Seven Tips from Scott: Make Money Slow! 🔗I began dabbling in the stock market in 1997. It's been a fun ride, and I've learned a lot. My success can be summed up in 7 key tips:
1. Patience is a Virtue.
It's not easy to make a lot of money in the market overnight. You really need to have patience and a (very) long-term outlook. I do a lot of homework before investing in a stock, and only invest in companies that I believe will be outperforming the overall market in 3, 5, or 10 years. I generally don't invest in a company unless I'm prepared to hold that investment for at least 3 years. I don't "invest and forget," though -- I continue to digest as much information about the company and market as I can, but in general I make few in-flight adjustments once I've picked a portfolio.
Holding a stock long-term also has significant tax advantages. Currently, the long-term capital gain tax rate (for any stock you hold for 12 months or more) is just 15%. There's a certain joy in knowing that your money is working for you, and is only paying 15% taxes.
Patience is also key because you often don't have a lot of principal to invest, which leads us to the second point:
2. You Don't Need a Lot of Money
A year ago, a relative came to me with some questions about investing. She had about $1,000 in "play money" that she was willing to invest in stocks (she had never invested in individual stocks before), and I gave her some tips, but in the end she did not invest the money. Her rationale: "even if it doubled in a year, that would still only be $2,000."
I had a discussion with a friend the other day who expressed similar reservations.
Had the relative invested that money in the stock she was looking at, she would have realized a 1-year gain of just under 80%. Her $1,000 would be worth $1,800 (before taxes). Instead, today it is worth $1,000 (or less, if you consider inflation). Granted, it could have been worth less than $1,000 -- there are certainly no guarantees in the market.
But that brings us back to Point #1: Patience is a Virtue.
An 80% gain in one year is nothing to scoff at. (Heck, a 20% gain in one year is nothing to scoff at!) An extra $800 probably won't result in any lifestyle changes -- not in the first year. But if you've done your homework and keep that money invested, after a few years the magic of compounding begins to creep in. If you grab an 11% return on investment each year for the next 10 years, that $1,000 is now worth almost $5,000. It could be worth significantly higher if the stock has some banner years during that time. In my experience, stocks go through occasional periods where they absolutely surge. You want to be invested in them before -- and during -- that key period.
Let me provide a concrete example. In early 2000, I discovered an upstart restaurant chain called the Panera Bread Company (PNRA). I spent a couple months doing research on the company. This included hands-on research, which was a good thing: Panera makes yummy food and pastries. I made several observations in my research:
- Panera was extremely efficient. All stores were modern and had an eye-pleasing and high-end design, and the company had put into place state-of-the-art business practices to monitor performance and minimize costs. For example, many of Panera's menu items rely on fresh sourdough bread (never frozen). Panera purchased or set up exclusive arrangements with providers of this key ingredient, locating them strategically close to clusters of stores. Panera also wired all stores into a master network and received real-time statistics on sales, allowing corporate to perform all kinds of useful data mining.
- Despite Panera's ability to rapidly take and construct orders, every Panera store I visited was extremely busy -- often the busiest restaurant around. People were willing to wait 10 or 15 minutes to get Panera food during the lunch rush. I spoke with friends and relatives across the country located near Panera stores, and they made the same observations -- in Michigan, Ohio, Pennsylvania, and Maryland.
- Panera regularly updated its menu item, always staying one step ahead of customer tastes. I was surprised by how quickly new menu items were added.
- Panera was capitalizing on the new and growing "fast casual" market segment. Around this time, there was a backlash against fast food restaurants such as McDonalds -- traditional fast food restaurants were perceived to offer low-quality, unhealthy fare. For about an extra buck per order ticket, customers could get a fresh sandwich, made with quality bread and quality ingredients. And they could eat it in a relaxed environment, with comfortable tables and chairs, and even fireplaces. There was also a perception that the food was healthier. (This is, sadly, a misplaced perception. Panera sandwiches have as much -- if not more -- sodium, fat, and calories as many popular menu options at fast food restaurants.)
- I was impressed by the management of Panera. The CEO of Panera had previously co-founded Au Bon Pain. But after Au Bon Pain's growth curve began to flatten out, his entrepreneurial spirit kicked in and he wanted new challenges. In 1993, Shaich purchased a 19-store chain of restaurants in the St. Louis area called the Saint Louis Bread Company, which he re-branded Panera. He began to grow this new concept, and in 1998, sold all of the units of Au Bon Pain. This was a difficult decision for him, but it allowed him to focus all of his efforts on growing the Panera brand -- and this part was key -- it allowed him to do that from a position of capital, not debt. Many restaurants start off in debt, and are lucky to ever turn a profit. Panera started on a strong financial footing -- with black, not red, ink. In my mind, this significantly reduced the risk of investing in a restaurant stock. And Shaich was clearly an expert in this market and passionate about it -- no pun intended, this was his bread and butter. I had always been a fan of Au Bon Pain, so I was familiar with his track record.
- The company's growth decisions were carefully considered and conservative. Many restaurants (such as Subway) immediately go to a franchising formula and try to maximize the number of franchise locations. They make their money on franchise fees and don't care if two franchisees over-saturate a market and end up in competition with each other. A lot of franchisees have been taken to the cleaners in this way. Panera's growth was much more measured. A large percent of the stores were company-owned (significantly higher than most restaurant chains), and the remainder were only given to hand-picked and carefully vetted franchisees. (Usually only ones willing to open a large number of stores in a region.) This resulted in careful quality control and helped to ensure that no market was oversaturated. Otherwise, the Panera brand could have quickly become a tired fad. (The industry is littered with examples of over-aggressive growth that eventually caved in: Boston Market, Krispy Kreme, etc.)
As you can see, I considered a lot of factors before I invested a dime in Panera. (I didn't consider "traditional" metrics, such as P/E ratios, one bit.) Working in Chick-Fil-A in high school had given me some background on the restaurant industry and what makes a restaurant successful, and I was able to pair that with extensive research to develop a clear picture of Panera.
However, there was one problem: I was poor, and did not have that much money to invest.
On March 13, 2000, I purchased 23 shares of Panera for $6.625 per share. With commission, the total price was $172.33.
I received a bonus at work several months later and used it to purchase an additional 67 shares of Panera. And later that summer, I added another 10 shares of Panera. The total investment was about $1,000.
And then I waited. Patiently.
In 2002, Wall Street suddenly discovered Panera. Analysts began to talk up the stock, touting many of the same points I had discovered two years before. Panera's careful growth continued unabated, with a strong balance sheet, and year-over-year growth in every location.
On June 25, 2003, Panera stock had a 2-for-1 split.
I sold my shares in Panera between late 2003 and mid-2004. Panera was still doing well in 2004, but by that point, the company was Wall Street's darling, and the secret was out. The stock became too risky and the surprise growth story had already been told.
My original investment of about $1,000 had turned into $7,500 in about 4 years.
That's not bad. My $1,000 in "play money" was suddenly $7,500 in "play money." That's definitely a lifetime supply of Panera bagels.
I turned around and re-invested that $7,500 in the market, and it's worth significantly more today.
The original investment wasn't that high. I just needed patience.
3. Do Your Own Research.
Wall Street analysts are bozos. There -- I've said it. I am disgusted by all the talking heads pontificating about companies and the market, and I'm particularly disgusted by how the market reacts -- in the short-term -- to these bozos.
I have seen stocks move significantly (in some cases 10% in a day) based on public statements by analysts that I knew were flat-out wrong.
I've blogged about this sort of thing in the past. For example, one master analyst made this following bold proclamation in early 2007, discussing the possibility of a merger between XM Radio and Sirius:
- "... in a Banc of America Securities report, analyst Jonathan Jacoby put the probability of [government] approval of the merger at about 35 percent, but noted that it was likely much lower."
Or, here's a statement from wizard analyst Richard Farmer of Merrill Lynch from years past:
- "Farmer said he expects Apple to exceed his own earnings forecast of 37 cents a share."
It's breathtaking, isn't it? What kind of analysis do you think goes into coming up with scientific-sounding numbers like 35% or 37 cents? Really insightful analysis, I bet. But analysts don't just come up with these scientific-sounding numbers. They then wrap them with clever disclaimers that let them claim victory regardless of the results. (Hint: if you believe the merger chances are lower than your estimate, lower your estimate.)
What's always annoyed me is that companies and investors are hurt when their actual performance doesn't match the voodoo predictions of these brilliant analysts.
But I've discovered something: if you follow my first piece of advice -- patience -- and do your own research, and have a strong stomach (see next point), analysts always fall into the noise.
Because the market is self-correcting.
An analyst's proclamation might cause a stock to fall significantly in the short term, but if the company is sound, actual results will quickly erase any effect of analyst pontifications. Because eventually the facts trounce everything. And you are investing for the long term, right? If you invest for the short term, you will be held hostage to the whims of Wall Street analysts.
The key thing here is to ignore analysts and do your own research.
Because the analysts are usually wrong. And if you're following an analyst, everyone else is too. You want to find opportunities that are under the radar of Wall Street and the analysts. I have taken advantage of two types of opportunities:
- Discovering a promising company (such as Panera) before the market catches on. But there are lots of promising companies that never take off. You have to do your own research to get a gut feeling for whether a company has what it takes to surprise the market and succeed.
Peter Lynch famously suggested years ago to "buy what you know." This advice is timeless, although I would amend it to say "consider what you know." What you know may lead to opportunities, but the next step is to research those opportunities. Study opportunities in markets that are geologically close to you, or ones that you already have an expertise in. But then divorce your expertise from the equation and try to look at the company objectively. And even though a store might be doing gangbusters in your neighborhood, that doesn't mean the formula will translate to a national growth one.
- Some promising companies suffer from a stigma that is unfounded. In the late 90's, you could not find a story that mentioned Apple Computer without attaching the word "beleaguered." This drove Apple stock to a split-adjusted low of less than 2 dollars per share. But I knew Apple's products, saw the potential, considered factors such as the growth of the Internet, and zagged when everyone else zigged. Apple has been one of the best performing stocks on the market over the past decade. (Guess what? All of those analysts were wrong!) If you had invested in Apple when it was "beleaguered," you'd be looking at an ROI of around 8500% today. Now, there are lots of beaten-down companies that never claw their way back to health. Once again, doing your own research is key. But you might find a gem or two that has already been written off by the "experts."
4. Have a Strong Stomach
The market suffers from huge swings, and it is hard to be patient when you see one of those swings take a huge swipe at your investment and principal. Even if a company is healthy, an unforeseen event such as 9-11 can have a big impact. You can't predict these events; you can only do your research, make sound investing decisions, and then hang on for the long term. There have been plenty of times when I have been tempted to panic and pull money out. I never did. Instead, having done my homework for the long term, I chose those times to buy more shares. Again, zag when others zig. And:
5. Dollar Cost Average Anytime You Can
Dollar cost averaging is a wonderful thing. By purchasing small amounts of stock or mutual funds at regular intervals, you even out the differences in price and minimize the overall risk. If you're averaging in when the market is low, you're getting extra bang (or shares) for your buck. The market is cyclical and there are inevitably times when the market goes down. If all of the factors that led me to purchase a stock are still in place, I use these times to buy extra shares at a discount. Everyone loves a discount!
6. A Down Market Can Be a Blessing
Everyone gets depressed when the market is down (such as right now), but for a young investor, this is a time to celebrate -- and a time to invest, even if you don't have much money to invest. Over the long run (decades), the stock market tends to be the best investment you can make -- returning an average return of 10% or more. (Of course, individual stocks can do far better or far worse.) But those stocks don't return 10% every year. They may go several years with steep losses, followed by relatively short burts of appreciation. Those short bursts are wholly responsible for those long-term average gains, and they're relatively infrequent. You want to be on the roller coaster car when it starts up that climb. To do that, hop in when the market is down.
7. It's OK to Take Profits Now and Then
And finally, it's OK to sell your stocks when they've done well, or to lower your position. Don't become attached to a stock just because it has done well for you. It was difficult for me to sell Panera at a time when analysts were all saying "strong buy." I loved the company, and I loved the gains I had made, but I knew it was time to go. One of the original factors for buying the stock -- that it was a relative unknown -- no longer applied. Since I sold, Panera has done OK, but the stock has been relatively flat. It certainly hasn't had the types of gains it had in those first several years. I was able to move the proceeds into companies that were still at the bottom of their own roller coaster hills.