[Briefing.com] Live Headline 27-Mar-01 The New Rules
[BRIEFING.COM - Robert V. Green] If you have been sitting on the sidelines in the market, you may be wondering when it is time to return. That decision is very personal, and no one is going to post an "All Clear" flag on top of the New York Stock Exchange. Eventually, you will have to come to that decision yourself. But when you do, you need to recognize that the rules have changed.
What Died
If you are new to investing in the last five years, you may think you came to understand the market. Certainly the "old-timers" became baffled in the mid-nineties as a new set of rules for success became evident. Those who played by the new set of rules made a lot of money in 1999. They lost a lot of it if the continued to play by those rules in 2000. Here are some of the rules of the market that worked then, that won't work now.
Momentum investing
"Target based premises"
Short term doubles
In short, sentiment based investing is gone. It is being replaced by old-fashioned purchasing on the future prospects of a business.
Momentum investing required figuring out what other people were going to do, and getting in ahead of the them. Playing multiple stocks in the hope that one would run was a successful tactic. With momentum failing to draw crowds now, playing multiple potential momentum stocks is simply bad allocation.
Targets are calculated future values, based on earnings and revenues projections and a future estimate of market valuations. (See the Stock Brief of March 9, 2000 "Target Prices" for a fuller description.) A target is not a "sell" price, nor is it a statement of what a stock is "really worth." But during 1998 and 1999, target prices became a yardstick for current purchases. If a stock price was currently below a published "target," people bought. Analysts even began published targets without a defined date in the future. After all, it worked. In some cases, they drove the stock to the target price within weeks. That game is over. Targets will go back to future estimates, and right now, many investors view them with great skepticism. If you make a decision involving target prices, you must understand the math used by the particular analyst in deriving the target price.
There was a time when we received an email a week asking us to "Please publish a list of stocks that will double by next month." Although no one could create such a list, as it is essentially predicting human behavior, not companies, stocks did double in a month. It became common. And people began to expect that from the market. Chat rooms could even cause stocks to double in a month. But in today's market, forget about hunting out the quick kill.
All of these rules are gone. If this is what you want from the market, you won't find much to invest in.
The New Rules
So, what is going to work going forward? Following the rules below is likely to be more successful than the successful approaches of 1998 and 1999.
Proven profit history
Reasonable valuations
Invest long term
Lower your return expectations.
Monitor your overall asset allocation
Dollar cost average
Know your risk profile
Here's a brief description of what each of these new rules means.
Proven Profit History
The market has adopted a "show me" attitude, and stocks with proven profit histories are likely to be favored. Stocks with expanding margins, and they do exist, will have a better chance of increasing in value, than stocks with "stories." While concept stocks of all kinds were big in the internet days, because no one could put numbers on the future size of the net, today stories are met with great skepticism. A stock with proven profit history will attract greater interest. This means small cap stocks will have a more difficult time than large cap stocks.
Fundamentals
The market is returning to standards where valuation is important. When you buy a stock, you must know not only its own "multiples" but you must also know the multiples of the stocks comparables. Whether a stocks is "cheap" or not depends on a comparison to other stocks like it. The prior history of the stock's price is irrelevant. Do not look at a stock's 52 week range to determine whether it is a good buy now.
Long Term Perspective
There are hundreds of stocks that will be worth a lot more three to five years from now.
Even if the overall market stays flat or struggles for a while, there are plenty of companies out there which will succeed in their business plans. As long as the current market multiples on that potential are not extreme, the stock should rise. But it may take several years. And you may see the value decline before it rises.
But for many stocks, if you can't ride out a 30% decline, even from today's levels, you probably shouldn't take a position now. At least, you shouldn't take a position in individual stocks. Even the large cap, dividend paying blue chips could experience even further declines over the next few months. But the successful investor starting now may have to live with those types of declines.
Lower Expectations
However, to take a long term perspective, you need to have more realistic return expectations for the future. The long term stock market average return is around 10%, depending on the time period measured. Returns averaging 10% over a period of years can be reasonably expected, but some years will have loses. That's the history of the market.
A 10% return for three years gives you $133 for every $100 you start with, three years later. And you may find your $100 worth of stocks worth only $70 at some point along that journey.
These are much lower expectations than many people grew to expect. But they are more realistic. Returns of 200% in a matter of weeks will still occur, but they will go back to being the oddities they used to be.
Overall Asset Allocation
To safely invest in today's environment, you need to know your overall asset allocation. You should be able, without having to look it up, recite the percentages you own in cash, bonds, and stocks. If you can't, (and many people can't), you aren't managing your money. You just own things.
Risk Profile
The biggest disasters in the market have occurred when investors choose positions with risk exposure completely out of line with their personal risk You must know how much risk you are exposed to. You must determine what level of loss you can sustain. You must have a sense for how low your stock can go. They can all GO TO ZERO! - but you should go with them. Learn how to use stops.
Dollar Cost Averaging
Long advocated for mutual funds, it is probably the best approach to building long term positions now. The benefit of dollar cost averaging includes:
Not having to pick the bottom. It's too hard.
Overcoming the inertia that prevents you from reentering the market. It avoids missing the rebound entirely.
Averaging out the price you pay. Some buys are cheap, some are expensive, but you build a position.
At the very least, dollar cost averaging can give you some piece of mind in difficult times. When the stock rises from where you have been buying, console yourself with the fact that you got some stocks cheaply. If the stock falls from where you have been buying, console yourself with the fact that you didn't invest it all now. It may be "mind-games" you play with yourself, but dollar cost averaging helps you continue building your wealth.
Parting Words
If these "new" rules sound like the "old-fashioned" rules that have been part of financial planning and basic money management techniques for years, they are. The "new" rules which dominated the market in the great bubble of the late-nineties did work, but they were short lived.
If you became a new investor in the online world in the last five years, it is time to recognize the change. There will still be opportunities to build wealth in the market going forward, but only for those who adapt. The market is headed "back-to-basics" and so should you.
Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com
Used with permission of Briefing.com |
