Monday, October 20, 2014

100 To 1 In The Stock Market

While the book's title is horrible, it accurately describes what the book is about. In 100 To 1 In The Stock Market, Thomas Phelps makes a case for how and why you should focus on a particular set of stocks, as they have the potential to return 100 times your investment.

The first half of the book was totally useless, in my opinion. Phelps rifles through a number of examples of companies that have seen their prices rise 100-fold over a few decades. He has found several dozen, but I struggled to understand what these stocks had in common and how the book can help me identify them...but that's what the second half of the book is about.

First, you're looking for stocks that are cheap. Historically, the stocks that have increased by a factor of 100 have been able to do so not only because their earnings have increased, but also because their multiples have increased. I've got no problem with this line of thinking.

Second, the company needs room to grow. A lot of the most popular stocks are already giants...if they were to compound at a reasonable earnings growth rate over the coming decades, they would own the world. So scratch out those.

Third, the stock will be in a game-changing industry. The company actually has to produce a product/service that helps people do new things or do things better/cheaper than they can do today. This rules out a lot of firms that may look great now, but aren't really doing anything special that would allow them to grow far into the future. I have a bit of difficulty with this one, because it is so hard to pick the winners from the also-rans. Phelps can grab a bunch of 100-1 winners looking backwards, but how many could actually determine which car company or which computer company would rule among the many that spawned when these industries were nascent?

Finally, the most difficult part is to hang on (i.e. avoid selling). I have a hard time with this one too, as Phelps argues that even if the multiple expands, one needs patience to hold for the very long-term in order to get the huge returns. He makes an okay case that with taxes and transaction costs, even switching to a lower-multipled stock is not a good idea, but I don't quite buy it.

I think the book could have benefited from some statistical data to back up some of Phelps' assertions. For example, of the stocks that did return 100 to 1, how many others were there didn't but which had the same criteria? The investor can't know which will become 100s and which will flatline as he holds on for the very long term. The survivorship bias here could be astounding. Of course, as the book was written in 1972, Phelps did not have the rather large statistical tools that are available today. But because the book is devoid of any such studies, we can only take Phelps at his word, which I'm not sure means much.

No comments:

Follow by Email