The Diamond Hands Myth | Erik Averill, Brandon Averill, Justin Dyer | AWM Insights #78
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Episode Summary
Is picking individual stocks a good investment strategy?
Yes, if you like not being compensated for a lot of risk…No, if you want to have an actual investment strategy.
While a case could be made for individual stock selection 50 years ago, in today’s information age, any edge investors may have had decades ago has been eliminated.
In this episode, Erik, Justin, and Brandon highlight the fallacies around having “diamond hands,” and being able to consistently pick the best performing stocks.
Episode Highlights
1:02: The news you should know: El Salvador now recognizes Bitcoin as legal tender, but Bitcoin has not performed as well as expected since then.
02:25: Markets have been a bit rocky as many investors get cautious around additional market highs. The surge in the Delta variant could also be priced into investor hesitation.
03:02: It’s not out of the ordinary for markets to see corrections – it’s actually healthy. What is abnormal is perpetual all-time highs.
04:28: It’s still commonplace for investors to pursue finding the best individual companies to invest in. Wall Street has made a killing off selling which company stock is “hot.”
05:25: While individual stock selection has cemented itself as the default investment strategy for most investors, it is a horrible strategy when looking at the risk you’re taking.
06:16: Individual stock selection was easier 50 years ago when investors could gain an edge by digging through financial statements that were not as easily available to all participants.
08:40: Everyone wants to pick a home run, and the lottery fallacy says that if I get one selection right, I’ll be compensated for the losses I incurred waiting on my “home-run pitch.”
12:28: If I play the individual stock selection game, what I’m really saying is I know something about this one company that no one else knows.
14:48: There’s no real information advantage in the public markets, but there is certainly an edge to be had in the private markets.
18:39: Even with private investments, we still need to stick to the fundamentals.
20:06: If we can’t predict the future, then having a strategy that’s not predicated on predicting the future (individual stock selection) is essential. I have to be confident in my decision-making philosophy and stick to it.
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+ Read the Transcript
Erik Averill (00:00):
Hey, everyone. Welcome back to another episode of AWM Insights. We are your hosts, Erik, Brandon and Justin, and each week we cut through the noise of what Wall Street is selling you to bring you the knowledge, the skills, and the access to the information you need to invest like a pro. Picking up on our conversation from last time around what really drives returns, that risk and return are related, we want to dive into a subject that is something that mystifies the individual investor and we see it as really probably the biggest hurdle to success for the amateur investor, is the desire to want to buy individual stocks. This belief that they have some special way to figure out what is going to be the next Apple, the next Amazon, the next Google. So we are going to dive into that topic, but before we do, as always let's find out what's been going on in the markets.
Justin Dyer (01:02):
All right. So, a somewhat busy week on the news front, the Chinese government continued its attack on their corporate sector, really honing in on celebrities and their affiliation with some companies. So, interesting to see that whole story and regulatory environment really unfold. I mean, and as we've touched on a couple of times, that really underscores this whole concept of risk, out of the blue, that the playing field has changed for companies there and investors really, at the end of the day. El Salvador, big news now recognizes Bitcoin as legal tender. Officially, what was it, Monday of last week, I believe is when it went into effect. A little bit of a rocky rollout and Bitcoin has not performed since then, we'll see how that all unfolds, but definitely something interesting to keep an eye on.
Brandon Averill (01:57):
It's also a little akin to Arizona. Now you can legally bet sports here in Arizona and I'm on location today, so I'll try not to become a total degenerate. But ruining lives of many sports addicts, I think here in Arizona, I'm hopefully not doing the same thing with all the crypto crazies down in El Salvador.
Erik Averill (02:17):
And now we are generating revenue for the state. So, it's the individual or the state, who's more important? I mean, come on.
Justin Dyer (02:25):
There you go. And from a market standpoint here in the US especially, it's been a little bit of a rocky week, so markets are set to end as we're recording this, on a down note. A lot of participants are getting a little cautious around additional market highs. We've touched on that, can't really make investment decisions solely based on that, but certainly some recalibration going on with market and growth expectations as Delta, the Delta variant surges throughout a lot of the country and the world. So, we'll see how that all unfolds.
Erik Averill (03:02):
Which I think a quick note, we're not going to spend time on it, but this is not abnormal in the history of the markets that we see corrections. These are actually expected and very healthy. What is abnormal is to see all-time highs every week in perpetuity. So, it's interesting that people are getting scared by something that if you actually just know the history of the markets and you know the evidence, this would be like an athlete panicking because Mike Trout struck out one time. It's like, well yeah, the guy's going to strike out, this is a normal part of the game.
Justin Dyer (03:34):
It's a great point and I'll try and link to this in the show notes, but we have been in one of the top, I think it's the top 10, periods of a lack of a correction of greater than 5% in the market, really. So, I think it dates back to the, I want to say summer of 2020. So it's been a long stretch where there has been very little volatility in the market. So exactly to your point, it's expected to have a little bit of a rocky week and even expecting more. It's definitely healthy.
Justin Dyer (04:07):
Moving on, Facebook and Ray-Ban partner up to make a smart sunglass, reminds me back to the good old Google Glass days. Not sure exactly what happened to that project, but hey, they're taking a shot at it and we'll see how that all unfolds. I think those are the main items, so let's turn to the main topic of investing in individual companies.
Erik Averill (04:28):
Yeah and why we're excited to have this conversation, is this is something I even think back to being a kid and when my dad talked to us about investing, trying to teach us about it, is you read The Intelligent Investor by Benjamin Graham, and you hear about Warren Buffett picking individual stocks and there's this belief that says, "All right, the way to participate in the investment markets is to try and find the best companies." So whether it's the famous names that we all know of, the Google and the Amazon and the Facebook, is really the way in which I invest is how do I do my analysis on which companies are going to do well and pick these individual stocks? Our time on Wall Street, this was the sales playbook they gave us as brokers, is saying, "Go out and sell to these investors that we've got the hot tip on the X, Y, Z stock of the future."
Erik Averill (05:25):
So, I think for most people listening in, the default when you think about investing, is picking individual stocks. So, spoiler alert for the audience in case you don't listen to the whole thing here and you have to pick back up, is picking individual stocks in the public markets is completely horrible for your returns. You're introducing risk that you are not being compensated for. So, the short answer is this is not in your best interest. No professional actually picks individual stocks because they know they're not going to get compensated for the returns. We'll dive into the private markets as well but Justin, I'd just love for you to start with talking about why is picking individual stocks, not the best solution?
Justin Dyer (06:16):
Sure. So, I mean, I think the short answer is that we're so lucky to be investors in this era, let's call it, because access, data, I mean just pure efficiency in investing your money, is at an all-time high. So maybe, 50, probably 60, 70 plus years ago when Benjamin Graham was an investor, when he wrote his book, when Warren Buffett even got started, there was probably a more compelling argument to talk about individual stocks, because there was an informational arbitrage. You knew something or you could find out, you could gain an edge, versus other investors and that's what Benjamin Graham really tried to seek to do.
Justin Dyer (07:06):
Fast forward to today, that edge is all but non-existent. People continue to try and find it and some people think that they can. If you can, hey, more power to you, let's start a company together. But really at this stage, we just have the quality of data, the experience, looking back over markets over the last 20, 30, 40, 50 years in many cases. To your point, all of that just tells us that investing in individual companies introduces risk to your investment portfolio that you're not compensated for.
Justin Dyer (07:46):
In fact, it can introduce risk where not only are you not compensated for it, but it can really set you back in terms of what your overall goals are and what you're seeking to accomplish by becoming an investor, by investing in the market. So, it's really just, hey, we're in a ... Like I said, we're super lucky to be investors right now. We can get access to the markets in an incredibly efficient way. We can get compensated for taking known risks and have a much higher confidence in our investing outcome as a result of all of this stuff. Whereas again, going after individual companies, I mean, you're just introducing risk that you can't fully quantify and you can't fully build a plan around really, at the end of the day.
Brandon Averill (08:40):
Yeah. I think it's probably a little bit of this lottery fallacy as well. We all want the big hit. So I think we're drawn to these. We want the company that's all of a sudden begin to explode and we're going to participate, but I think it all goes back to the evidence and we keep going back to this. To analogize to baseball for instance, if I'm a hitter, and the guy I'm facing throws 90% breaking balls but I'm a dead red hitter, I'm going to sit there, I'm going to sit fastball so I can hit the home run, that's not a good outcome. That's not leading to a good ... Now, he may happen to get a wild hair and try to sneak one past you and you're going to square that up and you hit a home run. Well, that's great but over the course of a season, if you're taking that approach, the odds are stacked against you.
Brandon Averill (09:28):
Same thing goes with your money. We know this from the evidence, that even the guys that show up every day with all their Bloomberg screens, and they've got all the research, and they've got the quickest information they possibly can have, those guys and gals are not successful at picking individual equities. We know that. The data, the DALBAR Studies, et cetera, show that year in and year out, especially when you take survivorship bias, so actually who's still in business over long periods of time, it's pretty dismal of the people that are out there trying to select companies, trying to use their crystal ball to create returns. So, I think that's the big ... Yes, can you get lucky, could you pick the right company that happens to explode in the current moment? Sure. Over the long period of time, as you invest, the odds ... It's the casino deal, do you want to be the house or do you want to be sitting at the table? We all know that you'd much rather be the house in that scenario.
Brandon Averill (10:25):
So I think it's going back to the evidence and just stacking the chips. So many people that have already built wealth, you've already won the darn lottery. Why are we trying to win it again? Take the odds, put them in your favor, create lasting generational wealth instead of trying to get this, get rich quick scheme that everybody wants the pill, it doesn't exist. I think everybody knows that.
Erik Averill (10:45):
And Justin, before you jump in to maybe going into the more technical side, one of the things I think is helpful is to take a step back and actually recognize the game in which we're playing. So when we talk about investing in the public stock market, how is the market structured? Once again, the public stock market is just a location, that's all it is. It's a location, just like a farmer's market, that you are going to show up and instead of buying pieces of fruits or vegetables, or arts and crafts, you're buying pieces of companies. But what the government is recognized as saying is, is that we want everybody to be able to participate. So this is like a public golf course. If you've got the 30 bucks, you can go down to the muni course, regardless if you are Jordan Speith, or you're a hack like me, you get to participate.
Erik Averill (11:40):
I give you my 30 bucks. They say, "Great, go enjoy your 18 holes." And then if they're holding a tournament, what do they do? They have handicaps. So guys like my dad, who I love to death, but thinks he's a pro golfer. He's like, "I'm pretty good. I'm a four." Well, guess what? You're not Jordan Speith, but in a tournament, they equalize everything so that there's no unfair advantage, is everybody comes in with a handicap to make sure that everybody has a fair chance at winning. In the public stock market, the rules are everybody gets access to the same information at exactly the same time. Therefore, if you trade on information or you make investments on information somebody else doesn't have, or beforehand, it's called insider trading and you get fined or you go to jail.
Erik Averill (12:28):
So in this situation, you have to ask yourself if I'm picking an individual stock, the thesis in which I'm saying is okay, the same information that everybody else has, I somehow see something that nobody else on the planet sees, and you're not investing against Joe Q down the street, you're investing against Justin, the CFA and all of the other intelligent millions and millions of people that came out of these elite schools with all of these educations who also spend 40 hours a week, 52 weeks out of the year on these specific stocks.
Erik Averill (13:01):
So if you're picking an individual stock, what you're saying is, is you are smarter than everybody else on the planet. So if you're that person great, call me, let's start a company but if you're not, look at the evidence and actually capture the returns that you deserve.
Justin Dyer (13:15):
Yeah. I mean, it's a great insight right there. It reminds me when I was really young in my career, I was at a conference and there was a portfolio manager there, I can't remember what company he was with, but it was actually a company that participated in this active management game, so to speak. But what he said while he was sitting up there on the panel, he said ... They were talking about Apple or some large company at the time and he's like, "Yeah, it's an interesting question to ask yourself. Why do I think I have any unique insight into the valuation of Apple," let's use that as an example, " ... versus the millions of others who are investing in Apple at the exact same time and add to that probably a hundred plus analysts that also have some insight. They're listening to the earnings calls and potentially having conversations with leadership outside. So why do I think I have an edge on any one of those people?"
Justin Dyer (14:18):
Really at the end of the day, if you ask yourself that question, you're probably going to say, "You know what? I don't." Maybe you think you do, and you get lucky, though that will happen, to Brandon, your point, anomalies exist in the market, but they are incredibly hard to spot beforehand and replicating that as an investment strategy has no merit whatsoever. You're just going to end up chasing your tail and then, whatever, five, 10 years down the road, you're going to be like, "Oh well, I missed out on a ton of returns and upside."
Brandon Averill (14:48):
Yeah, no doubt. I think, when we've about this before the place, that information advantage does still exist is the private markets because that regulation doesn't exist. We are allowed to have information that other people don't have. I think that's an important point too, because we often see these opportunities that pop up for a lot of our clients. It's like, "Hey, invest in this spirits company, or invest in this marketing company," et cetera. And it's like, "Okay, great. Let's go gather the information that we can gather that maybe somebody else doesn't know, so we can make an educated decision on whether we should advise our clients to invest in these companies." I think that's the key, can you get the information? We just happened to see an opportunity recently, pretty good previous founder, took a company, sold it, bunch of money, et cetera. We call the company, "Great, your new venture, this sounds really interesting. Why don't you send over the data room, let us take a look at the information?" "Oh, we're not giving any of that out. All you get is a private placement memo." We went to our venture partners, they just started laughing like, "Who in the heck in their right mind would actually put dollars into something that the founder and the executive team won't allow you to gain that information advantage. Why would you ever do that?"
Brandon Averill (16:09):
So I think again, it's taking that question and saying, "Okay, how do I get my advantage in this situation?" If people aren't going to be forthcoming with information, you don't have your advantage, you should pass. If you get that information, then maybe it's worth considering. I think in that too, and you could probably hit on this, Justin or Erik is the back to that single company risk. Even in that scenario, you're going to get this information advantage. You're not going to take your whole nest egg, or you're not going to take a big chunk of it and throw it at one company. I mean, that Andreessen and Excel and all these huge venture firms, they would never do that. If they would never do that, why in the heck would you do that as an individual investor? Maybe you guys can hit on that.
Erik Averill (16:52):
Yeah and here's where I think we have to take a step back and recognize who we are as humans and why investing is so difficult to be successful at, just like so many other things. So you, as the listener, think about what you do day in and day out, and who are the best in the world at that given thing? Very rarely would it be based off of emotion, without little information or little worker diligence in that.
Erik Averill (17:19):
So there is something that is inside of me, where I want to make money. I want to feel like I'm the one guy who happens to have this information, or I don't want to get left behind, that fear of missing out that, "Hey, this deal, somebody sent me this opportunity to be in this deal." And I feel like I'm dumb if I don't invest in it. When in reality, when you take a step back at what the professionals say is like, "Hey, this could be a good idea." What are the fundamentals? What do know actually leads to success? It's in the sports world, there's all these analytics. More information isn't always just better. There's not always this new thing under the sun.
Erik Averill (18:01):
It's a fun conversation we were having with multiple time All Star batting champion, and we're asking him, "Hey, what's one of the biggest things you've learned in your career." He goes, "You know what? I had another guy tell me, 'Just focus and catch the ball.' " We were talking about sometimes the fundamentals, this is what works. It's not the shiny, fancy thing.
Erik Averill (18:25):
So I just, going back to Brandon's point, the professionals rely on evidence. It's not emotion. It's not a, "I think this is going to be a good idea." It's literally, what is the probabilities? What is the evidence that's laid out?
Justin Dyer (18:39):
Yeah and to add to that, it's having a plan that reflects all of that. So let's go to the example, Brandon, that you were talking about. That company might hit a home run. It might double, quadruple, whatever. You have to be okay with that and understand, "Hey, I stuck to my plan. They didn't give us information. I had no ability to determine in a prudent manner, whether or not that company was set up to succeed." It doesn't mean it's not going to succeed. I think it's really important to underscore that, but it doesn't align with our plans and the rigorous nature in which we've built that plan, that's based on everything we're talking about here. What does the data stay? Do we have access? Do we, do we have a high level of confidence that we believe in the management team? We're talking private market investments here, we believe in the management team, we believe in the industry or the space that they're trying to build this company within.
Justin Dyer (19:34):
Then same thing on the public market side. Does the data support picking individual stocks? No, it doesn't because you're not compensated fairly for it. So, let's participate where we are. Let's get efficient access to those markets, get the returns we deserve and set ourselves up for success over the long term, the multi-generational approach that we're always talking about. I think it's really important to underscore that. The companies that you pass on could be successful, that does not mean you made a bad decision.
Erik Averill (20:06):
Yeah. I think the analogy once again, sticking to that plan is a hitter. If you know what you're trying to do and you stick to that, you might strike out every once in a while, but over the longterm, you know what your skillset is, your outcomes are going to be better. It doesn't mean that you aren't going to experience some negative results, but over the long term. And that's what we're talking about, is multi-generational wealth and the way to build that, we know it's a very straightforward plan, very difficult to implement because it requires your discipline. It requires you to actually go against the herd, to go against the masses, the everyday amateur that is all the media and talking about in the locker room or at your company. But it's you sticking to this plan and this is what the evidence says, is it says that you've already worked really hard for your money. You've done the hardest thing. You've put the work in. You've converted it into a financial asset. Now, stack the chips in your favor, look at the evidence and say, "In the public markets, I know I need broad global diversification that we're going to tilt to the factors that actually are these drivers of returns. I'm going to avoid the potholes of thinking that I can pick individual stocks or individual sectors because that's actually going to cost me money."
Erik Averill (21:24):
And then if I want to, and I have the ability in it is prudent based off of my priorities then I can try to capture the bigger returns, the outsized returns. I'm going to do that in the private markets, but I'm also not going to just go to anybody in the private markets. I don't want to join any country club. I know that returns only exist at Augusta, going back to that analogy, the top 10 decile firms in venture. If it's not coming from them, you should pass go because they said no already. So, put the chips in your favor #and until next time, own your wealth, make an impact and always be a pro.