Sosnoff's Law & Other Valuable Lessons
This past February, my newsletter, Capital & Crisis (C&C), hit its 10th anniversary. I let it pass without comment, because really, who cares? But a decade, more or less, is a good time to look back over the results. So I finally got C&C’s track record independently verified.
I want to share these results with you. I also want to share some things I’ve learned in those now almost 11 years that you might not hear elsewhere.
First, those results:
This table is from a report by Alpha Verification Services. The firm reviewed the performance of the C&C portfolio from its inception in 2004 to Aug. 31, 2014. The S&P 500 is a decent proxy for the market and serves as a good measuring stick. C&C killed it.
Now, the average holding period for a C&C stock is about 1.7 years. So the annualized results yield a return of 16% for C&C and just 5% for the market overall. We did it with a high batting average, too — 70% of stock picks wound up showing a gain.
The best ideas are often the simplest.
Given these exceptional results, what can I say about how they came about? I could write a book answering this question. Instead, I will to focus on a few quirkier aspects of investing. Things you might not think about.
Sosnoff’s law. This comes from a book called Humble on Wall Street, published in 1975 and still one of the best books on the experience of investing. Its author, Martin Sosnoff, wrote that “the price of a stock varies inversely with the thickness of the its research file. The fattest files are found in stocks that are the most troublesome and will decline the furthest. The thinnest files are reserved for those that appreciate the most.”
In other words, the best ideas are often the simplest. If I find myself working really hard to justify keeping or buying a stock, I think of Sosnoff’s law. This was not always the case. I’ve wasted countless hours on bad stocks that I should’ve just sold at the first sign of trouble or ignored altogether.
Many great investors have some version of this truism. (Peter Lynch comes to mind. “Never invest in any idea you can’t illustrate with a crayon.”) Simplicity is best.
Beware of “fixed ideas.” Max Stirner was a German philosopher who wrote a bombshell of a book published in 1845. English speakers know it as The Ego and His Own. It is a difficult book, but full of powerful concepts. Stirner contends that people do not have ideas. Rather, their ideas have them. These “fixed ideas” then rule over their thinking.
Stirner wrote that a thought was your own only when you “have no misgiving about bringing it in danger of death at every moment.” He actually looked forward to having his own ideas tested and knocked down:
I shall look forward smilingly to the outcome of the battle, smilingly lay the shield on the corpses of my thoughts and my faith, smilingly triumph when I am beaten. That is the very humor of the thing.
In markets, you see many people with “fixed ideas.” They are the ones that always recommend gold, no matter what. They are the ones always expecting the market to crash, forever obsessed with the Fed or the theories of dead economists. They are the ones always expecting the dollar to crash. They are the ones who can’t change their mind.
I have learned, painfully, to think like Stirner. I have no attachment to ideas. I have no problem changing my mind. In fact, I look forward to doing so, and actively try to poke holes in my own ideas and theories.
Be suspicious of abstractions. I here borrow from another favorite sage, that corncob pipe-smoking disheveled man of letters, Paul Goodman. “I can’t think abstractly,” he wrote. “I start from concrete experience.” He cracked that because he stuck so close to concrete experience, he “cannot really write fiction.”
People take easily, though, to big ideas. The New Economy. Peak Oil. The Chinese Century. The Great Moderation. All of these things are just abstract ideas. They are predictions about how the world might look. But they are far from concrete experience — and, hence, likely to lead you astray. And each of the abstractions I mentioned has led investors astray.
Ideas can come from anywhere. But my best ideas often come from people.
“Investment,” author John Train once wrote, “is the craft of the specific.” It’s about why A is a better investment than B. “It’s extraordinary how much time the public spends on the unknowable.” I’ve learned to identify and accept the unknowable. I’ve learned to distrust grand theories.
Investing is a people business. Early on, I relied on reported numbers and screened for statistical cheapness. I’d look for low P/E stocks, for example. Everyone can see these numbers. Yet these methods can still work well. Over time, however, I’ve learned that a good situation is worth more than any statistic.
A good situation is one where the story is not obvious from the numbers alone. Something else is going on in the business that makes it attractive. These are rare, but the rewards of investing with them are often great.
To find a good situation requires a lot of reading and networking. I talk to a lot of people in the course of a year — investors, executives, analysts and economists. Ideas can come from anywhere. But my best ideas often come from people. Hidden stories exist. And there is a person, somewhere, who knows that story. I want to find to those people and their stories.
I don’t know if I’ll do as well for you in the next 10 years as I’ve done in first 10. But I’m going to try. And I’m confident the lessons above will serve us well in the effort.
Ed. Note: Our sales guys would claim Chris beat the market by more than 300% consistently over a ten year period. And you know what? They’d be right.
Chris is the real deal. His ideas are sober and pragmatic. Even if you already value the advice you get from other sources, Chris Mayer can add a kick to your portfolio. He can help you take the pile you have… and make it bigger. If you value his contributions you’ll be doing yourself, your family — and your money — a favor when you subscribe to receive our daily e-letter — where Chris’ unique insights are regularly featured. In addition, each issue has exclusive market commentary you won’t find anywhere else. Click here to sign up now. Your regular issues will start hitting your inbox everyday at 4:00 pm.