The Most Important Thing in Investing

Investor Bob Rodriguez had recently gave a speech at a Chartered Financial Analyst conference. In it, he spoke about an encounter he had with investing maestro Charlie Munger in the 1970s.

At that time, Rodriguez was still very early in his investment career and he wanted to seek advice from Munger. Rodriguez asked, “Mr. Munger, I am early in my investment career. If I could do one thing that would help me make myself a better investment professional what would you recommend?” Munger replied:

“Read History! Read History! Read History!”

For me, Munger’s advice is one of the (maybe even the) most important things about investing. By learning about history, we get to learn from the mistakes of the past and more importantly, we also get to know what works in investing.

Learning from mistakes

For instance, we know from history that disastrous outcomes tend to happen when investors over-pay for shares.

There was once a bunch of blue chip shares in the U.S., known as the Nifty-Fifty, which were collectively valued at more than 40 times earnings in 1972. When a bear market came in 1973-1974, they were decimated as their valuations fell back down to earth.

More than a decade later, when Japan’s Nikkei 225 Index (a rough equivalent for the Straits Times Index (SGX: ^STI) here in Singapore) was valued at more than 100 times its earnings near its all-time peak in the late 1980s, what followed is a Japanese stock market index that is still more than 50% lower today compared to where it was at its late-1980s-peak.

If we move forward another decade to the 1990s, we’d see the dotcom bubble form in the U.S. and then burst. At peak valuations, the S&P 500 market index there had hit a sky-high CAPE (cyclically adjusted price earnings) ratio of 44 when the valuation measure’s long-term average was just 16.5.

Investors who had studied these episodes in investing history might have been persuaded to steer clear of penny shares like Blumont Group Ltd (SGX: A33) and Asiasons Capital Limited (SGX: 5ET) just prior to their epic collapse in price last October. They were part of an infamous trio that included LionGold Corp (SGX: A78) which saw their share prices sink by up to 96% in the space of less than a week. Near their peaks, Blumont and Asiasons were valued at more than 500 times their earnings.

What works in investing

History has also taught us about what truly works in investing. My colleague Morgan Housel once took a 140-year trip down the U.S. stock market’s memory lane and found that the longer you stay invested in the market, the higher the odds you’d actually make a decent return. This is clearly shown in the chart below which Morgan had made.

Stock market's long term returns

And lest you think the above is just an American quirk, it’s not – even in Singapore, the general relationship between time and the odds of losing money holds too.

A study of history has also shown that Warren Buffett’s simple statement that “if a business does well, the stock eventually follows” really does work. We just have to look at the experience of these four shares: Raffles Medical Group Ltd (SGX: R01), MTQ Corporation Limited (SGX: M05), Surface Mount Technology (Holdings) Ltd (SGX: Q7Q) and Metech International Ltd (SGX: QG1).

Share price table

Source: S&P Capital IQ (data covers the period 1 January 2004 till 1 June 2014)

These returns are part of a study I once did about Singapore’s best- and worst-performing shares over the decade ended June 2014.

A Fool’s take

There’s a French proverb which goes like this: plus ça change, plus c’est la même chose. The phrase is translated as “the more things change, the more they remain the same.” This is an incredibly apt description of the financial markets. And because of that, the study of history is incredibly important to us as investors. I know I’m definitely not alone in having this thought – at the very least, I have the venerable Charlie Munger for company.

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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 owns shares in Raffles Medical Group.