Here's How to Turn Yourself Into a 'Make Money' Investor

Editor's note: A stock can look like a bargain and still lose you money. Our colleague Whitney Tilson learned that lesson the hard way after years of searching Wall Street's bargain bin for undervalued companies. In this issue, last published in August 2024, Whitney realized that one of the most common investing strategies had a fundamental flaw – and fixing it changed how he picks stocks...

I had it backward my whole career...

For most of my time on Wall Street, I was an old-school value investor. That meant I dug through the "bargain bin" looking for stocks that traded at low multiples of earnings, cash flow, 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 that the cheap stocks were usually cheap for a reason... The underlying businesses were lousy. So what seemed to be deals from the bargain bin turned out to be value traps. They just went down and down as the businesses declined.

But years ago, I changed – and improved – my approach to investing and how I pick stocks...

The Investing Trap Hiding in the Bargain Bin

You see, falling for value traps is just one of the four mistakes that tend to plague classic value investors. The other three are:

1. Failing to buy high-quality businesses because their stocks don't appear cheap 
2. Selling great businesses too soon because their stock prices seem "too high"
3. Failing to understand and appreciate powerful new technologies and trends

I'll confess – despite all of my successes during my more than two decades in the markets, I've made every one 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 without considering their valuation. Growth investors frequently make the following mistakes that are, in many ways, the inverse of the ones value investors make:

1. They overestimate future growth, forgetting the powerful force of reversion to the mean. They miss the impact of changing technology, new competitors, size acting as an anchor to growth, etc. Trees don't grow to the sky.
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 their stocks and fail to sell when they should.
4. They get sucked into "story stocks" in the hottest, most overhyped sectors where expectations are way out of line with 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 the quality of the company. Only 25% 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 being a classic value investor, I call myself a "make money" investor – meaning that I try to combine the best of value and growth investing.

It's the best way to capture the upside – and avoid the common pitfalls – of both investing styles.

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.

Regards,

Whitney Tilson

Editor's note: Yesterday, Whitney went on camera with a legendary investor from Silicon Valley to unveil the next AI-boom transformation. It all centers on a small California company and its super chip that could be 50 times faster than what Nvidia currently offers. And if they're right, this tiny chip could spell the end of the Magnificent Seven... but the beginning of the Fabulous Five.