Why Picking Stocks Is So Difficult
Very few businesses will survive over a lifetime and yet Warren Buffet says that “Benign neglect, bordering on sloth, remains the hallmark of our investment process.” I wrote recently about how owners of Amazon had to experience a 90%+ decline in order to get the tremendous returns they did. The only way I could have held a stock down 90% would have been to completely ignore it as Buffet advises. Otherwise, I’m sure I would have thought it was doomed to fail - as is the fate of so many companies.
In fact, between 1980 and 2014, 40% of companies experienced what JPMorgan considered a “catastrophic loss” of over 70% without recovering. And nearly 70% of all companies underperformed the market.* Put another way, there were only a few companies responsible for the tremendous growth, and the average investor had little chance of finding it.
Why is this?
Morgan Housel wrote about this concept in “Why Competitive Advantages Die”* and I found several reasons compelling.
Maintaining a business requires a different skill than building one
Founders who started businesses from scratch had nothing to lose and often invested all their profits back into the business. Investors require that eventually established businesses start paying out profits to shareholders instead of reinvesting in the business. When a business’s core focus becomes maintaining a dividend for shareholders instead of reinvesting into the future of the business, they become susceptible to competitive companies that are only investing back into the business.
Being right once keeps you from being right in the future
When businesses know they have a competitive advantage, there is a tremendous incentive to not screw it up. Because of this, many established companies stop innovating, holding to their original beliefs. In 2007, the founder of Blackberry took apart an iPhone, said “They’ve put a Mac in this thing,” and then decided that people probably wouldn’t want a computer in their phone.* Two years later in 2009, Blackberry was still selling 50% of all smartphones. They had plenty of time to adapt but never did. They now sell 1% of all smartphones.
Mistaking a temporary trend for a competitive advantage
Sears was thought to have an insurmountable advantage over its competitors due to the number of stores and financial resources it had available. However, much of their success was due to the fact that in their early days, consumers had money to spend on mid-priced retail items. However, between 1985 and 2018 the price of household items grew at roughly twice the rate of wages for the middle class. Because of this, consumers pivoted from mid-priced retail items to discount items. While many factors led to their fall from grace, one of the biggest reasons was their inability to pivot when this trend changed, which gave a tremendous opportunity for retailers like Walmart to step in.
It’s widely known that half of all businesses fail in the first 5 years and 2/3 fail in the first 10 years. Not only that – successful businesses have to succeed over and over again to survive for decades, as competition is always lurking. Thankfully, we don’t have to find these rare businesses to be successful in investing. As Jack Bogle, the founder of Vanguard said, “Don't look for the needle in the haystack. Just buy the haystack!”
Thank you for reading,
Alex
This blog post is not advice. Please read disclaimers.
1 - Edited by JPMorgan, The Agony and the Ecstasy: The Risks and Rewards of a Concentrated Stock Position, 2014, privatebank.jpmorgan.com/content/dam/jpm-wm-aem/global/pb/en/insights/eye-on-the-market/eotm-the-agony-and-the-ecstasy.pdf.
2 - Housel, Morgan. “Why Competitive Advantages Die.” Collaborative Fund, Morgan Housel, 8 Feb. 2018, www.collaborativefund.com/blog/why-competitive-advantages-die/.
3 - Grant, Adam M. Think Again: the Power of Knowing What You Don't Know. WH Allen, 2021.