Why You Can't Win in the Stock Market Without Risk

When investing in the stock market, every company has a risk, and it's all about managing that risk to be successful. In this video clip from "The Morning Show" on Motley Fool Live, recorded on Feb. 14, Fool.com Director of Small Cap Research Bill Mann, advisor Jim Gillies, and advisor Jim Mueller chat about the software company Confluent (CFLT 0.04%) as a recent example of investment risk.

Bill Mann: Whenever you buy any company, any company, the risk part that we write is not proforma. It's not what we've got to say something. Every company has a risk. They all do. Companies are all dysfunctional in some form. Some of them hide it in the form of profitability better than others. Every company has a risk. By the way, the way that you can lower your exposure to the type of risks that exists and is extant in a company like Confluent is to own things like utilities but the risk there is that you're not taking enough risk.

You've to get to know we're not kidding. Yeah, and Gordon, I know you've been around a while. I mean, I know you are a BFOF, and you're one of us, but you've got to know that just because we recommend a company that does not ever mean, ever, ever, ever that the risks that are extant with the company's performance do not matter and have not gone away. Ever. Yeah, that advice was spelled out explicitly in the Confluent write-up.

Jim Gillies: Again, not picking on Gordon either.

Mann: No, not at all.

Gillies: Not at all. I want to explore that risks are spelled out, and you said they're not boilerplate.

Mann: Yeah.

Gillies: I think that's the best part of what you said, I agree with everything you said, but I think that's the best part. It's like we actually do agonize over this, and we really saw it, I'm going to speak for Herr Mueller here as well and he can tell me where I'm wrong, we really saw that back in the day in Motley Fool Options, and in fact, Jim and I have been on stage back when we used to do Fool events. But we've been on stage talking about all people like this, we're not picking on Gordon, I would wager that Jim, and I have engaged a little bit of misbehavior over the years is people focus on potential reward, and they kind of downplay potential risk.

Maybe that was magnified when you're dealing with securities like options, which can make or lose a lot of money in a fairly short period of time, but we would always see people emphasize the upside, and forget the downside, and it would get worse, that divergence would get worse, the more successful on the upside you'd been.

If you came in on your first option trade, and I hate the word trade, and I'm sorry to all of you, but on your first option trade, you lost money, you were probably wary, you were still taking it slow. But if you made money and like we're talking, significant yields or significant capital gains, depending on the style of options transaction you made.

If you made money on, say, your first 10 option trades in a row, I can almost guarantee you the first time you had a loser, that loser would probably wipe out a good number of the gains you've had in the previous 10, because you've gotten rewarded continuously for behavior where there was a risk, but the risk didn't manifest.

Jim Mueller: So, you make bigger, and bigger and bigger...

Gillies: Incrementally larger, I hate the word bets.

Mann: Yeah. That's what it is.

Gillies: But this company Confluent, I was today years old when I learned that Confluent was a company that existed and had been recommended.

Mann: Yeah.

Gillies: I'm not on the stock advisor team. I don't hang out over there. I don't read every REQ, sorry. Been looking at this but this is a high-risk potential hybrid work company. It's unfortunate that or maybe it's fortunate, it's unfortunate that it looks like because it's a fairly recent IPO, I think. But it looks like.

Mann: Yeah.

Gillies: You've hit the bumps early on in the lifecycle of this company. That again, like I said, with options when we would have that even though it sucks to lose money if you were with your burgeoning options investing career, it's actually, I would argue, better to lose it at the beginning rather than down the line after you've been rewarded.

Mann: Gordon, and I see that you're apologizing. There is no need to apologize.

Gillies: Gordon's good people.

Mann: No, it's all good. This is not a defense of The Motley Fool because we got a lot of mistakes in us.

Gillies: Oh, we've got more coming and don't know what they are. [laughs]

Mann: [Laughs] You wait till you see how big our mistakes in the future are, there going to be amazing. You think we've screwed up so far? No, it's totally fine. It's more than fine. It is why we are here and we spend this time together.

Just to know, you've got to know that every company that you are invested in has within it, its seeds of destruction or the seeds of disappointment, and the seeds of underperformance. It just is what it is and it could be as simple as the market is expecting an awful lot of this business, which is what, 50 times sales meets. The market is expecting an awful lot.

Now, just looking at Confluent and I'm just taking the revenue statement here. In 2020, the last quarter of 2020, they made $70 million in sales and they went to $77 million, $88 million, $102 million. Then this last quarter was a $119 million. That's a nice progression. That's 70% of sales growth year-over-year but for a company trading at 50 times revenues, that's what they've got to have and then some for a long period of time for the investment to work out.

Our stock advisor friends are saying because they looked, I guarantee you, directly at this valuation. They said, "It is worth it to have exposure to this company, even with that risk obvious to us." So, yeah. Gordon, all good, man don't apologize. Thank you but don't, that is exactly why we have these conversations.

Gillies: Also we're not afraid of these conversations.

Mann: No.

Gillies: Fire away. [laughs]

Mann: Seriously.

Gillies: Now, there is the caveat as well that if none of us recommended the company or know other company, we can only really talk in generalities because even the companies that we are passing familiar with, I'm passing familiar with Netflix (NFLX 1.74%).

Mueller: Yeah. There are a lot.

Gillies: I'm not going to defer to Mueller on Netflix.

Mann: Tell me that you are not already interested though, in a company that's technology is called Apache Kafka.

Gillies: Oh, 100% [laughs] I'm wondering where the large bug is now actually. [laughs] Is it in my house? [laughs]

Mann: Yeah, exactly.