Legendary investor Jim Rogers – who I spoke with earlier this year (you can read the full interview here) – co-founded the Quantum Fund, one of the world’s most successful hedge funds. After generating returns of 4,200 percent over ten years, Jim quit full-time investing in 1980.
He went on to travel the world a few times, and wrote a few books about what he saw and learned. Even if you’re not a travel or money junkie and know little about finance, these are some of the most educational and entertaining books you’ll ever read about investing.
I recently re-read parts of Adventure Capitalist, which Rogers wrote in 2003 after a three-year, 152,000-mile (244,600 km) drive around the world, and found a few lessons worth revisiting:
Value traps – and the ideal holding period for a stock
“I like to buy things and own them forever. And what success I have had in investing has usually come from buying stock that is very cheap or that I think is very cheap. Even if you are wrong, when buying something cheap you are probably not going to lose a lot of money. But buying something simply because it is cheap is not good enough – it could stay cheap forever. You have to see a positive change coming, something that within the next two or three years everybody else will recognize as a positive change.”
The perfect stock to buy is one that’s very cheap – and which appreciates steadily over time as the valuation becomes less cheap, and/or as the company grows. That might sound straightforward, but it’s not.
(A cheap stock is one that trades at a valuation level – for example, a price-to-earnings ratio or a price-to-book value – that is low, compared to the market as a whole, the sector, or a stock’s historical levels. Whether or not a stock is cheap has nothing to do with the absolute price of a stock. Shares that trade for hundreds of dollars can be very cheap – and a $3 share could be very expensive.)
There are a lot of ingredients to a stock’s valuation – and reasons why a cheap stock might be a value trap, and not be as cheap as its valuation suggests. Bad management, poor use of investment capital, assets that are delivering lower returns, and a company operating in a sector that’s in long-term decline are just a few of these reasons.
A value trap can stop being a value trap – and become an attractive, under-valued investment – if there’s a trigger for change. A change in management, a big change in the industry, higher commodity prices, a regulatory change – all of these things can turn a value trap into a great investment. Until there is, they’ll continue to be value traps.
When the best thing to do is… nothing at all
“The way of the successful investor is normally to do nothing – not until you see money lying there, somewhere over in the corner, and all that is left for you to do is go over and pick it up. That is how you invest. You wait until you see, or find, or stumble upon, or dig up by way of research something you think is a sure thing. Something without much risk. You do not buy unless it is cheap and unless you see positive change coming. In other words, you do not buy except on rare occasions, and there are not going to be many in life where the money is just lying there.”
One of the big advantages that individual investors have over so-called “smart money” is that they have the luxury of time. Unlike professional money managers, who earn a lot of their compensation based on the performance of their portfolios over short periods of time, individual investors can afford to be patient. You and I don’t have a boss demanding to know why we haven’t sold a stock that’s been flat… or that’s down a bit.
Of course there is still a very real opportunity cost to everything you own (we’ve written about this before). But unlike professional money managers with a twitchy finger on the sell button, we won’t lose our jobs if we accept the cost of opportunity.
That means that we can afford to wait for the big opportunity, as Jim says. Recognising that isn’t easy. But having the capital to take advantage of it is key.
These two ideas have worked very well for Jim Rogers. They should work for you as well.