change in share price||472%||701%||389%||465%|
|*EPS = earnings per share|
Source: S&P Capital IQ
But while those gains do look great after 20 years – they’d be even better if the gains from reinvested dividends were included – the journey was anything but smooth-sailing. Between 1994 till today, Singapore’s stock market had been battered and bruised umpteenth times due to events like the 1997 Asian Financial Crisis, the 2000 dot-com bubble, the 2001 September 11 terrorist attack, the 2003 SARS outbreak, and more recently, the 2007-2009 Great Financial Crisis. In fact, the worst of times – such as the Asian Financial Crisis and the Great Financial Crisis – would see the Straits Times Index (SGX: ^STI) fall by as much as two-thirds in value.
With each big fall in the index, those four shares mentioned would also inevitably tag along for their own downward spiral. But investors who held firm and allowed the market to eventually reflect the long-term business values of those shares would now be sitting on some pretty gains after 20 long-years. In fact, the Straits Times Index itself has also suffered through all the tough times only to come out 284% higher than where it was at the start of 1988 at its current level of 3,204 points.
Without patience and an understanding of how the stock market is like, it would be tough for any investor to follow any hypothetical tips given 20 years ago to buy and hold those four shares through such a long stretch of time.
Foolish Bottom Line
Ultimately, stock market tips would be useless for an individual if he or she fails to develop the proper mental fortitude and attitude needed to achieve long-term success in investing – and that’s not to mention as well that blindly copying the actions of other investors can be dangerous. Those are the most important things one has to realise about investing tips.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.