As sure as I live and breathe, I knew what was coming next.
A company in our Motley Fool Hidden Gems small-cap investing service, Ceragon Networks, had more than doubled in the few short months since I'd recommended it in our July issue.
That's a great result, of course -- we found a little-followed small company with a great wireless technology sitting in a sweet spot in the telecommunications space. It caught fire as the general investing community discovered its worth ... right after we did.
But, as with any company that rises that quickly, at some point the stock will start its trading day a little lower, and then fall ever more rapidly, as the multiple forces of those who think "someone knows something," the technical traders, the folks with sell stops, and the short-termers all simultaneously decide that they want out. In Ceragon's case, the company closed down 17% in one day.
Admittedly, some sellers must have moved on because Ceragon hit their fair-value target. I think they're wrong, but they're entitled to their opinion.
What came next, you ask?
Weeeeeellll, as Ceragon's recommender, I suddenly got flooded with emails from people wanting to know what was "wrong" with the company.
Got that? To recap: Up 103% in about three months, but one big down day, and something is "wrong."
I'll tell you what was wrong with Ceragon -- it had a bunch of investors who were focusing on all the wrong stuff. Instead of focusing on its business, they were focusing on its share price. Up means they were right; down, wrong.
As far as dementias go, focusing too intently on ever-wiggling, rarely meaningful share prices can be a pretty expensive one.
Want a lower-beta stock?
That's right. I said "rarely meaningful." And I called it costly. In a famous study, researchers Terrance Odean and Brad Barber looked at data from thousands of brokerage accounts, determining that the decile of investors who traded the most also generated the poorest overall returns.
For this reason, Peter Lynch famously noted that even though Fidelity Magellan turned in market-crushing returns during his time managing the fund, most people who were invested in Fidelity Magellan actually lost money. Too many people jumped in just after the fund had done particularly well, just in time to catch one of his inevitable lulls.
In this day and age of instant market access from anywhere, the neither tried nor true way to lower the volatility of the stocks you own is to quote them less often. The fact is, the desire to quote stocks many times a day (or hour) comes from a deep-seated human need to feel in control.
Well, guess what? You're not. All that stock-quoting is only driving you crazy. One of the best things you can do for both your sanity and your portfolio returns is to be a little more negligent.
And now that I've saved you all this time ...
Since you've been burning up all of this kinetic energy fretting about the uncontrollable, let's refocus our energy on things that are firmly within our control. Worried about market fluctuations? They're inevitable. What the great investors focus on is staying away from P-LOC, or "permanent loss of capital."
The best way to avoid P-LOC is to not do stupid things. Remember that time you were going to do something stupid, and then someone came up to you and said, "Hey, don't forget to not do that"? Avoiding P-LOC is a lot like that. Amazingly, if avoiding it becomes the center of what you do, you'll be in the distinct minority of investors, most of whom forget to not do stupid things all the time. To be blunt: Stop being stupid, and you'll make more money.
I've already told you about quoting your stocks less often. Even large companies like Celgene (Nasdaq: CELG), Valero (NYSE: VLO), and EMC (NYSE: EMC) will have huge 52-week ranges. (In the past six months, EMC went from $16 to $25 per share, and then back again.) Small-cap companies like Ceragon will tend to move even more on a percentage basis. But that's the noise part. The "making lots of money" part comes from determining how much you think a company is worth, and then waiting for the stock market to send you a meatball to clobber.
It's the advantage individuals have over institutions
P-LOC is what happens over time when investors focus on all of the wrong stuff. Believe me, getting a grasp of the right stuff is hard. Why waste time on the wrong stuff? In 2005, person after person told me that I needed to take another look at Midway Games (NYSE: MWY) because the company was doing so well. Problem was, the company wasn't doing all that well; its stock was.
Institutions have companies they must own; they also have ones they can't own. Companies like Yum! Brands (NYSE: YUM), Urban Outfitters (Nasdaq: URBN), and even JPMorgan Chase (NYSE: JPM) have had bad stretches, thus becoming companies that funds were too embarrassed to own. Incidentally, this happened at the same time when the potential for P-LOC at each of them was at rock bottom.
We at Hidden Gems tirelessly search for just these kinds of opportunities, and our results have savaged those of the market.
We haven't gotten it right every time, of course. But by focusing on whether the price offered gives us protection against permanent loss of capital, we offer the ability to invest in small-cap companies at lower risk. And that focus on both risk and gains has paid off with extraordinary returns for our subscribers.
Motley Fool Hidden Gems has achieved gains of 35% since inception in 2003, versus 14% for like amounts in the S&P 500. You can try the service free for 30 days and have full access to all of our research, ideas, and more -- including our top five small-cap stocks for new money now. Click here for all the info.
This article was first published Oct. 18, 2007. It has been updated.
Bill Mann does not own shares of any company mentioned in this article. JP Morgan is an Income Investor recommendation. The Motley Fool has a decidedly non-stupid disclosure policy.
