The One Thing Great Investors Focus On

Original post

In my last two columns, I discussed why market timing – the attempt to be in the market for the rallies and out for the corrections – is a deeply flawed investment approach.

(The rare exceptions – every decade or so – are market extremes, when sky-high valuations are accompanied by unbridled optimism about the future… or when rock-bottom valuations coexist with abject pessimism.)

Around 95% of the time, the market itself is neither an urgent sell nor a table-pounding buy. (Although the same cannot be said for individual securities.)

Investors who regularly switch in and out of the market – paying commissions, covering spreads and forking over capital gains taxes – often do it at precisely the wrong times.

That means they’re in for the corrections and out for the rallies.

Worse still, if they get caught on the sidelines during a long-running bull market like this one, they can miss out entirely.

Certain that the market will go lower eventually, they watch it (with increasing frustration) go higher and higher instead.

Then – having missed a serious leg up – they are reluctant to get back in. So they remain stuck, earning low returns in cash or fixed income investments.

A colleague recently told me, “I admit that I can’t time the market. But if what you say is true, I might as well just buy and hold an index fund.”

Wrong.

Buying an index fund is fine for people who don’t have the interest or time to be active investors and don’t mind settling for average returns.

But it is possible to beat the market. You just aren’t likely to do it by guessing when to be in the market and when to be out.

What sophisticated investors do instead is evaluate businesses. That’s where outperformance is entirely possible.

Look at the great investors throughout U.S. history. Warren Buffett, Peter Lynch and John Templeton are all good examples.

These three men had entirely different investment methods. Lynch was a growth investor. Templeton was a pioneer in global investing. Buffett was (and is) a value guy.

They all earned extraordinary long-term, market-beating returns.

But none were market timers. All conceded that they didn’t have a clue what the market was going to do next.

All they knew how to do was identify companies that were selling for less than what they were worth… and then sell them when the market recognized those values.

(A partial exception is Buffett, who claims his favorite holding period is “forever” but has nevertheless sold dozens of individual stocks during his more than half-century at the helm of Berkshire Hathaway.)

You should do exactly what the great investors did.

Forget about the fantasy of riding the market up, sidestepping the downturn and then riding it up again. That’s just a pipe dream.

A recent conference attendee was skeptical, arguing that you can’t know for certain what an individual stock will do either.

He’s right. There are precious few certainties in the world of investing.

But it’s a lot easier to analyze the prospects for a particular business than to forecast world financial markets.

After all, the market gyrates day to day based on economic growth here and abroad, interest rate changes, rising or falling commodity prices, currency fluctuations, inflation numbers, new legislation and executive orders, political events, and all sorts of other events… many of them entirely unforeseeable.

The world is too big, too dynamic and too complex to fit into some model about how “the market” will behave.

That’s why it’s far more effective to think smaller and focus on individual businesses and their sales and earnings prospects.

Of course, in a correction like we’ve experienced lately, some stocks go lower even as their business outlooks get better.

That, in fact, is where the best opportunities lie in the market.

And in my next column, I’ll show you exactly how to take advantage of them.

Good investing,

Alex

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