When I was 15, I was convinced that I was at least as smart as most adults. I was also convinced that I knew everything worth knowing about the world. So, naturally, it seemed inevitable that I would accumulate great wealth in the stock market. To that end, I asked my parents to authorize an investment account for me at a full-service broker, and I deposited my $800 of savings.
Fish
Eagerly, I met with my broker to buy a penny stock. Because that stock had bounced between two prices for a few days, I was convinced that it would continue to do so. I'd buy at the low price, sell at the high price, and retire to the Caribbean just as soon as I finished high school. It didn't matter what the company actually did. (I really had no clue.) All that mattered was the stock fluctuations. I was a 15-year-old master of technical analysis.
Imagine my surprise when the broker suggested that my strategy might not be perfect. Conspiratorially, he whispered to me that a different company, a mining exploration firm, had just consolidated its shares -- whatever that meant -- and was "poised to skyrocket." He typed something on his computer and pulled out a stock chart. I was incredibly impressed; such charts meant he probably knew even more than me. Upon his recommendation, I bought shares. The commission was $100.
I checked the newspaper every day, but the stock didn't move. It felt like I was waiting forever. Then, three weeks after I bought, the stock went up 50% in a single day. I sold immediately. My commission was $100, which means that I had made $150. Weeks later the stock fell to one-tenth of my purchase price.
Despite the victory, I wasn't pleased. Even with such a large jump in the stock, I didn't make much money. Plus, I didn't really understand why the stock jumped, or why it collapsed, and that bothered me. If I couldn't understand the logic, it seemed unlikely to be a recipe for wealth. So I stopped investing.
Chimpanzee
Fast-forward to my second year of college. My roommate invested in the market, and he told me how to open an account with a discount broker and make trades for only $30. A bargain! He also pointed me toward a mining stock that his broker recommended, which almost immediately doubled. Clearly, I had to buy some of these mining penny stocks.
This time, my strategy was more sophisticated. I subscribed to a mining newspaper and actually read up on the companies. It turned out that my second year of college was a great time to speculate in mining -- within a year, diamonds were discovered in northern Canada. I eventually worked out my first contrarian strategy.
Mining companies in northern Canada move drilling equipment to promising drilling areas by building roads out of ice. Consequently, they drill in the winter and release results in the spring. My strategy was to purchase the stock when nobody wanted it (summertime), then sell right before results were released and excitement was high (wintertime). It seemed to me that the probability of hitting diamonds was low, so it was better to sell into speculative hype than bet on positive drilling results.
That strategy brought me returns of 40% per year. But, more importantly, I learned several lessons. First, there was value in understanding a company and its industry. Second, patience could be profitable. Unlike most people, I was willing to hold a penny mining stock even though it was likely to have no news for eight months. Third, buying when nobody wanted a stock and selling when everyone did could be lucrative.
Neanderthal
Some real problems with this strategy became apparent a few years later. For starters, one of my speculative stocks, AberDiamond (NASDAQ:ABER), actually found diamonds. Of course, by then I'd already sold it for a buck -- a 50% profit. The stock is now above $34. Ouch.
Also, mining fell out of favor because of low metals prices, fraudulent exploration companies, and the beginning of the Internet bubble. When that happened, the strategy stopped working, and I lost money. That exposed another flaw: The process wasn't very logical. My profits were completely dependent on hype and the willingness of people to make speculative buys.
Obviously, I needed a new strategy. At the time, the "natural" strategy would have been to jump into Internet stocks; everyone, it seemed, was making money from tech stocks. But my experience taught me that I'd much rather be selling into hype than buying hype, so I was reluctant to go there.
Instead, I picked up some books and read about Benjamin Graham and Warren Buffett. I began to realize that stocks weren't simply scraps of paper -- they represent an ownership stake in a company. I learned to distinguish a good business from a bad one, and how to value a stock. Most importantly, I learned that it's possible to buy stocks for less than their fair value. Rather than just speculating on which stocks would go up, I started buying undervalued stocks.
I met people on The Motley Fool message boards who shared the value philosophy and who were able to sniff out the technology bubble. When the bubble popped in early 2000, I owned a few tech stocks, but most of my portfolio was piled high with undervalued old-economy stocks. I owned REITs like Healthcare Realty Trust (NYSE:HR) and Hospitality Properties (NYSE:HPT), retailers like J.C. Penney (NYSE:JCP), and an assisted-living company, Sunrise Senior Living (NYSE:SRZ). My focus on value investing not only saved my skin, but it also led to decent profits.
Homo sapiens
Since then, my confidence in the superiority of value investing has only increased. I've learned how Buffett makes such spectacular profits buying well-established companies like Moody's (NYSE:MCO) and Wells Fargo (NYSE:WFC). These companies may not be as exciting as the average tech company, but, now that I understand value investing, I know why they're more likely to outperform most tech stocks over the long term.
I've also met Philip Durell and become part of the community of value investors he has built around the Motley Fool Inside Value newsletter service. At this point, Inside Value has been running for a little more than a year. Philip has made 24 stock recommendations, and those picks are, on average, beating the market by more than 6 percentage points. The current issue reviews every recommendation from the past year and points out the top nine stocks for new money.
Just as important as the picks, however, is the newsletter's community and educational philosophy. I'd have reached this stage in my evolution as an investor significantly faster had I been a part of such a community earlier in life. Even as an experienced investor, I continue to learn new perspectives on value investing, which have helped me identify undervalued stocks. This sort of ongoing education could be the most profitable component of the Inside Value service. If you want to see what I mean, you can sample the service for 30 days -- for free.
Just like when I was 15, I still believe that the stock market can lead to great wealth. But now I know how.
Richard Gibbons considers it a small miracle that he didn't lose all his money early in his investment career. He does not own any of the securities mentioned in this article. Moody's is a Motley Fool Stock Advisor recommendation. The Motley Fool has adisclosure policy.
