One broker I know was fond of saying, "If you hold on to a good stock long enough, you'll end up making money." Coming from a stock broker, this was meant to be a bit tongue-in-cheek, but it actually makes sense: In the long term, strong stocks with good fundamentals win.
So the key word here is "good." For the stock to move higher, investors must have reasons to like it. They look at the business' future promise and determine whether or not today's price fully reflects those expectations.
But because so many analysts and investors do their homework, they are rarely collectively wrong. Without having a special knowledge of the future, the market processes all available information and makes a determination about the company's future -- and a stock's ultimate direction is a reflection of that collective opinion.
Of course, the markets can and do misprice individual stocks and even entire sectors -- this is what stock picking ultimately relies on, and it's exactly what we do in my premium aggressive growth investing newsletter, Game-Changing Stocks. But it always pays to listen to what the market tells you, even if you believe that your analysis and assumptions are correct.
A couple of simple rules help here.
First is diversification. Obviously, you shouldn't put all your money in only a few stocks, or even a few sectors. Spread your risk around -- not only because you might be wrong, but also because changing market and economic conditions affect different sectors in different ways.
The second rule is to be extremely careful when doubling down on your bets. While sometimes you can pick up more shares of your favorite investment on the cheap if you see excessive value where nobody else does, it always makes your position bigger relative to the rest of your portfolio and, therefore, riskier.
In fact, doubling down can get you in real trouble.
When Risk Goes Wrong
Valeant Pharmaceuticals (NYSE: VRX) is a prime example. The stock, which was trading at about $10.50 as I write this, was a favorite of many growth-oriented investors just a few years ago, as its price went up five-fold in 2012-2016, from about $50 to a high of around $260 in April 2015.
Bloomberg calculated that, when large hedge fund Pershing Square Capital Management, run by activist investor Bill Ackman, exited its huge position in VRX on March 13, it lost $2.8 billion -- only counting the shares it owned at the end of 2016.
The New York Times believes that the hedge fund's total losses from Valeant may have been as high as $4 billion.
Regardless, others have lost money after doubling down on Valeant too. At least one mutual fund has suffered mightily as the VRX share price cratered.
Sequoia Fund (NYSE: SEQUX), a fund that was known and recognized for its large bets, went too far with Valeant. At some point in 2015, the stock accounted for more than 30% of the fund's total assets. A resulting shake-up at Sequoia made headlines last summer, and its longtime manager Bob Goldfarb had to step down.
Both Pershing Square and Sequoia fund had probably been doubling and tripling down, buying more and more as VRX was falling -- which is how they ended up with stakes that large. Clearly, though, it wasn't worth it. The risks were growing, but these two well-known investors continued to spend good money on a bad investment. In this case, high risk didn't correlate to higher returns.
How We're Mitigating Risk With Game-Changing Stocks
Here's my point: If it can happen to these "experts," then you better believe it can happen to you, too.
Losing on a position is one thing. Stock-picking implies that some positions won't work out. Still, had these two funds followed the two simple rules above, much of the pain could have been avoided.
This doesn't mean that investors should be getting out at first sign of trouble, though. Again, some volatility is unavoidable. Smaller, riskier stocks -- like the ones my subscribers and I own in my Game-Changing Stocks newsletter -- tend to be more volatile by nature.
But by diversifying among 13 current positions in our portfolio, we're able to spread some of the risk around. So when an investment idea doesn't work out, we can assess the situation, confident in the knowledge that whatever we decide, it won't disproportionately affect the overall portfolio.
As an example, let me show you a table of the closed trades my readers and I have made since I took over the helm of Game-Changing Stocks.
While I'm proud of the winners we've booked so far, you can see in the last line of the table that AMAG Pharmaceuticals didn't work out for us. It happens. We can't be right every time. But readers who followed every single one of these trades are likely doing quite well for themselves.
But what do you do when you believe the market selloff creates an opportunity? How do you play that?
Here's one possibility. A somewhat safer way to benefit from temporary stock woes is to "double down" on the whole sector rather than a single stock.
You diversify your bet on the company by buying competitors that might also be suffering from the market's inefficiency. You might still be wrong, but with this move you reduce the likelihood that your portfolio will be hurt by one single company's problems (whether it's an inferior product, rogue management or regulatory problems) in an otherwise strong sector.
That's the approach my readers and I took in the most recent issue of Game-Changing Stocks. It's also the approach I'm taking in my most recent research report.
While I can't get into all the details about the report, I can tell you that it has to do with eccentric billionaire Elon Musk's most recent secret project. It'll revolutionize an entire industry -- just like he did with online payments, electric cars and space travel. What's more, there are a number of publicly-traded companies that will help make it possible. I'm recommending investors get in on them now. To learn more about this new project, check out the report here.