I was at my favourite book store browsing for interesting reads with a friend when we started talking about investing. She asked, “What exactly is value investing?”
After I explained the concept – which in essence is buying a dollar for fifty cents – she commented: “It seems like the hardest part about investing is determining what the value of a company is.”
That’s when it dawned on me: Not many may be aware that the hardest thing about investing isn’t learning how to interpret financial statements and work out the value of a company. The hardest thing is having the discipline to stay the course.
You see, it’s one thing to know that patience and time is needed for an investment to work. It’s another thing to hold onto your shares when you’re deep in the red.
As Mike Tyson once said, “Everyone has a plan until they get punched in the mouth.”
Behavioural economists have established that our emotions can wreak havoc on our attempts to think rationally. When a share we’ve bought goes down for extended periods of time, fear sets in. We start questioning our own judgement – even if we know we have a great investing process where the odds of long-term success are heavily stacked in our favour.
It’s not just me who thinks staying the course is the hardest thing about investing. Investor Joel Greenblatt discussed this topic in his book The Little Book That Still Beats The Market. Greenblatt, who generated an astounding return of 45% per year for 19 years according to the book Excess Returns, wrote:
“The unpredictability of [the stock market] and the pressures of competing with other money managers can make it really hard to stick with a strategy that hasn’t worked for years. That goes for any strategy no matter how sensible and regardless of how good the long-term track record is.”
Short-term pain, long-term gain
In general, the longer we hold our stocks, the lower the chances of us suffering a loss. This can be seen from the history of Singapore’s stock market benchmark, the Straits Times Index (SGX: ^STI).
Source: S&P Global Market Intelligence
The chart above, based on a study I did, shows the chances of the Straits Times Index making a loss for various holding periods from May 1992 to January 2016. You can see that the chance of a negative return showing up reduces dramatically as the holding period increases.
But, our resolve can get tested severely, given that it’s common – almost 30% of the time – for the index to decline by more than 20% from an annual-peak in a calendar year.
Volatility is normal
The same goes for individual shares. A company’s share price tends to do well when its earnings improve. Warren Buffett once said that “If the business does well, the stock eventually follows.”
In Singapore’s stock market, companies such as private healthcare services provider Raffles Medical Group Ltd (SGX: BSL) and semiconductor precision parts supplier Micro-Mechanics Holdings Limited (SGX: 5DD) have done exceedingly well over the past 15 years since December 2003. Their total returns are 1,229% and 1,069%, respectively. Along the way, their profits have also grown manifold.
But despite their great long-term returns, Raffles Medical Group and Micro-Mechanics also had periods when their share prices would have tested the mettle of investors. During the Great Financial Crisis of 2007-2009, both companies’ share prices dropped by more than 60% from peak-to-trough.
It’s incredibly common to experience temporary but significant losses in the stock market over short spans of time.
A failure to recover
But we also need to be cognizant of a crucial fact: Many stocks fail to bounce back after painful declines.
According to a study by US bank JP Morgan, 40% of all stocks from 1980 to 2014 in the Russell 3000 index – a broad index for the US stock market that consists of 3,000 stocks – had suffered a permanent decline of 70% or more from their respective peaks.
How then can we tell if a fallen stock will return to grace?
Separating the wheat from the chaff
We focus on a stock’s business. At our premium investing services, such as Stock Advisor Singapore, Stock Advisor Gold, and Stocks 2019, we’re trying to find companies that enjoy powerful long-term tailwinds, have strong competitive positions in their markets, have innovative management at the helm, possess robust balance sheets, and display a good ability to generate free cash flow.
We believe these positive traits give us a great chance of owning shares in a company with a business that can do well over time. Moreover, we make sure that the price we pay is reasonable, which provides another layer of protection for us as investors.
The bottom line
Understanding the financial math to value a business is not rocket science. But staying the course may be the emotional-version of it.
It’s not easy to stare at temporary losses in the face. But long-term investing is what we believe in at The Motley Fool Singapore and is also a cornerstone for the phenomenal success experienced by legendary investors such as Buffett, Greenblatt, Peter Lynch, Shelby Davis, Philip Fisher, and so many others.
That’s why it’s important for you as an investor to make an iron-clad commitment to yourself to stay the course (provided that you had invested in good companies at reasonable prices!).
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An earlier version of this article first appeared in the 10 December 2018 edition of The Motley Fool Singapore's free investment newsletter, Take Stock.
The information provided is for general information purposes only and is not intended to be personalized investment or financial advice. The Motley Fool Singapore has a recommendation for Raffles Medical Group and Micro-Mechanics Holdings. The Motley Fool Singapore writer Chong Ser Jing owns shares in Raffles Medical Group.