Stock Market Investing Lessons Learned April 2014

Just over one year ago I had a pretty big pile of cash sitting in the stock market - the result of a few years of extreme saving and frugality. But I was about to embark on a year of traveling abroad. I wanted to be completely in the moment while I was traveling with no commitments and no possibility of waking up to find that my savings were suddenly destroyed in a stock market crash. I wanted to have a year of being young and care free. So I sold all of my stocks and let my money sit in the bank as cash for a year. I checked back in with the stocks that I had owned previously, and by taking my money out of them a year ago, I missed out on a chance to more than double my money in a year. I had made very good investments in Google, ACMP and AE and they would have paid off. But instead I had the privledge of spending the 23rd year of my life having fun and being care free. I don’t regret that one bit. There are always going to be more opportunities to make money when I’m older, but I can never be young again. At the time that I had sold my stocks, I wrote down everything that I learned while investing in stocks. I’ve been meaning to publish those thoughts for awhile. Here they are.

What I’ve learned about investing this year:

Bubbles are very difficult to tell apart from reasonable speculation. Stocks are generally valued based on their future value, not based on current value. Thus, the market is driven by information asymmetry, speculation, and expectation, not by actual current value. This is not necessarily a bad thing, but the market must be viewed through this lense if it is to be utilized correctly.

The best (and maybe even the only way) to buy stocks is to buy them when they are undervalued and sell them when they are overvalued. This usually means that by the time a stock is getting hype and is being talked about, it is probably not a good time to buy it. I have two anecdotes to prove this point. This past summer, I purchased some shares of Apple because it was getting a lot of hype, it had solid fundamentals, and seemed like a good investment. Turns out that the stock price fell dramatically this winter and that by the time the rumors of how great a stock it was reached me, the price was already too high and it was overvalued.

The second anecdote was Google. I felt very strongly that it was a great company and I continuously observed Google producing amazing, high quality products. It seemed like every time I blinked they had made some UI improvement and released a new product. All this, and the vast majority of their revenue was generated from advertisements?! I figured that they had so many promising products on the line and that if they could just figure out how to monetize one or two of them, they could be creating entirely new revenue streams. That, and Google remains the number one desired place for computer science graduates to apply when they finish school. I bought a lot of shares because I truly believed in Google, even while nobody seemed to be talking about Google and some even suggested that it was not a very good investment. And the Price to earnings ratio was pretty low - only around 20%. Turns out the stock has done fantastically and the gains I’ve made so far with Google have more than compensated for all of the losses I’ve taken with other stocks.

TL;DR: Invest in companies that are doing great things but that nobody is talking about.

The next lesson I learned is to not invest in companies that I don’t understand or come into contact with on a daily basis. I come in contact with Google every single day: Google Drive (Docs), Gmail, Calendar, Chrome, Adwords… and even their other products - Google Glasses, self driving cars, chromebooks, are very easy to understand and are quite tangible. I can tell if the company is creating valuable shit because I can touch it and understand it. Same with Apple - it is and was a valuable company, although very overpriced. The investments that I made in abstract, enterprise-y companies have not done well. EMC may be an OK long-term investment, but it’s so difficult to really know what it’s worth because I don’t really understand it’s business model, it’s product, or it’s revenue streams. I invested in it because I associated it with Cloud Computing and Cloud Infrastructure, which is a huge emerging (or emerged) market that is growing like crazy and predicted to continue growing for a long time. But the stock has not gone damn near anywhere. It’s hovered at the same price since I bought it, plus or minus a dollar or two. The thing is, it maybe very well be a good company. It may be a great company - in fact, it probably is. Glassdoor reviews by employees suggest that most people enjoy working there. But regardless of how great a company it is, I can’t keep an eye on it because I don’t interact with it and will never hear rumors about it because the social networks that I am connected with never have a reason to do business with them. I don’t know very many corporate or enterprisey people. While it may or may not be a good investment in a general sense, it was a poor investment for me personally. And even if it the cloud computing industry is exploding, that doesn’t necessarily mean that EMC is going to explode. It’s entirely possible that EMC gets squashed by other, better cloud computing companies, like Amazon. In fact, this is probably true, because Amazon (and Rackspace) seem to be what many of the newer and more successful companies these days are using - the very companies that will probably be replacing the older generation of corporate companies.

The other trend that I’m noticing in the world is this trend of distributed innovation rather than hierarchical innovation. Stephen Johnson has written a book about this very phenomenon, called Future Perfect - a spectacularly spot-on book. Most innovation now happens in small bursts by small teams that work together in a networked way. Rather than innovation happening in large corporations in a top-down hierarchical effect, innovation and wealth creation is increasingly happening through small startups that are free to try radical, new things. In fact, because of this phenomenon, I kind of hate that I’m restricted to investing in publicly traded companies. Once a company goes public, it’s more than likely done with it’s spectacular period of rapid growth and has more or less hit it’s final plateau where it will increase slowly over the long run at a few percent a year - and that’s if everything is done correctly. Quite likely the company will lose many of its top employees and executives upon IPOing as they cash out and opt to work at smaller, more innovative companies at which they can again get access to equity at the bottom of this growth curve and increase its value at 100’s of percent points rather than the few measly percentage points that public companies are likely to expand at.

The real money being made right now is in private capital - investing in startups in emerging markets, hoping that one or two of these startups succeed wildly, and cashing out when they IPO. I wish I were an accredited investor so that I could get access to this. Come on JOBS act!

TL;DR: Most innovation is happening in small companies following a networked pattern rather than a top-down hierarchical pattern. The real money to be made is in private equity in these small growth companies. Once a company is public, it has more than likely already plateaued.

The corollary to this though is that some companies IPO, more than likely lose their top employees and executives, but then market conditions will change, or a new visionary leader steps on and sees new opportunities where the original management team had not looked, and is able to continue to grow the company rather than allow it to plateau as a vehicle to be operated, not a vehicle to be built. This does happen. This happened with Apple. And Google. It’s not the norm, but it does happen.

TL;DR: Find companies that are not just operating, but growing. Companies with second and third plateaus. Companies that are actively seeking out new markets.

The last things I’ve learned were that insider trading is not an especially good way of predicting what stocks would do at face value. For example, Google’s history is full of red insider sales, but this is due to the founders desiring to diversify their portfolios and have liquidity, not because they don’t believe in the future of Google. URRE, a declining and nearly bankrupt uranium mining company had an enormous insider purchase from one of it’s top 10% VC’s, yet this huge purchase in stock was no indication of it’s success.

Sidenote: I wrote this over a year ago before ACMP and AE hit their massive price jumps. In the cases of ACMP and AE, insider trading actually was a good indicator.

Small cap companies like URRE, AE, and ACMP can have their stock prices much more easily manipulated than large cap companies, because there is less volume. The insider purchase of a top 10% investor in URRE was actually not an indication that the investor believed the stock was valuable and a good investment, but rather more of a cash transfusion to give the company a last chance at surviving. It was somewhat similar to a VC giving money to 10 startups hoping that one would succeed. And I’ve also observed other penny stock companies’ executives doing strange trades in order to manipulate the stock prices and other weird accounting manipulations: executives and directors making purchases so small that they don’t matter immediately before making huge sales. It’s also important to take into consideration an insider’s portfolio when they make purchases or sales. Just because an insider makes a huge purchase doesn’t necessarily mean anything if it’s only .1% of their overall portfolio. Similarly, just because an insider makes a huge sale, it doesn’t mean anything. You really have to understand the logic behind the insider purchases, which is not always possible.

TL;DR: Insider trades require looking at the big picture: how large is the company, how does the purchase fit into the insider’s overall portfolio, what was their motivation for making the transaction? All things considered, insider trading is difficult and sometimes impossible to understand.

Another thing I’ve observed, but is so far inconclusive because I’ve only been investing for 8 months, is that the old mentality to go long-term and buy and hold is not as universally true as people make it out to be. It’s not a bad thought, and for many value-stocks, is probably true. If you’re saving for your retirement and nothing but your retirement, that may be true as well. But there are plenty of stocks that have not gained money or lost money over the long run, and the importance of buying the stock low and selling high seems to tremendously trump the notion that a valuable company’s stock price will continuously increase in the long run. Markets in all sectors are being toppled and innovation is creating new markets and destroying old markets like never before: the internet and the latest set of philosophies around research and innovation are changing the playing field in ways that are unlike things have been for the past 50 years. Also, the United States economy has peaked, in my opinion, and will continue to be surpassed by the developing nations. Our purchasing power will decrease in relation to the rest of the world, and our economy will plateau - this is on a broad, big-picture view, but generally speaking, I think this is going to be true. Because of this, the philosophies and strategies that our parents may have held for the stock market may not work quite the same for ours. Many of the philosophies will always hold true (buy low, sell high), but many also won’t (buy and hold), or at least won’t be as true as they once were.

TL;DR: The old idea of “buy and hold” is not as relevant as it once was, and generally speaking, we need to be aware and thinking critically of the current economic playing field. Things are different today than they were for our parents’ generation and we need to be aware that the strategies that held true for them may need to be adjusted for a changing economic environment.

Lastly, after all I’ve learned so far, the biggest takeaway here has been that investing in the stock market is nowhere near as lucrative for the average amature investor as people may make it out to be. Yes, it’s probably the best place to keep your money in the long run. And yes, it can be somewhat lucrative. But here’s the thing: for the amount of time, energy, and attention that you need to put into researching, managing, and monitoring your stocks, it’s not a very good investment. As a software engineer, I can make somewhere between $50 and $100 an hour. If I put in just 10 hours a week doing part time contract work, I can make $1000 a week or $4,000 a month. Let’s take one year of savings and see what I could make if I invested that in the stock market: $30,000. If I invested well and made 10% during that year, I could make $3,000 during that year. That’s a decent chunk of money. But in reality, that’s 30 hours of contract work. I’ve spent at least 30 hours this year reading up on the stock market, researching stocks, and freaking out about losing or gaining money. It was worth it this year, because this has been a huge experiment in learning where I accepted that I would (A) spent a lot of time learning something new and (B) probably lose a lot of money. I would have been far better off this year if I had placed all of my money into a mutual fund or ETF, let someone else manage my money, and focused on putting my time and energy into my career - starting my own company or selling consulting hours. Maybe I would make only 5-7% with mutual funds instead of 10%, but with so many hours spent not worrying and keeping up with the stocks, I would have made an extra $3,000+ and been able to invest that money. I’m extremely glad that I did spend the time this year learning about the stock market and investing, and I will continue to do it next year because it’s fun and because as I get better at it, I will not need to spend as much time thinking about it, but generally speaking, my new strategy will be to keep my money in mutual funds with the exception of when I see an exceptionally good investment opportunity and want to take a stab at it. These opportunities will be things like Google, where I hear about and interact with the company on a daily basis and do not have to waste any extra time or attention than my normal day-to-day life to keep up with them. These stocks are the kinds of stocks that make sense, and this is directly in line with the mantra that you should invest in what you are familiar with.

TL;DR: Investing is time consuming and for the average investor ($10-500k), it’s probably a better time investment to focus on your career and let a money manager (read: Mutual Fund/ETF) take care of your money than to spend your time researching stock opportunities. The exception, of course, is day trading, in which the stock market is your career. But day trading is an entirely different ball game than long term investing.

Don’t think too much about Seeking Alpha articles. They are generally correct, however, by the time you’ve read it, most changes that are going to happen to a stock’s price due to the whatever is discussed in the article have probably already happened. And even if they haven’t, a lot of Seeking Alpha articles are just opinions (as are much of any analysts essays and articles). Actually, for that matter, I wouldn’t recommend reading any content where stock market investors are the target audience. It seems that the correct way to approach investing is to be current with news that is relative to that industry, and to truely understand the industry, and how different variables in that industry interact, so that when things in the industry change, you know what the implications are. By the time analyst writings come out, the market has probably already priced in most of the change that the analyst’s recommendations are going to make, and it’s too late. On top of that, analyst articles are only able to see things from the perspective of company fundamentals, markets, and economics. They are unlikely to understand the true value or lack of value in a company and will not know a truely good product from a bad product.

TL;DR: Don’t get your news and opinions from analyst essays. Get your news from the industry itself.