Equity Market Free Lunch

by | Jun 17, 2019 | General

There’s no such thing

Everyone wants the following—a stock that only goes up and never goes down. We all know that’s a fantasy, but many investors still expect something like that to happen. 

What about a stock that outperforms when the market is weak? Make some money when times are good, lose less when things are bad. Sounds like the way to go. 

But here are two problems about actually implementing that strategy:

  1. Equity markets trend upwards most of the time—and equities are high-compounding assets. So trying to implement this strategy means foregoing gains during the long period when gains can actually be had. And that effect is significant because compounding is both powerful and underappreciated. 
  2. Are we talking about temporary losses or permanent losses?  There’s a difference. When a collection of very good businesses all have their stock prices fall 10%, that’s exactly the kind of loss than can be made up with time. So long as there’s no impairment to the businesses themselves, their stocks will recover. 

So what are we doing when we try to avoid a loss? Most of the time we just end up avoiding years of compounding gains. 

Take the most recent major downturn in stocks—the fourth quarter of 2018. It was terrible. And several very good businesses saw their stocks perform worse than the market did. But then, what happens next? The story doesn’t just end there. Life goes on. And for very good companies, that means profitable business growth continues through the rough patch for the stocks.

Focusing on loss avoidance takes your eye off the ball. You’re allowing the stock price to tell you how good the business is rather than the performance of the business itself. 

Best regards,

Evan McGoff



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