Back in my younger days, when (I vaguely recall) I occasionally had spare
time. I used to go to the race track with some friends once in a while. These
guys were very up on horse racing, and I wasn't. I'd probably gone less than 1
time for every 20 or 30 times they had. But I used to give them fits because I'd
almost always win more money than they did, despite the fact that I could hardly
tell the front end of a horse from the back.
How did I do that?
The same way I pick stocks. I study the numbers real hard; then, I make
rational judgements about the probabilities of winning; then, I only bet when I
get a probability I like. Most of the time when I would bet, I would bet on the
third or fourth best-looking horse in the race. I'd look for horses that were
likely to go unnoticed because they had had a few bad prior races, where they
may have gotten "boxed in" and couldn't break clear, but that had
shown winning characteristics at some earlier time.
The upshot of my strategy was that I would win 2 or 3 races a night, but
they'd each have big payoffs, and I'd either break-even or win a lot of money.
This would drive my friends crazy because they'd study hard to find the best
horse every race, and they'd win 5 or 6 races in a night and either end up
losing money or winning only a little. They were betting on better horses, but
they weren't winning often enough to make up for the low pari-mutuel payoffs
because they were betting the same favorites as everyone else.
Once my friend Neil, in utter frustration said to me, "How could you
think that horse would win?" I told him, to his utter astonishment, that I
didn't think it would win. Then he said, even more incredulous and agitated,
"How could you bet on a horse you didn't think would win?" To this I
replied, "Well, does the fact that you think your horse is going to win,
make him win?"
It was a beautiful moment. His face went blank. It was a strange epiphany for
him. After a moment he said, very sheepishly, that no, it didn't. Then I
explained to him that it wasn't important to me to win races. I wasn't even a
racing fan. (In fact, I seldom even watched the races because I was busy reading
the stats for the next race.) My only interest was in winning money. And I
correctly gauged that you could win more money by getting 2 or 3 well-chosen
long-shot winners out of 10 than you could by hitting "chalk" all
Now, I'm much choosier about picking stocks, but there is a certain
similarity of attitude that I have which I believe holds us in good stead.
You've heard me say over and over again that the most volatile component of a
stock's price is market sentiment. A company's actual prospects change very
slowly and can be reasonably assessed, but the over-reactions of alleged
investors to a company's good fortunes or problems make stock prices swing way
out of line (in both directions) from its intrinsic value. When a good company
is having problems, no one wants to look at it; they want to go with the latest
winner. They want to put that next race under their belt and brag to their
friends at the cocktail party that they own XYZ Corporation, and boy is that
baby flying! We saw how those babies flew last year -- like the Hindenburg.
Me, I prefer the unloved companies with low market expectations. The ones
that have problems the JCPenneys, the Cendants, the Celgenes. When, after a few
months, Chicken Little discovers that the sky isn't falling after all, we cash
in. Just like at the race track, no one wants the third best-looking horse, even
though you get a much better risk-adjusted reward.
Three weeks ago, I recommended Celgene when it was $23. Our official
recommended price (the closing price on the first full day of trading after I
recommended it) is $23.95. Today, with the stock at almost $33, we are already
up 37%. We are also up 141% in JCPenney in just 6 months, 55% in Cendant in just
5 months, and up between 28% and 44% in 5 others. We have nasty losses in two
stocks of 22% each. All in all, we have 9 winners and 3 losers. Our portfolio is
up 27% in 6 months. Our average holding period for our stocks is 4.4 months.
Not that I expect our results to continue to be this good, but
theoretically speaking, our performance works out to be a 73% return,
That's not a bad day at the races.