Thursday, February 04, 1999

The Jumping to Conclusions Fribble

by Selena Maranjian

"I am certain of nothing but the holiness
of the heart's affections, and the truth
of imagination."
John Keats

Uncalled-for certainty can get any of us in trouble. It's definitely taken me by surprise.

Investors too often jump to conclusions, feeling overly certain of a desired outcome. (Voters suffer from this tendency, too. On an election day, many people conclude too soon who will win at the polls and thus, unfortunately, don't vote.) But let's discuss "certainty" in regards to investing money -- in any venture.

A decade ago, I lost $1,000 jumping to some incorrect conclusions. I had seen lots of tiny classified ads in women's magazines, offering various recipes for around $3.00 each. I suddenly saw a sure thing. These ads offered merely a single recipe. Using my new Macintosh SE/30 and some newfangled desktop publishing software, I prepared a little cookbook of 21 recipes and figured I'd sell it for $5.00 a pop. Why wouldn't someone buy 21 recipes for $5.00 (only 24 cents each!) when the alternatives cost $3.00? The little math I did was convincing. I picked Women's Day, which had an enormous circulation of several million. I bought a small ad for around a thousand dollars. It was a heck of a lot of money to me, but I figured I only needed 200 orders to break even. If only 1 million subscribers read my ad, I needed just a .02% response rate. Just two out of every ten thousand. Can't miss.

Well, I got perhaps one or two orders, total. In my certainty, I hadn't stopped to ask some vital questions. How many subscribers actually read through the classified ads in the back? How many of those readers ever order anything from them? Were all these one-recipe-for-$3.00 ads I saw actually getting any business? (Probably not, I think now.) A little scuttlebutt mining would have served me well.

The silver lining in this cloud was that I learned some important lessons about jumping to conclusions.

I've noticed that investing in the stock market also offers many chances for people to jump to a conclusion prematurely.

In fact, conclusions about the entire market can be wrong. For example, reading the Fool's morning news product, "Breakfast with the Fool," you might learn that a bellwether company has announced that it expects to miss earnings estimates. Many people might assume that this company's stock is destined to take a big spill during the day. That's not necessarily the case. Perhaps the market has been expecting this news and it's already been built into the price. Perhaps investors actually expected the news to be worse. Stocks can sometimes go up on bad news.

I've jumped to many conclusions in investing, myself. When I was a more bone-headed investor than I am today, I would read an article on an intriguing company in a magazine, read a little more about it online, and then buy. Without ever comparing it to its industry peers. Without ever considering what its risks were. Without ever evaluating my portfolio as a whole, to see if I was perhaps a little over-weighted in one sector or another.

Some people believe in some uncalled-for certainties with our trusty Rule Breaker Portfolio, as well. Look at some past years' performance, compared with the S&P 500.

RB vs. S&P 500
1995: 68% vs. 34%
1996: 43% vs. 20%
1997: 26% vs. 31%
1998: 199% vs. 29%

Imagine someone at the end of 1996 saying to herself, "Gee... these Fools have got a market-beating system down pat. I think I'll copy their trades -- I'm bound to do well." A year later, she sees that the Fool Portfolio didn't manage to beat the S&P 500 in 1997. Disheartened, she gives up on Foolery. Of course, the next year, the Fool beats the market. She groans. She's just been guessing, really, and she guessed wrong. Thinking she was being Foolish, she was being most un-Foolish.

The portfolios you'll find in our trusty Hall are meant to be teaching portfolios. We don't expect people to mimic our trades blindly. Instead, we hope that by explaining in great detail why we buy and sell what we do, and what we think of our holdings as time marches on, that readers can watch and learn. Learn how we're evaluating companies (the various portfolios have different styles and focuses). Learn from our successes and from our mistakes, too. (Because after all, we're still learning, ourselves.) For best results, you should be reading, learning, thinking, and questioning along with us.

"The only certainty is that nothing is certain." -- Pliny The Elder

There's little certainty in Fooldom, except the certainty that we'll keep doing our best and that we'll all keep learning together. We're pretty confident that over the next few decades, the stock market should continue to return an average of about 11% per year. Because that's what it's done in decades past. What happens tomorrow is highly uncertain. What will happen in ten or twenty years, relying on averages, is much less so.

We're confident that in the long run, truly Foolish investors should thump the S&P 500 soundly. But that's not a 100% certainty. We thought that buying ATC Communications and Sonic Solutions were smart moves, too. Like other mortals, we make mistakes. But fortunately, in the world of investing a few home runs can render fairly insignificant a few blunders.

I'll close with the words of good old Ben Franklin, who said:

"In this world nothing can be said to be certain, except death and taxes."

[Warning: shameless promotion coming up...]

Ben was surely referring to the certainty that some 200 years later, a brave little company called "The Motley Fool" (well, perhaps he imagined us as "Ye Motley Foole") would issue an Investment Tax Guide, to help individual investors make sense of the madness that is our tax code. It's proving to be a popular little number in FoolMart -- check it out and see if it might be of use to you.

Fool on!

[This Fribble first appeared as a Fool Portfolio report on 11/3/98.]

[This has been another installment of Selena's Fribbles. If you're a glutton for the absurd, check out her archive.]

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