A Guide To Eye-Watering Stock Market Returns

Investing is a difficult space. Investing your money requires a combination of analytical skills, strong psychology, emotional intelligence, and reasoning. One of the most important things I have learned over the years is that, to be successful, I must work within a structure that is my own. That isn’t just from the perspective of analyzing companies, but also from a psychological one.

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“Sounds like bull”

If the strategy that I am using at any given time makes me feel uncomfortable, I am bound to sell at the wrong time and for the wrong reasons – not to mention, it is going to be a drain on me throughout day-to-day life. In my past, I have experienced a variety of situations with an equally diverse set of reactions. I have lost money in strategies that left me with no concern on the strategy or the outcome.

In the situation in question, it pays to understand what I was doing. At the peak of the boom in oil prices, I would invest in 4-5 companies on the verge of drilling large wells. By working out the probabilities of success, the return in the event of success, and running through a simple Bayesian decision-making process (a way of valuing multiple uncertain outcomes), I had confidence that the results were heavily skewed in my favor. In this strategy, there was always a chance that all wells could be unsuccessful, and I would lose 70-80% of my capital, but there was a much higher likelihood the gains would be well into the double digits or triple digits. Therefore, I felt comfortable in the situations where an individual stock would drop 70% on a bad result – the good wells would make up for the poor ones.

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The important takeaway is that I developed a strategy for myself, back-tested it, and executed according to a plan. If wells were successful, I sold on the hype, if unsuccessful, I sold out – either way the decisions were pre-made. The emotion was not part of the process. This became impossible to execute as oil prices faltered. Afterward, I set on to the next strategy.

I applied a nearly identical approach to tech companies, with short-term spectacular results. However, as I became more aware how little I truly knew about these businesses, my trust in my rigid principles failed. It was no longer clear when to sell and when to buy. Much of the decision-making process was left up to me on a day-to-day basis. And, on a day-to-day basis, people are more likely to follow their recent psychological feelings than the overall plan. As feelings and emotions began to choose when I bought and sold, I started to lose money. As more money was involved in the strategies, it was harder to ignore the extreme volatility my portfolio experienced. I proceeded to underperform for a few years. Herein lies what I view as the most important part.

Remove Emotion From The Equation

One of the keys to self-directed investing is to find a way to remove emotion. For some people this is easy, and for others, this is tough. If you can’t do this, then you likely should not be managing your money. I have converted over time to something of a value investor, although I am still happy to take significant risks with high prospective returns. In using money that I am prepared to lose, and comfortable without, I can take these risks. Looking at the probability of success and the expected returns, I can value a company based on an uncertain future event; exactly as I had been doing with oil companies.

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“May I say that I have not thoroughly enjoyed serving with humans? I find their illogic and foolish emotions a constant irritant.” – Spock

Investing Where No One Else Will

A recent case of this I can describe is on my views of copper. It was easy to back-test this on previous cycles without much effort. Of all commodities, copper is the one I am most confident of a coming bull cycle – despite the timing being difficult to nail. My favorite investment is one that many wouldn’t touch (something the price reflects), and for this reason, it is so attractive to me (have a read here).

I see it as readily apparent that we are moving to a copper shortage, the current surplus is unlikely to survive past 2018, and for many reasons could end sooner. While I remain reticent of confirmation bias, I still feel the odds are skewed in my favor. If I’m right, and if copper heads to $3.00/lb, this investment will pay many multiples, if it reaches previous highs, the returns will easily be over 1000%. Now, this might sound like someone just trying to make a quick buck, but for me, it is a quantifiable scenario. To be sure, the probabilities I assign to the different outcomes is uncertain in and of itself, but some sound reasoning and conservatism can balance out that uncertainty. It can’t go unmentioned there is a very real chance this investment goes to zero in the next few years – something I am completely fine with. Higher returns are almost always accompanied with increased risk.

These types of situations are exactly what I hope to find. In a very Yogi Berra fashion, I find myself more comfortable buying when it almost sickens me to do so. When everything looks bad, when debt seems insurmountable and macro factors were in every way against a company, I want to buy. The trick is always to get the timing right. These are the investments that can make eye-watering returns. If you do it right, you create a strategy, and you follow through, it is one of the few ways to not only beat the index, but shatter it.

“It’s tough to make predictions, especially about the future.” – Yogi Berra

When A Strategy Fails

The tricky part is to stick to a strategy such as this. I wouldn’t recommend this to everyone, but it is one of the few ways of making eye-watering returns. To do this, you need to be comfortable with the idea that this money may be gone. I utilized funds that are not earmarked to retirement savings or otherwise, and as the gains pile up, I can use successfully larger chunks of money. I think of this method as a high watermark. I start a new strategy with a small portion of my investable capital. As the approach makes more money, I allocate a greater percentage of capital from the earnings.

Conversely, if the strategy fails initially, or starts to fail during the process, I abandon it and allocate no more money to it. This method forces me to adapt to market conditions as they change. I also remain cognizant of the fact that luck may have played a significant role in my successes – surely enough luck makes up a portion of many outcomes in life. I have been at the game for less than a decade and only have a few data points. Time will tell how much of my experiences have been saddled with luck.

Wrap-Up

Investing in this style is difficult. It requires a mountain of research and the confidence that comes with it. And, while making moon-shot investments with ridiculous returns is rare, it can transform your returns over time. However, it is far from a strategy for everyone; it requires patience, confidence, and an almost complete indifference towards losing the money assigned to it. That being said, it has worked for me for many years, and I am certain it will do so again.

Opportunities, as I have described, do not always show up in the same place, and usually, exist for short periods – after executing these strategies three times and succeeding twice, I remain hesitant. Currently, I am looking at my fourth. Applying the same principles, understanding what drives human behavior, and being willing to buy when everyone else can’t sell quickly enough will often bring about rewards when the proper time is invested. It may sound like gambling, but to me, the odds are in my favor. I hope I can continue to find such opportunities.

The idea for this article came after a recent interview I did with Brian Bain over at Investor In The Family. Check out the podcast below. It’s a podcast for anyone in the investing space, and provides directly applicable insights from hedge fund managers and financial writers.