I have a collection of quotes about investing that I refer to every now and then to remind me of the things that are truly important. The three below are some of my favourites because when taken together, they can tell you what you really need to do when investing. On what to watch in the stock market “[There’s] an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which…
I have a collection of quotes about investing that I refer to every now and then to remind me of the things that are truly important. The three below are some of my favourites because when taken together, they can tell you what you really need to do when investing.
On what to watch in the stock market
“[There’s] an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch.
But in the long run, you know he’s heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the [dog watchers], big and small, seem to have their eye on the dog, and not the owner.”
– Ralph Wanger
Over the short-term, the share price of a company (the dog) can fluctuate wildly, and often with no connection at all to the performance of the company’s business (the dog owner). But over the long-term, those two do converge.
Here’s a good example.
Since the start of 2005, Vicom Limited (SGX: V01) and Global Yellow Pages Limited (SGX: AWS) have respectively clocked a gain in 30.4% and 28.5% of all their trading days – from that perspective, there doesn’t appear to be much of a difference between the two firms.
Source: S&P Capital IQ
But, with Vicom’s consistent profit growth over the past decade (see chart above), its shares have gained 543% in price since the start of 2005; meanwhile, Global Yellow Pages, with its rapidly shrinking earnings, has seen its shares lose some 98% of their value over the same time period.
Don’t have a myopic focus on what a share’s doing daily. Instead, keep a close eye on what its underlying business will do five, 10, or even 20 years from now – it’s the business’s performance which ultimately matters.
On the importance of having a long-term focus
“As many advisors have told us, your investment portfolio is like a bar of soap. The more you handle it, the smaller it gets.”
– William Smead
In other words, the more you trade in out and of your shares, the more you lose.
Finance professors Brad Barber and Terrence Odean, from the University of California, published a paper in 2000 which looked at the trading records of 66,465 households over a five year period from 1991 to 1996. What the professors found was that those who traded the most under-performed the market by up to 6.5% annually.
If you think it’s only the mom-and-pop investors who can’t make fast trades, you’d be wrong.
A group of finance professors had studied 105 million trades made by 1,186 institutional investors (professional fund managers and pension funds) over a 10-year period between 1999 and 2009.
They found that 96% of these investors had bought and sold a share within a month and that collectively, the average returns on short-duration trades made by them were negative. In fact, the professors wrote that “the shorter the duration the more negative the returns.”
On understanding risk
“Using volatility as a measure of risk is nuts. Risk to us is (1) the risk of permanent loss of capital, or (2) the risk of inadequate return.”
– Charlie Munger
Investing is a risky affair, no doubt. Yet, those risks can be controlled – but only if we have a good idea of what risk is all about. Many investors have confused the idea of short-term price swings (volatility) with investing risk (losing capital permanently).
One way to control risk is to be aware of situations of extreme over-valuations. Some prominent past examples include Japan’s stock market in the 1980s and a more recent case involving Singapore-listed mining and energy outfit Blumont Group Ltd (SGX: A33).
Regarding the former, Japan’s Nikkei 225 Index was valued at more than 100 times its earnings when it was at its peak of around 39,000 points in 1989; that was clearly not a sustainable situation for a broad market index. Today, the Nikkei, at 20,000, is still down by more than 40% from its 1989-peak.
As for the latter, Blumont was part of an infamous trio of penny stocks in Singapore that saw their market values collapse by up to 96% in the space of three trading days in October 2013. Investors who had kept an eye on value might not be too surprised at the turn of events; near its peak, Blumont was valued at around 500 times its earnings and 60 times its book value. Blumont’s trading at S$0.01 per share at the moment, a far cry from its peak at S$2.45.
Timbre flooring specialist Jason Holdings Ltd (SGX: 5I3) might be a cause for concern now given that it’s valued at 330 times its trailing earnings and 9.4 its book value at its present price of S$0.64.
I’m not saying that the firm’s necessarily carrying an unsustainably high share price, but Jason Holdings does have an extremely demanding valuation. For some perspective, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking the fundamentals of Singapore’s market barometer the Straits Times Index (SGX: ^STI) – has a price-to-earnings (PE) and price-to-book (PB) ratio of just 13.5 and 1.3 respectively.
When Jason Holdings’ high valuations are coupled with historical evidence of its inability to grow its business, investors might want to tread carefully with the firm.
A Fool’s take
To sum up, here are what the three great investing quotes are telling us about what we’d need to do when investing: 1) Watch the business and not the stock; 2) think and invest for the long-term; and 3) understand where investing risks come from.
For more investing analyses and to keep up to date on the latest financial and stock market news, sign up now for a FREE subscription to The Motley Fool's weekly investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.
Also, like us on Facebook to follow our latest hot articles.
The Motley Fool's purpose is to help the world invest, better.
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 Vicom.