Everyone knows that the way to build great wealth in the stock market is to find an exceptional stock and hold it for the long term. The power of compounding will do the hard work of multiplying your investment if you hold the right name.
Warren Buffett is the classic example. He bought stocks like Coca-Cola (KO) , American Express (AXP) , and Apple (AAPL) at an early point, and they have made him one of the richest people in the world. About 90% of his money is invested in just five stocks, and Apple alone is nearly 50% of his current holdings.
It is a deceptively simple approach. It is easy to explain the theory, but the actual execution is extremely difficult to do. The reason that so many people think it is easy is that they do it retroactively. It is very simple to look back and identify what stocks would have made you tremendously rich if you held them long-term. Everyone knows if you bought and held Microsoft (MSFT) for 30 years, you would be extremely wealthy, but that wasn’t so obvious in 1990.
The problem is that we have to do this prospectively. Identifying the next Apple at an early stage is the hardest thing to do in investing. So how do you do it? Buffet has said that we may have only 20 exceptional investment opportunities in our lifetime.
The Buffett Way
“Big opportunities in life have to be seized. We don’t do very many things, but when we get the chance to do something that’s right and big, we’ve got to do it. And even to do it on a small scale is just as big of a mistake almost as not doing it at all. I mean, you really got to grab them when they come. Because you’re not going to get 500 great opportunities, you would be better off if… you got a punch card with 20 punches on it. And every financial decision you made, you used up a punch. You’d get very rich because you’d think through each one very hard. I mean, if you went to a cocktail party and somebody talked about a company, and they didn’t even understand what they did or couldn’t pronounce the name, but they made some money last week in another one like it, you wouldn’t buy it if you only had 20 punches on that card.”
All that Buffett is saying here, in his folksy manner, is to be highly selective, and when you do find one of those great opportunities, then go big.
That is great advice, but it still doesn’t address the question of how you find these super stocks. It obviously requires doing a lot of research, but no matter how much work you do to identify a winning stock, you will make mistakes. If you make the mistake of thinking this is one of those 20 opportunities you will encounter in a lifetime, then that mistake can be extremely costly.
An Alternative Approach
An alternative to this highly selective approach is to be less selective, but if you do that, then you also have to be much faster to admit a mistake and exit the position. As long you don’t impair your capital as you keep hunting for the next great stock, then you can just keep on trying.
The advantage of this is that you will learn much more about a company if you own a small position and continue to study it. You will not only see how fundamentals develop but you will come to understand the price action.
As another multi-billionaire has said, “It’s not whether you’re right or wrong, but how much money you make when you’re right and how much you lose when you’re wrong.”
I believe that this is the single best piece of advice to employ when you are looking for the next super stock. It is critical that you cut those losses quickly when you are wrong and are extremely aggressive when you are right.
Folks like Buffett and Soros counsel against diversification. They want to be very heavily invested in the names that are working for them. They want to leverage their money when they feel they are right and not dilute it by holding less productive investments.
Soros is essentially using Buffett’s advice about staying selective and recognizing that there are only a small number of great opportunities in a lifetime, but he is modifying it by taking a more active approach. We will never be 100% sure about any investment, but we can manage risk by recognizing mistakes very quickly and keeping losses small.
My Plan
My plan for finding the super stocks that emerge from the current market environment is to continue to do extensive research. I will keep looking for stocks with exceptional fundamentals and will establish some smaller positions in the most interesting names.
Perhaps none of these will be the 20 opportunities that Buffett says come along in a lifetime, and I will eventually dump them. However, there may be one that is special, and it will start to prove itself with good earnings reports and powerful price action. That is the one that I will keep on building and will hold in substantial size.
There are only going to be a limited number of great opportunities in our lifetime, and it is going to take some hard work to find them. I have no idea what the next super stock might be, but through the process of researching and tracking, I have a good chance of eventually identifying one.
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