Investors Who Succeed Stay Rational
Have you ever wondered why some investors have tremendous success with their portfolios – meeting or exceeding their financial goals – while others struggle, earn low returns or actually lose money over the years?
Well, you shouldn’t.
Investing is essentially the transfer of wealth to those who have a process and can execute it from those who do not or cannot.
Put differently, investors fail because they either aren’t using a proven strategy or can’t adhere to it, instead buying and selling on “gut instinct,” a great story or some equally unreliable technique.
Any investment recommendation is meaningless if it’s divorced from a battle-tested strategy.
The strategy, in turn, should be based on a proven investment philosophy.
And that philosophy should reflect a valid sensibility – a realistic, clear-eyed picture of the world.
Let me walk you through an example.
Last year, I recommended that subscribers of my Insider Alert trading research service invest in Continental Resources (NYSE: CLR), one of the nation’s top 10 independent oil producers.
I pointed out that the company is the largest leaseholder and producer in the country’s premier oil field, the Bakken play of North Dakota and Montana.
I noted that the firm used the latest advanced technologies to find and produce oil and gas – and that the valuation was cheap.
However, I had a better reason for recommending the stock.
Continental founder and Chairman of the Board Harold Hamm had just purchased 346,486 shares, an investment of $12.6 million.
Indeed, a bit of research revealed that he was a regular buyer and owned over 80% of the outstanding shares.
“I could argue that Continental is undervalued at 2.3 times book value and only 16 times prospective earnings,” I wrote at the time. “But Hamm’s ownership interest and recent purchases tell you all you really need to know.”
Just 101 days later, the stock was up 37% versus 2.5% for the S&P 500.
The strategy is based on insider buying. And there is more than anecdotal evidence that it works.
Multiple studies – and more than 35 years of personal experience – have shown that when a company’s shares are under heavy accumulation by its officers and directors, they generally outperform the market by a significant margin.
The strategy requires a bit of due diligence about who is buying how much, at what price and when.
But the main point is that corporate insiders have access to material, nonpublic information about the future prospects of the business – and that gives them an unfair advantage when they go into the market to trade.
So the recommendation (Continental) was based on a specific strategy (insider buying).
But what is the underlying philosophy?
One used by all-time investment greats like Warren Buffett, Peter Lynch and John Templeton.
It’s called market agnosticism.
No one can tell you with any certainty what the stock market will do from day to day, week to week, month to month or even year to year.
People who pretend to know these things are either fooling you or kidding themselves… or both.
History shows that investment outperformance comes from evaluating businesses, not outguessing the market.
How about the underlying sensibility?
It’s the recognition that – despite all the negative news in the media each day – things are getting better for most people in most places in most ways.
It’s an appreciation that human beings, machines and capital markets drive innovation, solve problems, raise living standards and create prosperity.
Despite our innumerable challenges and setbacks, we live in an astonishing age of instantaneous communication, space probes, heart transplants and lifesaving vaccines in record time.
So let’s do a bit of summing up.
The recommendation was Continental Resources. The strategy? Insider buying. The strategy, in turn, is based on a philosophy of market agnosticism – also known as a “market-neutral” approach – and an underlying sensibility: human progress in a chaotic world.
Compare this approach – fact-based, logical and rational – with the typical punter who day trades or buys hot tips, not knowing what he really owns or why.
These folks are like newbies in a poker game. No way are they taking the chips home at the end of the night. They’re just fattening the pot for the rest of us.
Don’t be one of them. Before you invest in any recommendation, make sure it’s based on a dedicated system, a proven philosophy and a valid sensibility.
Combine these with a proven sell discipline – like trailing stops – and only one further step is required.
The discipline to follow through.