Save Your Short Game for Golf; Don't Use It to Invest
Jason is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you've ever played golf, you know that getting to the green is usually the easiest part. Within a few strokes, you can cover hundreds of yards, easily more than 95% of the distance to the pin.
Investing can be the same way. The long game is what happens after we've bought -- it's the waiting and watching, while the ball travels though the air, flying out over the nice, short grass in the middle of the fairway, or occasionally veering into the rough. Every so often, it hits a tree and careens wildly out of control, unpredictable and usually not ending up where we want. Sometimes it ends up in the water. Under water.
But most of the time, getting close to the green only takes a few strokes. But depending on the terrain we are in, and where the pin is placed on the green, it's easy to take just as many swings (or more) to cover that last 20 yards. And as investors, we deal with the same thing, but the difference is simple.
In golf, we have to take the swings to get the ball in the hole. As investors, sometimes the best thing to do is just leave our clubs in the bag.
What does that mean?
In golf, as in investing, emotion can ruin your game. Loss of focus and control usually leads to a bad shot. And sometimes that leads to a club following the ball into the water. Talk about putting good money after bad...
It's times of high emotion, much as in investing, that we typically lose focus and try to overcompensate for the previous shot. It's like trying to hit the ball over the water, knowing that your best shot will come up a few yards short. But you do it anyway, and there's your ball. Under water.
As investors, we do the same thing when we respond to share price movement or "the whisper," or try to time our buying and selling to how the market will respond to earnings announcements. We do these things despite the overwhelming data that shows us over and over how there is no predictability in the short term. Heck, the long term is hard enough.
Here's a good example:
Google (NASDAQ: GOOG) was moving toward earnings with rumors that the numbers might not live up to expectations. There were a number of articles written encouraging investors to short the stock. As you can see in the chart above, shares have risen over 7% in recent days, partially based on strong earnings. Here's another example.
Company A is growing at a 20% rate, shows earnings per share of over $13, pays a 2% dividend, is debt-free, and has increased cash on the books by over 30% in the past year. Its PE is around 11. Earnings are coming up, and expectations are tempered due to tightening margins based on a refresh of 80% of its product mix.
And the stock price for this cash cow is down nearly 30% from its recent high, just a few months before.
Company B is also growing at around 20%, was losing money as recently as last quarter, and carries an EPS of only $0.13, and has more debt than cash. Also, there's no dividend, and the PE is near 130.
Oh, and also note that the share price has already doubled in the past 6 months, mostly on rumors of a merger or buyout.
Which company would you buy the day before earnings are announced, and sell the day after?
Here's a chart to help you decide:
Okay, so predicting the short-term is hard
It's not just hard. It's risky, and frankly dangerous for most investors.
And as compared to golf, we don't have to play the short game to win. As close as we need to get is when we buy shares, as we are subjected to the volatility of the market and must act to invest. That's where smart strategies such as buying in thirds, or any other method of easing into your investments comes in to play.
The idea is simple: Chances are not very good (about 1 in 220) that you'll be buying shares on the lowest price of the year for any given stock, so by spreading out your investment, you have a better shot and getting the best price. Look at it this way: If you buy today and the shares do down, if you didn't spend all of your investment dollars at once, you have an opportunity to buy more. On the flip-side: If the price goes up, you got some at the lower price, and can add more at the higher price if the valuation still warrants it.
And unlike golf, if the market has priced the stock outside what you consider reasonable value, you don't have to buy. On the golf course, you still have to take the shot to score, and like investing, the more shots you take, the further behind it puts you.
So what's an investor to do?
It's simple, but sometimes hard for us to do. Let's use the three companies we've talked about in this article as examples:
Looking at the past 5 years, it's clear to see that all three of the companies, despite all of the volatility, have not only outperformed the market, but done so by considerable margins. And all three are at the center of a massive revolution with the way we interact with one another, entertain ourselves, gather information, and buy and sell things. In a nutshell, they are all right in the middle of a new world -- one that's easy to see gathering steam, and continuing to grow.
Additionally, by adding a measure of time to our investments, all of the daily, uncontrollable volatility gets smoothed over, and the best investments, tied to the best companies, performing in predictable, measurable ways, will reward us for years to come. Taking the risk of a small gain by trying to play short-term games, is small "f" foolish.
Foolish bottom line
Even if you've never played golf, there's a lesson here for us all. With investing, it's typically the actions that we take in haste, anger, frustration and panic, that cost us money. It's trying to compensate through action -- trying to time the market, or rushing to add positions in one stock that's dropping by selling shares of our biggest winners, only to see the loser keep falling and our winners go ever higher, instead of doing nothing and staying the course -- that costs us the most money.
Lastly, stick to your investing plan, and don't let emotion make you reach for your 7 iron, when the best thing to do is just head to the clubhouse and have a beer.
elihpaudio owns shares of Apple and Netflix. The Motley Fool recommends Apple, Google, and Netflix. The Motley Fool owns shares of Apple, Google, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!