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The Hardest Part About Picking Stocks for New Investors

By Brian Withers and Brian Feroldi - Feb 10, 2021 at 6:53AM

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Unfortunately, this quirk is just a natural part of being an investor.

No one can predict the future. When you are picking stocks, in a sense, you are predicting that the stock will go up over time. Given enough research, you can choose companies with great management teams, industry tailwinds, and solid growth opportunities, but there's no guarantee that the stock will go up in value. Additionally, only a fraction of companies will beat the market. As a result, it's inevitable investors will often own stocks that are duds.

In this video from Motley Fool Live, recorded on Jan. 14, Fool.com contributors Brian Withers and Brian Feroldi discuss the odds of being wrong and why that shouldn't discourage you from investing.

 

Brian Feroldi: All right. My turn. A key lesson for me. You're going to be wrong a lot. Here is my CAPS score.

Brian Withers: A wonderful CAPS score.

Feroldi: If you notice, the accuracy rating there is 51.4%. Now, that spans about 15 years, and I am very confident that my accuracy rate now is much higher than it was in times past. But even still, the wonderful thing about CAPS and looking back at your own stock history is you learn that no matter how confident you may be in a company, you're going to be wrong a lot. Period. You will.

There is no such thing as, this company is guaranteed to succeed, even if you've convinced yourself of that. If you look back at your own history, you will learn that you are wrong a lot. So judging by this, my accuracy rate with picking stocks that beat the market is roughly 50-51%, which means my long-term history as an investor, I am slightly better than a coin flip.

Withers: There you go. [laughs]

Feroldi: That has taught me, don't go overweight. No matter how confident you are, set rules for yourself to make sure you don't go all-in on one company because if you go all-in on one company and it just happens to come up that you are wrong, you can get hurt pretty badly. Brian, can we go to the next slide?

Withers: Yes. Here we go.

Feroldi: This is roughly the odds that you are going to be correct. A few years ago, J.P. Morgan did this wonderful 30-year study where they looked at every single company in the Russell 2000 or something like that, and they said, of all the public companies, what are the odds that any given company is going to lose the investor money, beat the market, make the money, or be a big winner? This is the data that they came out with. Now, it depends on what sector you are going in. Some sectors have much higher percentage of winners and much lower than others, but overall, I love this data because it says, if you pick any given stock, what are the odds that you are going to lose money randomly?

If you're randomly picking stocks, the odds that you were going to lose money on that stock are 40%. Forty percent of the time, that stock is going down from where you bought it. Significantly down, too, it stays down. Twenty-six percent of the time, the stock will go up, but it will lose to the market. So you will make money, but you will be better off buying an index fund.

Twenty-seven percent of stocks beat the market by a little bit, so you are right to own them, and only 7% of stocks are mega winners, and those seven percent out-of-stocks drive the vast majority of the market's returns over time. I just love this idea as a rough framework for judging your own results.

What this tells me is that roughly, any given stock that you pick has a two-thirds chance of losing to the market and a one-third chance of beating the market. Again, that's how often you're going to be wrong if you were just blindly picking stocks. So don't be hard on yourself if you find that for every 10 stocks you buy, five of them are losers. That's actually better than average. Your system is working, but that's a really hard thing to internalize.

The best analogy I can think of is baseball. Somebody gets up to the plate, and they got on base 40 percent of the time, and they hit a home run one out of every 10 times, they get up to bat, move over Babe Ruth. You are the best baseball player of all time, but that still means you're going to strike out and fly out a lot. You have to get comfortable with that. If you're an investor, you're going to be wrong a lot.

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