I must get the email about once a day.
How dare you say that about _________?! (Pick one: Taser, Ipix, Sirius Satellite Radio, Altair Nanotechnolgies.)
Don't you realize that _________ (stun guns, security cameras, satellite broadcasts, nanotechnologies) are the next big thing?
How I usually respond: "Uh huh. Good luck with that."
What I usually leave unsaid: "You're going to need it."
It's not that I don't enjoy investing in companies with the capacity for monstrous growth. I do. But I keep these holdings small, because too much can go wrong with the next big thing. Finding it, and paying the right price, is far more difficult than anyone lets on. Here's why.
The next big thing may be neither big, nor next, nor even much of a thing. For every Microsoft (Nasdaq: MSFT) out there, there are dozens, if not hundreds of wannabes that crashed and burned. How do you tell them apart? It's not easy. If there's such a thing as a superior crystal ball, I haven't seen it. I certainly don't have one myself, and I'm willing to bet most of you don't either. Anyone remember Iridium? The satellite phone biz seemed like a great idea to me, and to plenty of happy investors. Who wouldn't want a phone that worked anywhere? It turned out that most people didn't. Oops. By 1999, Iridium was toast, taking billions of dollars down the drain.
You'll probably be late to the party anyway. When next big thing's CEO is on the cover of the magazines, and the guy washing your car is telling you to buy the stock, it's probably too late. Consider the hype at Sirius (Nasdaq: SIRI). By the time the Howard Stern hysteria hit and the new management got the public whipped up to a frenzy in December, the easy money was gone. Since then, the stock has shed 40%, and it's still wickedly overpriced. Why would I say that? Because...
...the next big thing is always overpriced. You know why? Because it's the next big thing! Everybody wants it! No matter what you pay now, the story goes, it will seem cheap in retrospect, because the next big thing will grow so quickly and become so huge. The trouble is, that attitude can get your portfolio killed. Do we need to talk about Taser (Nasdaq: TASR)? Wow, it was growing at triple-digit rates! Gimme that market order. It'll look cheap later. Really? I'm not so sure 50-60-100 times earnings seems so smart in retrospect.
The next big thing might not make any money, even if it's "successful." What do I mean? There are companies out there that achieve a great measure of success in the marketplace but rarely scrape together a dime to repay shareholders. Martha Stewart Living Omnimedia is one. TiVo (Nasdaq: TIVO) is an even better example. Everyone likes TiVo, right? Well, everyone except those who've held the stock since day one. What happens when the realization finally hits that the next big thing isn't making money? The shareholders share the losses. And those can be steep. The long-term TiVo chart is an abject lesson in the harsh realities of faith in the next big thing. This is the risk with something like XM Satellite Radio (Nasdaq: XMSR). I've no doubt it'll be around for a while. But whether it makes any money? Still up in the air, and a long way off if it happens.
The sickness
Why do people make these kinds of mistakes over and again? Greed may be a part. Everyone likes money, right? But I think it's more than that. My guess for the real reason is this: Hubris. Everyone loves to think he knows more than the next guy. Everyone loves to think he's in front of the curve. And the trouble with that pride is this: It don't goeth before a fall. In the stock market, pride leadeth directly to the fall. If you're smart, it will go afterward.
The cure
Here's a modest proposal, one we espouse at Inside Value. Toss the pride. Admit your limitations. Concentrate on the obvious. And limit your risk.
I have no faith that I can see the future better than anyone else. But there's a secret Wall Street won't tell you: You don't need to. You won't need to, because you're going to concentrate on obvious stuff that you can actually measure, like free cash flow, market position, and price.
Take Nokia (NYSE: NOK) late last summer. It was a wounded giant, but one that had great balance sheets, world-beating market share, and continued to produce massive amounts of cash. Those who bought back then -- and I'm glad I was one of them -- didn't need to see the future, or predict when Nokia would go back up. We only knew that the odds were huge that it would. And it did, in short order, earning me a return in the neighborhood of 50% over a few short months. There's a similar situation brewing with Inside Value pick Coke (NYSE: KO), which is up 11% since it was highlighted in January.
And the best part of both these investments is that the downside risk was limited. It was limited because everyone already expected the worst, and had bid the stock down accordingly. It was limited because the firms have stellar balance sheets and brand names that command market share the world over. It was limited because the firms turn a large portion of their sales into actual cash and use the excess to reward shareholders through dividends and buybacks.
The Foolish bottom line
If you're interested in repeatable, time-tested methods for market-beating returns, stop looking for the world-beater of tomorrow. Instead, look for the obvious thing right under your nose. Anyone who's followed the stock market for even a brief period knows that it's a fickle beast at best, and an absolute psychotic most of the time. Paying bargain prices for top-notch companies is the best way to build wealth over time, and better yet, it helps you avoid those stomach-churning screamers that can turn the next big thing into the next big joke.
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Seth Jayson
likes growth, but he'll take a lead-pipe cinch on a stable cash-maker any day of the week. At the time of publication, he had positions in no company mentioned. View his stock holdings and Fool profile
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