Investors who pick individual stocks want to beat the market. Otherwise, they could just buy a fund that tracks the performance of the market and be done. However, more than beating the market, investors who pick individual stocks want to always be right. To the first desire, the average investor can beat the market by using good and simple investing principles. However, to the second desire, being right all the time isn't realistic.
In this video from Backstage Pass, recorded on Sept. 9, Motley Fool contributors Jason Hall, Lou Whiteman, and Jon Quast talk about this important issue. More importantly, Jason introduces viewers to a powerful truth in investing: Often, 80% of your gains are going to come from a mere 20% of your stocks. And that's why selling a winner too soon can be devastating to your long-term returns.
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Jason Hall: But what I wanted to do, guys, is I want to share from yesterday something that I shared at the end of The Five that I think is relevant here, and it's really interesting. We're using this slot here on Backstage to try to cover earnings for hundreds of companies. The companies that are in so many of the services that our members that have access to Backstage subscribe to. It's a ton that we have so many different people coming on or talking about them, and we're doing it to meet that need and demand from our members to get relevant, timely information about the companies they own.
But sometimes, it's just impossible to keep up with everything, every single company you own. So I decided yesterday to share this neat little statistic about my portfolio. I own 128 separate stocks, individual stocks, and two index funds. This is between my accounts, my wife's accounts, our retirement funds, our taxable savings, our taxable investing, all that kind of stuff. And I was looking at it and just looking at my two biggest winners, and then I said, "Well, let me look at all of my losers." So I looked at every stock in my portfolio as of close yesterday that had lost value. There were 34 of them. Either of the two biggest-gaining stocks in my portfolio, either one of them, have won big enough, have generated enough gains, to cover all of the losses of those 34 stocks, plus half again, those losses, in extra gains. Either one of those two stocks alone would more than cover for those losses.
So I thought, well, that's kind of cool. Then I decided, well, 34 is an interesting number, because it works out to about 25% of the individual stocks that I own. And I decided, well, let me look at my biggest 34 winners. What are they worth in terms of gains in my portfolio? So again, it's 25% of the individual names, are in those 34 holdings. Those 34 holdings, those 25% of my investments, 80% of my total returns. Eighty percent.
Now, here's the thing. You start looking in a lot of these services, like the Everlasting service and some of the other services out there. You start reading those rules to winning. Something that's abundantly clear is that you should have an expectation that, like, 80% or more of your gains are going to come from 20% of your stocks. So as much as that might sound like, well, that's crazy, it's, like, right on track. So it's like a feature, and I just thought it was really interesting in real time looking at my portfolio of investing for the past 13 or 14 years, it's basically doing what the Gardner brothers have said, "These are the expectations that you should have." And I think the key thing about it is it tells me, focus on owning great businesses, as many as you feel comfortable with. Don't try to be precise, and let your winners win. And it's working for me, Spiffy. I hope it continues to work for you.
Lou Whiteman: Quick question, just curious. Is that just red versus green, or is that relative to the S&P 500?
Hall: That's just red versus green.
Hall: I'm not trying to get cute and look at weighted returns against any index. That's just straight-up returns.
Whiteman: For what it's worth, you're doing a lot better than I am. I think I have 16 reds of 78 stocks. Total red is 334%. I have about five stocks that singlehandedly are up more than the combined of the total red. Just doing, spreadsheet fun, but yeah. To your point, one good winner can take out a lot of...
Hall: And I think, sometimes, Jon, I'd love to hear you weigh in on this too. I think sometimes, and I apologize we're getting off the earnings topic here, but I really wanted to talk about this. I think it's really relevant. Sometimes, we try too hard to get precise because somebody could look at that and be like, "Well, why didn't you buy more of those two stocks, you big dummy?" Because I didn't know they were going to be the big winners! That's the obvious answer. I bought those other stocks for a reason. I thought they would be big winners.
Here's the big one I want to point out. Here's the big one I want to point out. I'm going to go back that chart for RH (RH -0.12%). Again, March 20, David Gardner recommended it in Rule Breakers. It essentially market performed, and then was a losing investment for all of 2016, almost all of 2017, and then again, 2018, and it underperformed the market for a lot of time before the quality of the business shone through. Its ability to generate these strong operating earnings shone through, and investors have been rewarded for that patience in following the business, not just the stock price. I promise a lot of Stock Advisor members sold here. A ton did. You don't know what's going to happen next, if you don't follow the business, you don't understand the business. And that's how you get through this if you understand how things are working, and then you get to that.
Jon Quast: Jason, it's interesting that we're all talking RH, because what I want to say is just how important it is what you're saying to not touch, as little as possible, just don't mess with it. I was a new investor back when David first recommended RH. Back then, I was looking at all the stocks that he was recommending and thinking too high, too high, too high, too high. RH dropped, like, 60% from his recommendation. And I thought that's the one I'm going to buy, because it's cheap. I bought RH at $30. Then I sold it when it got back to David's recommendation of around $90, because I thought I was really smart and I had just tripled my money. I exchanged the three-bagger for a more than 20-bagger. Had I just not messed with it, not try to get cute, not try to be smart, that would've been one of those stocks in my portfolio that would be driving those returns right now. But I had to mess with it and one of those 20% that I could have had is not in my portfolio anymore.
Hall: Lou, how many times do you hear that and you look at your own situation, and nobody ever says, "Yeah, man, the dumbest investment I ever made was buying that stock." It's almost always, "The dumbest thing I did was selling that stock."
Whiteman: And this is the thing. Don't sell.
Hall: Be glacial. Sell for two reasons. This is the way I think about it. Again, this is not specific to anybody, but this is the best advice anybody ever gave to me. Sell for two reasons. No. 1, the thesis is clearly broken and you no longer want to own this business. Or you've reached your financial milestone and you're selling to pay for whatever you were investing to pay for. You're retiring; you're sending your kid to whatever it is.
Every investing mistake I've made that has meaningfully impacted my life is because I sold because I thought it was overvalued or it was expensive, or I was getting cute, and I was going to time my way into better returns.
Whiteman: Right. Because again, you just don't know.