As investors, it's easy to play the "what if" game. If you'd only bought shares of some high-flying stock 10 years ago, then you'd be set for life. It would be like winning the lottery.
Dreaming of huge riches is part of the psychology of investing. At the same time, though, it's important to be realistic about your expectations, or else you'll fall into traps that could cost you your life savings. Instead, if you give yourself the proper outlet for your high-risk plays, you'll ensure that you'll be financially secure, even if you turn out to be wrong.
Assembling the perfect storm
In hindsight, it also seems as if stocks that produce lottery-like gains were destined to do so. Apple makes a good example. Looking at the mania over iPhones and iPads, it seems like common sense should have told everyone that Apple shares were a screaming buy when those products and their predecessors first came out.
But the key thing to remember is that a huge number of things have to go right for a stock to emerge from the thousands of peer companies that don't share the same level of success. For every blockbuster stock, you'll find dozens of companies that never even got to the point where they traded publicly -- and plenty of public companies whose ideas never really got off the ground. And there's no secret formula that says which one will win.
For instance, take priceline.com (Nasdaq: PCLN). Coming out of the tech bust, the online travel site had lost 99% of its value. Competition from Expedia (Nasdaq: EXPE) and Orbitz (NYSE: OWW) seemed an insurmountable threat to priceline's profitability. But as it turned out, priceline's unique "name your own price" model made it a winner. Everyone involved in the transaction got what they wanted: Customers got lower prices, and travel-related companies got to shed excess inventory without broadcasting loss-leading promotions to their entire customer base.
In priceline's case, being first mover was a huge advantage. But in other cases, being early can cost you. Ballard Power (Nasdaq: BLDP) was a leading company in early fuel-cell technology, pioneering alternative energy that has now become much more prevalent. Yet in this industry, later-generation stocks such as First Solar (Nasdaq: FSLR) have provided the huge returns, while Ballard's share price has languished.
You can see this scenario repeat countless times in history. Dell (Nasdaq: DELL) and Gateway went head-to-head on direct-order computers, but only Dell emerged victorious from that fight.
Playing the big game
Even though you can't count on identifying the next multibagger stock, you don't have to stop trying. Even if you lose everything on several of your picks, it only takes one big winner to make up for those losses.
Now, it's true that by hedging your bets, you're essentially guaranteeing a certain level of failure. But by improving the odds of finding a winner, you'll stand to benefit far more often -- and greatly reduce your chances of suffering a catastrophic loss of investing capital.
In fact, many investors split their portfolios into two parts for precisely this reason. They have a core portfolio that might simply use broad-market index investments like the Vanguard Total Stock Market ETF (NYSE: VTI) as well as similar funds to cover other asset classes. But then, with a significant but not vitally necessary portion of their overall savings, they look at hundreds of individual stocks and choose the ones that look most promising to them.
Be a winner
Just like tossing a dollar at the convenience-store clerk might seem like your best chance to become a millionaire, betting everything on a "sure-thing" stock appeals to your inner sense of greed. But except for a lucky few, counting on finding a lottery stock is a losing proposition. You'll be better off balancing your desire for big gains with the discipline and certainty of a longer-term investing strategy.
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