Easy Come, Easy Go
Charmin as investment lesson
by David Gardner (DavidG@fool.com)
ALEXANDRIA, VA (Jan. 12, 1999) -- The Rule
Breaker Portfolio gave back most of its gains from
yesterday's amazing session, dropping a whopping
7.88% today.
Yesterday we rang up an historic mark: in one day, we
made over $50,000. Why is that historic? Because we
started with exactly $50,000 on August 4, 1994 -- which
means that yesterday in one day we made more than our
entire initial investment.
And you know what? Today we lost exactly $50,451.69
-- more than our entire initial investment. Easy come,
easy go!
Ah, but it's all part of the Rule-Breaking investor's way of
life. We don't mind volatility. Check that. We prefer
volatility; in some sense, we court it. You see, the stock
market has risen at an annualized rate of over 11% this
century, so you have lots more up periods than down.
And in those up periods, volatility is what makes you rich.
Then there are the down periods. For all I know, we're
about to enter one. I look down my list today and find:
Amazon.com: -21 1/4
America Online: -10 1/8
@Home: -21 7/8
...these are the horses that got us here of late, helped
along by:
Amgen: -1 5/8 today
Iomega: -1/4 today
Lucent: -4 7/8 today
Any regular reader knows that we make no presumption toward predicting
market movements. We are long-term investors who make our effort to locate
what we think will be winning businesses, companies that Break the Rules of the
existing business environment to their shareholders' wild happiness. We let the
market take care of pricing from there.
We've had lots of debate recently on the Rule Breaker Portfolio message board
and the Amazon.com message board about the market's pricing mechanism.
One of the great conventional wisdoms of the here and now, to my way of
thinking, is that the so-called "Internet stocks" are grossly overpriced, a bubble
just waiting to pop. (Certainly, they got hammered today, although all they did
was give back yesterday's gains.) To my way of thinking, this foregone
conclusion on the part of media commentators is very very Wise, just as it has
been over the past five years, as they've been saying pretty much the same thing
all along.
I remember when I was on CNBC in early '98 and was about to go on the set
when I saw David Faber sneer at Amazon.com as if it was a joke investment --
that would've been about 500% ago. And Lord knows Money magazine hasn't
ever anywhere along the line suggested that Amazon.com would make a good
investment. In fact, here's one of my favorite article titles over the past couple of
years, referenced in our new book. (Our new book, by the way, is the #1
bestseller among all 2.5 million titles on Amazon.com -- woo hoo! Thank you,
Fools!) The title:
"Amazon.com Stock Soars After IPO... But Can the Good Times Last?"
It was from May '97. The key quotation was this: "Clearly, though, there are
many reasons to think that Amazon.com is overvalued at Thursday's closing
price of [and we adjust for split, here] $3 7/8." (Bold mine.)
$3 7/8! Less than two years later, we are here at $163.
The financial media has been pretty much been dead wrong all along on these
stocks, but don't take my word for it -- just go back and read their publications
over the past few years. (MAN, was America Online ever flamed back when
we bought it in 1994 -- today, it's everybody's no-brainer Internet play.) Which
all leads to the question of why the media would suddenly be right, right now.
Listen, I'd be much more worried if news anchors led off their market
summaries by explaining how attractive and fairly valued all these stocks are!
Let's dig a bit deeper in our thinking about all this and ask ourselves the
question that DDelruss asked me on the message boards today. He essentially
asked if there is any price I'd sell Amazon at:
"What if Amazon started selling at $7000 a share tomorrow? Wouldn't it make
sense to sell at that price?"
There is simply no single dependable valuation tool that can be applied to Rule
Breakers, as true of Internet stocks today as it was of Wal-Mart in the '70s, or
Cisco Systems in the early '90s. Rule Breakers over market history have always
possessed such power, potential, and momentum (these are special situations --
always will be -- and again, this has been a reality for decades), that we let the
market price our stock as it will.
Some people can't understand this, but I regard it as rather a simple point. Is
Charmin overpriced in my grocery store? I don't think so; at least, I buy it. If it
were double the price it is, would I still buy it? Depends on what other values
were out there. One of the beauties of free markets and capitalism (just one of
the beauties) is the pricing mechanism -- the market sets the prices. I don't have
to buy Charmin if I don't want to. And you don't have to pay $7000 for
Amazon if you don't want to.
The Foolish approach dictates that selling occurs when you find a better
place to stick your money, what I proposed more than three years ago, in a
chapter entitled "Selling Strategy" in our first book. We have actually twice sold
off some AOL -- the first time was to buy Amazon (among a couple of others),
while the second time effectively bought @Home (or Amgen). Sometimes we
make bad mistakes and sell off a good stock in order to buy something not so
good -- we are quite fallible!
When you get away from price targets, technical analysis, and trading, and just
buy strong companies planning to hold them (the Rule Maker Port holds its
stocks for a decade -- doesn't trade at all -- and will whip the S&P 500 over
that time), your sell decisions wind up coming down to YOU and your needs
for the money, not any sort of arbitrary price target.
I used to invest off of price targets, and I'm very glad I've gotten beyond that.
Certainly, any stock can -- in retrospect -- have appeared undervalued or
overvalued at the time. Amazon now looks really undervalued when we bought
it at $7 (having paid $3 more than Money Magazine suggested anyone
should!). Iomega, at its top of $27, now looks as if it was really overvalued
back then -- would've been nice to have sold. Retrospect makes value quite
evident.
Most investors will confound themselves if they set price targets for all their
different stocks and invest using them. If we had set one for any of our best
stocks (America Online, Iomega, Amazon.com), we would have sold long ago
-- and perhaps never have gotten in. That's because strong stocks will always
appear overvalued. Note that if we had cut short our losers (a "downside
price target"), we would have sold some of our losers earlier. Great, but which
would have been better -- to trade out of our winners and losers quickly, using
targets, or only to sell our winners and losers when we felt we had found a
better place to stick our money? The answer is quite evident; it's one of the
lessons of the Rule Breaker Portfolio, born out eloquently by the numbers.
In making valuation only a tertiary issue, we essentially trust the stock
market's incredibly complex, elaborate, and self-interested pricing
mechanism, in just the same way we trust a grocery store or a Wal-Mart
and its prices.
That's all to say that if Amazon went to $7000, I believe that it would only have
gotten there for some incredibly good reasons -- making the price at that point
look fair (actually, probably "slightly overvalued," since that's the way all the
great stocks -- Coke, Dell, Gap, America Online -- always appear).
The same would be true if Amazon dropped from $170 to $70. It would be for
some incredibly good reasons.
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