The Three Most Dangerous Words in Investing

The three most dangerous words in investing... Value investors often miss these stocks... Don't fall into this trap... The one thing I had backward my whole career... From classic value investor to 'make money' investor...

Editor's note: We're doing something a little different today. In lieu of our regular fare, we're sharing a special guest essay from our good friend, Whitney Tilson.

As Porter explained in the April 5 Digest, Whitney developed into one of the most famous hedge-fund managers on Wall Street during his 20-plus-year career. He has two degrees from Harvard University and a phenomenal history of major market calls. And perhaps most notable, despite his accomplishments, he's as humble, kind, and generous as anyone we've met.

Whitney launched a financial-research company called Empire Financial Research earlier this year. In his newest endeavor – which Stansberry Research has invested in – Whitney aims to educate investors and help them make better decisions through his in-depth analysis.

In today's essay, Whitney shares some of his timeless advice...

It's a common cliché on Wall Street...

The four most dangerous words in investing are, "This time is different."

But I (Whitney Tilson) have found a three-word phrase that's uttered just as frequently... and is arguably even more dangerous.

"I missed it."

You've probably grumbled these words before if you've ever passed on a stock you were considering buying... then watched as it marched to new high after new high.

The thing is, a great run higher doesn't necessarily mean it's too late to buy.

Today, I'll show you why this simple, three-word phrase can be so misleading... and explain how it has played a role in changing – and improving – my approach to investing in recent years.

In my decades as a value investor, I've seen it time and time again...

Value investors like me tend to look in the "bargain bin" for beaten-up stocks that are trading at 52-week (if not multiyear) lows. They get a sense of satisfaction from getting a better deal than the guy who bought it a month or a year ago.

It's a great strategy if – and this is a big if – you can correctly identify companies whose fundamentals turn around. The key here is to avoid "value traps"... the companies that never turn around, and thus their profits (and stocks) keep falling and falling.

But what about stocks that never really fall out of favor and thus are never in the bargain bin?

Value investors often miss them.

Take Alphabet (GOOGL), for example... In August 2004, the company went public at a split-adjusted $42.50 a share. By October, the price had already more than doubled. A year after that, it had doubled again. And two years after that – in October 2007 – shares were trading at $355. Today, they're up to around $1,100.

Sure, it would be great to have bought as soon as it went public. You'd be sitting on gains of roughly 2,500% today. But even if you didn't buy on day one, you didn't miss it.

Heck, if you had sucked your thumb for a year, watched the stock go up 300%, and bought shares in October 2005, you still could have doubled your money in only two years...

If you made this mistake, well, join the crowd. I watched Google's shares go from $50... to $100... to $150... to $200... to $250... (You get the point.)

It would be one thing if I had done the work on it and concluded that it was outside my circle of competence or was too expensive. (It wasn't.)

But that wasn't the case. I simply didn't do the work. Why? It's not because I was lazy.

Rather, every time I looked at the stock, it was usually trading at or near an all-time high, so I kept telling myself, "I missed it" and moved on. If I had just bought what I knew was a great business at any of those points, I'd be sitting on a multibagger today.

Let me give you another example...

My friend Chris Stavrou first bought shares of Warren Buffett's Berkshire Hathaway (BRK-A) back when he was a stockbroker in the 1970s.

He started buying it for his clients at $211 a share – after it had risen more than 2,000% over the previous decade. But Chris didn't fall into the "I missed it" trap.

A decade later, he opened up his own hedge fund. By then, Berkshire was trading at an all-time high of $1,800 a share.

So did he say to himself, "Wow, this stock has moved up a lot – I think I'll wait for a pullback" or "Drat, I missed it"? No. He saw that it was a great company run by a brilliant investor and the stock was still attractive, so he bought it for his nascent fund – and still owns those shares today, each valued at more than $312,000!

So learn this lesson well...

Whether a stock is trading at a 10-year low or a 10-year high tells you absolutely nothing about whether it's cheap or expensive.

Some stocks trading at multiyear lows are horrible value traps that are headed to zero. And some stocks trading at multiyear highs are going to be spectacular winners going forward.

The lesson here is, don't fall into the "I missed it" trap. Ignore where the stock price has been, do the work, and make a rational decision based on your assessment of where the stock is likely to go in the future.

As I said, though, I had a lot of that backward my whole career until recently...

For most of my time on Wall Street, I was an old-school value investor. I spent most of my time looking at stocks that were statistically cheap, meaning they were trading at low multiples of current earnings or book value.

Of course, I cared about the quality and future growth prospects of the companies I invested in... But to me, that part was secondary.

The problem was, these cheap-looking stocks were usually cheap for a reason... because the underlying businesses were crummy. So most of them turned out to be value traps – they just went down and down as the businesses declined.

But I've recently changed – and improved – my approach to investing and how I pick stocks...

You see, falling for value traps is just one of the four mistakes that tend to plague classic value investors. The first is failing to buy the stocks of high-quality businesses because they don't appear cheap based on current earnings. The second is falling into the "I missed it" trap. The other two are...

1. Selling long-term-compounding stocks of great businesses too soon, and

2. Failing to understand and appreciate powerful new technologies and trends.

I'll confess... despite all of my successes during my 20 years in the market, I've made all of these errors.

I want to emphasize, however, that the lesson here is not to just do the opposite and buy the stocks of great growth companies irrespective of valuation. Growth investors frequently make four mistakes that are, in many ways, reflections of the ones value investors make...

1. They overestimate future growth, forgetting the powerful force of reversion to the mean due to changing technology, new competitors, size acting as an anchor to growth, etc.

2. They pay too high a price for a stock, such that even if the business performs well, the stock doesn't.

3. They fall in love with great companies and fail to sell when they should.

4. They get sucked into "story stocks" – businesses full of excitement and promise, but where expectations far exceed the fundamentals.

The truth is that both quality and price matter... But they're not equally weighted. I estimate that 75% of what determines a stock's performance over time is how the company performs, and only 25% of it is the valuation at the time of purchase.

Unfortunately, for my entire career I had this backward: I looked among cheap stocks and tried to find good businesses, when I should have looked among good businesses to find reasonably priced stocks.

That's why I changed my approach...

Today, rather than a classic value investor, I call myself a "make money" investor – meaning that I try to combine the best of value and growth investing.

I believe it's a great way to avoid the common pitfalls of both sides, while investing in better businesses right from the start.

So stop digging in the bargain bin. Instead, look for high-quality companies and wait until you can buy their stocks at a reasonable price. If you are smart, courageous, and patient, you will crush the market.

I'm sharing exactly these types of ideas with my Empire Investment Report readers...

My first recommendation in April was a stock I was famously short for... and then made national headlines when I went long. My second recommendation is a real estate company I know intimately and whose properties I've personally visited dozens of times. And the most recent recommendation – published last Wednesday – is in the education sector... a topic near and dear to my heart, and one I know well.

All told, I've recommended seven companies whose businesses have had the risk "wrung out" of them. And right now, all seven are still trading under their maximum buy prices.

You can get instant access to this research with a trial subscription to the Empire Investment Report, which we're currently offering at a 40% discount to its normal price. Get all the details here.

New 52-week highs (as of 6/25/19): Sprott Physical Gold and Silver Trust (CEF), Western Asset Emerging Markets Debt Fund (EMD), SPDR Gold Shares (GLD), Lundin Gold (TSX: LUG), McDonald's (MCD), Polymetal (LSE: POLY), Royal Gold (RGLD), Sprott (TSX: SII), and Travelers (TRV).

A busy day in the mailbag: One longtime subscriber comments on his recent decision to become a lifetime Stansberry Alliance member... Another shares how he's personally investing today... And a third reader has a question about Doc's Advanced Options strategies. As always, send your notes to feedback@stansberryresearch.com.

"In December of last year, I had felt that I had reached the limit of my Stansberry subscriptions. There were some others that I wanted, and I decided to just pony up the money for Alliance membership.

"In all sincerity it was one of my better investment decisions because all of the research that I get gives me a much broader picture in my investment world. I am a daily trader and have been for a few years now and having so much extra research is just a huge benefit.

"Thanks to all of you for what you do. It is so appreciated." – Paid-up Stansberry Alliance member Jeff S.

"I have moved to a bearish position and a have taken all my positions to cash with the exception of my bond positions managed under the guidance of Stansberry's Credit Opportunities.

"After a 40-year career I plan on retiring next month and now believe the right move is to follow Doc's Advanced Options strategy. This leaves the bulk of my portfolio in secure bond and cash holdings and only risks defined amounts that have huge upside. I prefer understanding exactly what I can lose on each trade, instead of risking the whole kiddy on the market. Last week I caught the GDX options trade recommended by Ten Stock Trader and made 380% on one trade and 167% on another, while only exposing a fraction of my portfolio.

"I am all for the 'Melt-up' but as Porter has taught me position sizing and minimizing our exposure is more important." – Paid-up Stansberry Alliance member Steven M.

[Yesterday's DailyWealth essay by Doc Eifrig] falls short on explaining how the calendar spread really works.

"I wish it could be supported by an actual example with numbers and steps on how to actually perform this strategy... Is the option sold a call option or a put option, etc. Thank you." – Paid-up subscriber Akram B.

Brill comment: Technically, you can make a calendar spread trade using either call options or put options. However, when Doc uses this strategy, he typically recommends using call options.

If you're interested in learning more about these kinds of strategies, you won't find a better instructor anywhere than Doc and his Advanced Options service.

For a limited time, you can take advantage of a huge discount off the usual price.

Click here to get started with Advanced Options right now.

Regards,

Whitney Tilson
New York, New York
June 26, 2019