Each of these methodologies works at some point. The effectiveness of value and growth strategies tend to alternate: One will be in favor while the other is out until they trade places. For one stretch of time, value stocks outperform. Then for another few years, growth will be stronger. Eventually, value will be back in fashion.
Whichever is in vogue at the moment, supporters of each will come up with all kinds of statistics that prove their method is the only way to go.
The same dynamic applies when it comes to fundamentals versus technicals. The technical analysts who read stock charts assert that everything you need to know about a company is reflected in its price and revealed in the charts. Fundamental analysts, who study the company's financial statements, maintain that technical analysis is akin to throwing chicken bones and reading tea leaves.
There are plenty of other methodologies as well. These include quantitative investing, cycle analysis, and growth at a reasonable price (GARP), to name just a few more.
Die-hard supporters of all these strategies claim that their way is the only way to make money in the markets. It's almost like a religion whose most fanatical followers act as if their beliefs are the only truth – period, no debate, end of story. They're right and you're wrong if you don't believe the same thing they do.
I'm no authority when it comes to theology. But when it comes to investing I know this: Dogma does not work.
You will not consistently make money investing only in value stocks. Again, sometimes they're out of favor. If you only read stock charts, sometimes you'll be wrong. Charts are not crystal balls. Quantitative investing tends to work until it doesn't. Just ask the investors in Long-Term Capital Management, which lost everything in 1998.
Long-Term Capital was a $4.7 billion hedge fund that utilized complex mathematical models to construct trades. It made a lot of money for investors for several years. It was supposed to be fail-safe. But like the Titanic, which was also supposed to be unsinkable, Long-Term Capital hit an iceberg in the form of the Russian financial crisis and nearly all was lost.
“Y'all Must've Forgot”
During his prime, legendary boxer Roy Jones Jr. was one of the best fighters that many fans had ever seen. However, Jones didn't seem to get as much respect as he thought he deserved. So, in 2001, he released a rap song that listed his accomplishments and reminded fans about just how good he was. The song was titled “Y'all Must've Forgot.” Roy was a much better fighter than he was a rapper. The song was horrendous.
Looking back, investors in the mid to late 1990s remind me of boxing fans in 2001, when Roy released his epic tribute to himself. Both groups seemed to have forgotten how good they had it – boxing fans no longer appreciated the immense skills of Jones, and investors grew tired and impatient with the 10.9 % average annual returns of the Standard & Poor's (S&P) 500 (including dividends) since 1961. After decades of investing sensibly, in companies that were good businesses that often returned money to shareholders in the form of dividends, many investors became speculators, swept up in the dot-com mania.
I'm not blaming anyone or wagging my finger. I was right there with them. During the high-flying dot-com days, I was trading in and out of Internet stocks, too. My first “10 bagger” (a stock that goes up 10 times the original investment) was Polycom (Nasdaq: PLCM). I bought it at $4 and sold some at $50 (I sold up and down along the way).
However, like many dot-com speculators, I got caught holding the bag once or twice as well. I probably still have my Quokka stock certificate somewhere in my files. Never heard of Quokka? Exactly. The company went bankrupt in 2002.
With stocks going up 10, 20, 30 points or more a day, it was hard not to get swept up in hysteria.
And who wanted to think about stocks that paid 4 % dividends when you could make 4 % in about five minutes in shares of Oracle (Nasdaq: ORCL) or Ariba (Nasdaq: ARBA)?
Did it really make sense to invest in Johnson & Johnson (New York Stock Exchange [NYSE]: JNJ) at that time rather than eToys? After all, eToys was going to be the next “category killer,” according to BancBoston Robertson Stephens in 1999. It's interesting to note that eToys was out of business 18 months later and BancBoston Robertson Stephens went under about a year after that.
If, in late 1998, you'd invested in Johnson & Johnson, a boring stock with a dividend yield of about 1.7 % at that time, and reinvested the dividends, in mid 2014, you'd have made about 8.6 % per year on your money. A $3,000 investment would have nearly quadrupled.
Johnson & Johnson is a real business, with real products and revenue. It is not as exciting as eToys or Pets.com or any of the hot business-to-business (B2B) dot-coms that took the market by storm.
But 16 years later, are there any investors who would complain about an 8.6 % annual return per year? I doubt there are very many – especially when you consider that the S&P 500s annual return, including reinvested dividends, was just 4.2 % during the same period.
Now, you might have gotten lucky and bought eBay (Nasdaq: EBAY) at $2 per share and made 16 times your money. Or maybe you bought Oracle and made five times your money. But for every eBay and Oracle that became big successful businesses, there were several Webvans that failed and whose stocks went to zero.
In the late 1990s, the stock market became a casino where many investors lost a ton of money and didn't even get a free ticket for the buffet. It doesn't seem that we've ever completely returned to the old way of looking at things.
My grandfather, a certified public accountant who owned a seat on the New York Stock Exchange, didn't invest in the market looking to make a quick buck. He put money away for the long term, expecting the investment to generate a greater return than he would have been able to achieve elsewhere (and possibly some income).
He was willing to take risk, but not to the point where he was speculating on companies with such ludicrous business ideas that the only way to make money would be to find someone more foolish than he to buy his shares. This is an actual – and badly flawed theory used by some. Not surprisingly, it is called the Greater Fool Theory.
There were all kinds of companies, TheGlobe.com, Netcentives, and Quokka, to name just a few, whose CEOs declared we were in a new era: This time was different. When I asked them about revenue, they told me it was all about “eyeballs.” When I pressed them about profits, they told me I “didn't understand the new paradigm.”
Maybe I didn't (and still don't). But I know that a business has to eventually have revenue and profits. At least a successful one does.
I'm 100 % certain that if Grandpa had been an active investor in those days, he wouldn't have gone anywhere near TheGlobe.com.
One principle that I believe many investors have forgotten is that they are investing in a business. Whether that business is a retail store, a steel company, or a semiconductor equipment manufacturer, these are businesses run by managers, with employees, customers and equipment, and, one hopes, profits. They're not just three- or four-letter ticker symbols that you enter into Yahoo! Finance once in a while to check on the stock price.
And these real businesses can create a significant amount of wealth for shareholders, particularly if the dividend is reinvested.
According to Ed Clissold of Ned Davis Research, if you'd invested $100 in the S&P 500 at the end of 1929, it would've grown to $4,989 in 2010 based on the price appreciation alone. However, if you'd reinvested the dividends, your $100 would've grown to $117,774. Clissold says that 95.8 % of the return came from dividends.3 (See Figure 1.1.)
Figure 1.1 1929–2010: $100 Original Investment
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