By Whitney Tilson, founder, Empire Financial Research
Over the past decade, you could have done pretty well just by throwing a dart at a list of stocks…
The S&P 500 Index has more than tripled since bottoming in March 2009. The tech-heavy Nasdaq has done even better.
But you would have outperformed both if you had followed these three lessons I have learned over nearly two decades of managing multiple hedge funds and mutual funds…
The first is to look for accelerating growth…
Look at some of the top performers over the past decade. I’m talking about companies like Amazon (AMZN), Netflix (NFLX), Facebook (FB), and Alphabet (GOOGL).
They all have one thing in common: Not only were they growing their revenue, the rate of their growth also increased. That’s accelerating growth.
It’s simple to figure out… Look for a company’s quarterly revenue on its income statement. Then, compare the current revenue with the same quarter in the previous year to calculate its annual percentage growth rate.
Many of the companies that performed the best in recent years were growing at 10% annually. Not bad. But then, their growth rates accelerated up to 20% or more. In the case of Alphabet, its annual growth rate has been at least 20% for the past 11 quarters. And the real moonshots – like Amazon and Netflix – soared to 40%-plus for an extended period.
These stocks go against the traditional mindset of value investors like me…
Normally, we look for stocks that trade at a low multiple to either the company’s trailing earnings or book value.
However, it’s important to set aside a part of your portfolio for growth stocks like these, too. They look expensive on traditional value metrics. But their growth is so rapid that if it can be sustained – a big if – then current-year valuation numbers almost don’t matter. The accelerating growth swamps the premium price you’re paying.
When I recommended buying Netflix back in 2012, shares traded for less than $8. For the next two years, I benefited from the company’s accelerating growth. The stock rose sevenfold over that span.
But instead of sitting back and profiting from correctly identifying one of the greatest moonshot stocks of all time, I focused on short-term traditional valuation metrics and began trimming (and eventually sold) the position far too soon.
I should have simply told myself I’d hold my shares until the accelerating growth slowed down. It never did. To this day, Netflix is still going strong.
Now, let’s look at the opposite problem from a moonshot stock…
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What should you do when a stock is running against you?
I had this experience with SodaStream, an Israeli-based company that traces its roots back more than 115 years. In the 1970s, the company’s home-carbonation machines – which turn regular tap water into sparkling water with the touch of a button – became popular across the United Kingdom. According to the Guardian, 40% of British people had one in their kitchens in the 1980s. To this day, the company has a strong franchise across Europe.
As it expanded into the massive U.S. market, investors got excited and bid the stock up to nosebleed levels. But the company botched its marketing in the U.S. and was also relocating its main factory in Israel, so its sales and earnings declined – as did the stock.
I finally bought a small position in 2014, but the stock continued to fall for the next two years.
As painful as it was to see the position run against me, I knew my thesis was correct…
The company still had huge profit margins. Every quarter, it disclosed how many replacement bottles it sold. Even as the stock plunged, this metric rose like clockwork every quarter – about 10% year over year.
The underlying business was healthy. I tuned out the “noise” and continued to buy shares all the way to its eventual bottom. When I closed my hedge fund in 2017, the position was a five-bagger. Last year, soda giant PepsiCo (PEP) bought SodaStream for $144 a share – 12 times the price from just two years earlier.
It’s wonderful to get the timing perfect and buy a stock at its exact lows… just before it soars. But that’s hard to do consistently, and it’s not necessary. As you can see in the case of SodaStream, if you’re right about the company, you’ll still end up making a lot of money.
The real key is having the courage to stick to your guns and not get spooked out by negative headlines and short-term price moves.
That brings me to the final lesson…
You must be super careful to never be dumb, even for a single day…
Imagine that you bought the stock of an incredible company that grows and grows for a decade or more. Think membership club Costco Wholesale (COST), credit-card company Visa (V), sports-apparel firm Nike (NKE), or Warren Buffett’s Berkshire Hathaway (BRK).
To make a fortune, all you have to do is hold on to it and do nothing.
Sounds easy, right? It’s not. The markets are open for trading 252 days each year. Over 10 years, that’s 2,520 trading days – and each day presents an opportunity for you to do something dumb: Sell the wonderful stock you own.
Let’s say you’re really smart and disciplined, however, and you only have one dumb day out of every thousand. In other words, you’re smart 99.9% of the time.
The odds that you sell the stock at some point over those 2,520 trading days over a decade is 92%!
When I look back and analyze why I sold some of my biggest winners way too early – costing my investors and myself millions of dollars – I found that I usually made a terrible decision and acted on it quickly… often in one day.
I can’t recall exactly what was going on in my life on those fateful and costly days, but I suspect that something weighed on my mind and clouded my judgment.
I’ve studied the extensive research that has been done on decision-making. It clearly shows that humans are much more likely to make emotional, irrational, self-defeating decisions that they later regret when they’re stressed, depressed, distracted, under time pressure, sleep-deprived, hungry, etc.
Here’s how to combat this...
First, look at what factors cause you to become stressed, depressed, or whatever. Then, take steps to address these issues… Turn off CNBC while you’re working. Make sure you get enough sleep. Avoid redeye flights. Eat regularly during the day.
But no matter how hard you try, there will always be times when your mind just isn’t in a good place. That’s OK. It happens to everyone.
The key, however, is to recognize these periods and avoid making decisions during them – because they’re likely to be bad ones!
I failed to do this, and it cost me dearly.
Soon after I closed my funds in October 2017, I launched a new business teaching seminars. I spent the first week of December with my students. We spent 12 hours a day together, as I tried to teach them everything I’d learned over the previous two decades.
It was an exciting period. My entrepreneurial juices were flowing. Each night, I came home and prepared the teaching materials for the next day based on what we’d covered that day.
As you’d imagine, I got little sleep that week – or the two weeks after that – as I prepared to teach the next seminars. Over 21 consecutive nights, I averaged four hours of sleep per night.
I’ve never been so creative and productive – but I was also emotional and loopy during this period. I felt like I was permanently semi-drunk.
Unfortunately, I didn’t recognize what was happening. In my giddy state, I was overly optimistic about the prospects for my new business, so I built up an expensive cost structure… and in turn, I lost a lot of money.
Now, I monitor myself much more closely – and ask my wife to do so as well – so I avoid going through such a period again. And if I do, I make sure I don’t make important decisions regarding business, investing, or life.
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Following these tips will improve your investing results, but I’d like to do you one better…
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Editor’s note: During his long career on Wall Street, Whitney made a string of predictions so accurate that CNBC called him “The Prophet.” He predicted the dot-com crash… the housing crisis… the bottom of the market in December 2008… the bubbles in bitcoin and 3D printing stocks, and more. But in a FREE online event on April 17, he’ll share a prediction that could be his biggest one yet.